United States

Spending legislation clarifies and modifies partnership audit rules

Cooperatives pass-through deduction modified by spending legislation

TAX ALERT  | 

The recently enacted Consolidated Appropriations Act, 2018 (H.R. 1625) (CAA), along with providing funding for the government for the remainder of the fiscal year, contains several changes to the tax law. Of particular interest for pass-through businesses are a series of technical corrections and clarifications to the new partnership audit regime, and an amendment to the new section 199A pass-through deduction for agricultural and horticultural cooperatives.

Partnership audit clarification

Established under the Bipartisan Budget Act of 2015, the new partnership audit regime provides a centralized approach for auditing partnerships. However, the legislation required clarification regarding several technical uncertainties. Largely following a technical corrections bill proposed in 2016, the CAA provides these clarification and corrections.

Among other things, the CAA modifies the scope of adjustments subject to the partnership audit rules by eliminating any reference to adjustments to partnership income, gain, loss, deduction or credit. Instead, the CAA changes the scope of adjustments subject to the new partnership audit regime to include “partnership-related” items. This includes, “any item or amount with respect to the partnership that is relevant in determining the income tax liability of any person, without regard to whether the item or amount appears on the partnership’s return […]”, including any imputed underpayment and any amount related to a transaction with the partnership. Overall, this change results in a significant broadening of the scope of adjustments subject to the new partnership audit regime.

In addition, the CAA sets forth requirements regarding partnerships choosing to “push out” adjustments to the audited partnership’s partners in a tiered structure, and includes provisions regarding alternative procedures to filing amended returns (so-called “pull-in”). Furthermore, the CAA also updates the “push out” regime to provide for net tax decreases to be taken into account by partners receiving push-out statements. Previously, only net tax increases were considered. Other clarifications include that the partnership audit rules generally do not apply to taxes imposed or required to be withheld under Chapters 2, 2A, 3 or 4 of the Internal Revenue Code, and that items of different character (i.e., capital or ordinary) may not be netted for purposes of determining the imputed underpayment.

Changes to Section 199A

The CAA also amended section 199A, enacted as part of the Tax Cuts and Jobs Act, to fix the so called “grain glitch” contained in the original legislation, which could have resulted in a lower tax bill for farmers selling their grain to cooperatives when compared to other businesses. In general, the CAA modified the deduction under section 199A for agricultural and horticultural cooperatives to instead provide a deduction similar to that under the former section 199 (Domestic Production Activities Deduction). Specifically, the deduction from taxable income is generally now equal to nine percent of a cooperative’s Qualified Production Activities Income or taxable income, limited to 50 percent of the cooperatives W-2 wages for the calendar year.

For those following the progression of the new partnership audit regime and the application of section 199A to cooperatives, the clarifications and correction contained in the CAA likely come as no surprise. Indeed, the provisions affecting the partnership audit regime closely follow those provided for both in the proposed 2016 technical corrections bill, and proposed regulations issued by Treasury, hopefully minimizing the additional time required to finalize said regulations. Similarly, a correction to the treatment of agricultural and horticultural cooperatives has been debated since the enactment of the Tax Cuts and Jobs Act. In any event, cooperatives and farmers affected, either positively or negatively, by the section 199A deduction generally believe this amendment comes as a workable compromise, and those partnerships and partners subject to the new partnership audit regime will likely welcome the long-awaited corrections and clarifications necessary to successfully implement the new regime.

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