Developing a uniform state approach to the new federal partnership audit regime

A new law and process for federal audits of partnerships will likely require states to consider legislation to amend their laws to ensure their tax agencies can administer their taxes under the new federal regime. With the many state tax issues involved, the AICPA is working with several other organizations to develop draft model state legislation (available at www.mtc.gov for reporting federal tax changes to the states, including the new partnership audit process. States are likely to consider this issue over the next year.

This column, the first part of a two-part discussion on state issues with the new federal partnership audit regime, discusses key issues states must consider and the steps some states have taken to align their partnership audit rules with the new federal rules. Part 2, which will appear in the March 2018 issue, will review the major points of draft model state legislation that the AICPA is working with other industry organizations to develop.

Starting with tax years beginning on and after Jan. 1, 2018, many partnerships will be subject to a new auditing regime Congress enacted as part of the Bipartisan Budget Act of 2015, P.L. 114-74, to improve the IRS's ability to audit partnerships. In June 2017, the IRS issued proposed regulations (REG-136118-15) to provide further guidance on implementing the new audit procedures.

On Oct. 7, 2016, the AICPA developed and submitted to the IRS and Treasury suggestions for guidance needed for implementation of the new partnership audit rules (the letter is available at www.aicpa.org.

On Nov. 17, 2016, the AICPA submitted to Congress suggested recommendations for technical corrections legislation (the letter is available at www.aicpa.org. On Dec. 6, 2016, the Tax Technical Corrections Act of 2016, H.R. 6439, was introduced in the 114th Congress with Title II containing technical corrections to the partnership audit rules, including several of the clarifications that the AICPA requested. The technical corrections legislation was not enacted before Congress adjourned on Dec. 9, 2016, but it is expected to be reintroduced and enacted in this 115th Congress.

In June 2017, the AICPA requested that the IRS and Treasury consider asking Congress to provide a one-year delay in the effective date of the new audit process because the regulations are not yet final and technical corrections are needed to address various issues with the legislation (the AICPA's letter is available at www.aicpa.org.

On Aug. 14, 2017, the AICPA submitted comments (available at www.aicpa.org on the proposed regulations issued in June 2017 and testified at the IRS hearing on Sept. 18, 2017 (the testimony is available at www.aicpa.org.

Practitioners should stay tuned for further developments with the new partnership audit procedures. The AICPA Tax Policy and Advocacy group will continue to monitor, comment as appropriate on, and keep members updated on future changes.

As discussed in the March 2017 State & Local Taxes column (see Sherr and Wlodychak, "State Challenges With the New Federal Partnership Audit Rules," 48 The Tax Adviser 202 (March 2017)), there are many state tax issues related to the new federal partnership audit process.

Of concern to the AICPA and other organizations is that not all states will respond in the same way as they address the new federal procedures. This will contribute to additional complexity in resolving audit matters when dealing with a partnership operating in multiple states.

States are starting to consider their own legislation, which would cause substantial variances across the nation. Arizona, however, is the only state to have enacted legislation thus far. One concern is that state attempts to adopt legislation similar to the new federal process could be constitutionally suspect. States have to consider issues such as a partner's state of residency and whether a tax is fairly apportioned—issues that are not of concern at the federal level. This means that any new state laws about adjustments from federal partnership audits will probably have to differ from the federal process in some ways, which is likely to impose significant administrative burdens on taxpayers and their representatives.

Numerous additional concerns exist at the state level. For example, partnerships and their partners will need to consider whether nexus existed in a particular state for the reviewed year versus the adjustment year. Resident/nonresident considerations may arise when individual partners move from one state to another between the reviewed year and the adjustment year. In addition, partners who made overpayments are likely to encounter statute-of-limitation issues when claiming refunds. Additional concerns, also raised by state tax administrators, relate to the increased compliance burden of filing amended returns and obtaining enough detailed information from the federal audit to make proper adjustments at the state level.

Some states are already addressing these issues, while others likely will start addressing them over the next year.

