Final regulations governing the new partnership audit regime issued
TAX ALERT |
Effective for tax years beginning on or after Jan. 1, 2018, a new regime for examining partnership tax returns and collecting any related tax—commonly called the BBA from the Bipartisan Budget Act of 2015 in which it was enacted—will apply, replacing the old process known generally as the TEFRA rules. After several false starts and guidance proposals, caused in part by the enactment of technical corrections to the BBA enacted earlier this year, final regulations constituting the bulk of the regulatory guidance to be issued around the BBA were published by the IRS and Treasury on Friday, Dec. 22, 2018. These regulations finalize the most recent proposed regulations issued by the IRS in August of 2018 (see prior alert). As these regulations are necessarily all encompassing, we aim here to highlight only a few of the most significant developments from prior proposals.
Most notably, the final regulations continue to narrow the scope of items that are subject to adjustment under the BBA regime. Earlier proposals had taken a very expansive view, such that virtually any item that is somehow connected to a partnership would be within the scope of the new rules. These final regulations instead limit the new regime to any item which appears (or should appear) on the partnership’s return, or is required to be maintained in its books and records. Explicitly, this does not include items which, under TEFRA, would be considered a partner’s affected items—a characteristic example of which is a partner’s outside basis in their partnership interest.
The final regulations also provide numerous revisions to the procedural rules for so-called modifications, by which a partnership that chooses to remain within the default regime of paying examination-related liabilities itself, at the entity-level, may seek to reduce that liability. In particular, the final regulations provide that this modification process, which takes place after the IRS has issued a Notice of Proposed Partnership Adjustment (a NOPPA), is the only guaranteed avenue by which the IRS will take into account any partner-level attributes that may reduce the entity-level tax below its theoretical maximum. However, the final regulations also make it clear that the IRS will not consider, at any point during the examination, and regardless of the collection alternative (entity-level tax or so-called push out) selected by the partnership, any partner-level penalty defenses (such as partner-specific reasonable cause). Rather, a partner who wants to assert a defense of this type must first pay the assessed penalty, and then claim a refund of that payment in an individual proceeding.
In lieu of paying the entity-level tax, a partnership may elect under the new rules to push out its adjustments to persons who were partners during the year under examination (the reviewed year partners). Although there are no restrictions on which partnerships are eligible to make this election, it will not be considered valid if the prescribed procedural steps are not correctly followed. In part, this includes providing accurate “push out” statements to the reviewed year partners. Under prior proposals, the IRS could invalidate a push out election because of a single error in a push out statement, without being required to offer the partnership an opportunity to correct the statement. Under the final regulations, the IRS will not invalidate a push out election because of an inaccurate push out statement, as long as the partnership corrects the error on its own initiative within 60 days of issuing the original inaccurate statement.
Although not addressed in the regulations themselves, the preamble does provide a window into the IRS and Treasury’s intent regarding access to the IRS’s Office of Appeals in the course of a partnership examination. Specifically, the preamble suggests that Appeals consideration would come prior to the mailing of a NOPPA. This would necessarily limit Appeals intervention to substantive issues relating to the partnership adjustments themselves, and not, for example, the availability of any modifications to the imputed underpayment (as those would not be dealt with until after the mailing of the NOPPA). Although Treasury has declined to provide explicitly for Appeals consideration in these regulations, they have indicated that subregulatory guidance to expand upon these procedures is forthcoming.
In addition to the above highlighted items, the final regulations revised proposed guidance in the following areas, amongst other:
- Procedures around partner treatment of an item that is inconsistent with the partnership’s treatment of that same item
- Computational issues with respect to interest and penalties, as well as the entity-level tax itself
- Guidance on what procedural avenues taxpayers must use to receive refunds from taxpayer favorable adjustments determined during examination
- Special rules for publicly traded partnerships, and certain special types of partners (including pass-through partners, regulated investment companies and real estate investment trusts)
- Rules governing when a partnership ceases to exist
Left for future regulations is the important question of effect of payment of the entity-level tax on other attributes of the partnership’s partners, such as their capital accounts or outside basis. As this may have an effect on how partnership agreements are drafted to anticipate this new regime, the lack of answers to these questions is significant. In additional, many of the practicalities of these regulations have been left open to be dealt with in sub-regulatory guidance. As always, however, it is impossible to tell exactly how procedural rules such as these will work until they are actually implemented, that is to say when examinations under the new regime commence. To that end, RSM will be monitoring activity in this area closely.