To date, Arizona is the only state that has enacted legislation in this area. S.B. 1288 was signed into law on May 11, 2016 (enacting Ariz. Rev. Stat. §43-1414). Arizona's legislation provides some insight on how states might address these issues, but it does not comprehensively address the federal changes and the state will need to address additional items such as tiered partnerships (presumably through its administrative regulatory process). Arizona likely will need to amend its enacted law to reflect the final IRS regulations as well as any statute changes in the possible technical corrections bill if it is ultimately enacted.

As of October 2017, four states (Georgia, Minnesota, Missouri, and Montana) have considered legislation this year, with Georgia enacting a bill that was revised to exclude the partnership audit provision that was in the original bill. The other states had not moved forward with the legislation as of October 2017.¹ All the proposals had different approaches and were not as comprehensive as the draft model statute discussed below and in Part 2 of this column in the March 2018 issue.

On Dec. 8, 2016, H.B. No. 47 was prefiled in the Montana Legislature for consideration during its 2017 legislative session. It would revise the state's laws for partnership audits and is similar in many respects to the legislation enacted in Arizona. On Jan. 11, 2017, the Montana House Taxation Committee held an initial hearing on the bill.² On Feb. 3, 2017, the bill was tabled in committee, and it died in the House. It is possible that the committee may instead consider a study bill that would require an interim committee to track the issue leading up to the 2019 session.

In Georgia, on Feb. 7, 2017, H.B. 283 was introduced and on Feb. 16, 2017, the Georgia House Ways and Means Committee passed and reported out to the Rules Committee a revised substitute H.B. 283, which did not contain the partnership audit provision that was in the original bill. On March 21, 2017, Gov. Nathan Deal signed the state's revised bill into law.³

On Feb. 15, 2017, H.F. 1227 was introduced in Minnesota.⁴ It is limited to partnerships that opt in early to the new federal regime and is only effective for tax years before 2018. The bill was revised to no longer include the partnership provision. The bill passed the state House and is now being considered in the Senate. It passed the state Senate Committee on Rules and Administration on May 19, 2017.

On March 1, 2017, S.B. 521 was introduced in Missouri. The bill provides that for tax years beginning on or after Jan. 1, 2018, a partnership that is audited by the IRS and is assessed an imputed underpayment must pay income tax on the adjustment rather than passing the adjustment through to each partner. The state would require the partnership to file a return for the reviewed year within 90 days after the final determination of the partnership adjustments by the IRS. The bill did not move forward in the state Senate Committee on Ways and Means when it adjourned on March 9, 2017.⁵

To study, analyze, and provide possible recommendations to assist the state CPA societies regarding state tax partnership audit issues, the AICPA formed a State Partnership Audits Task Force, which is made up of members with expertise in state tax and partnership tax issues.

In addition, the AICPA State Partnership Audits Task Force has joined with the Council On State Taxation (COST), Tax Executives Institute (TEI), the American Bar Association (ABA) Tax Section's State and Local Tax Committee, and the Institute for Professionals in Taxation (IPT) to form a joint multi-organization task force that is working together with the Multistate Tax Commission (MTC) on this issue and on draft model state legislation on adjustments from federal partnership audits.

In June 2017, the multi-organization task force developed and shared a draft model bill ("Model Uniform Statute and Regulation for Reporting Adjustments to Federal Taxable Income and Federal Partnership Audit Adjustments," the latest version of which, dated Sept. 27, 2017, is available at www.mtc.gov and presentation with the MTC Partnership Informational Project for consideration by the MTC Uniformity Committee at its Aug. 3, 2017, meeting, where the MTC Uniformity Committee decided to consider the full draft model bill submitted by the multi-organization task force as its drafting starting point.

As part of the MTC Partnership Informational Project, an issue list was developed and the multi-organization task force developed a comprehensive list of issues related to the impending changes and a checklist for partnership conformity. In addition, the MTC developed a comparison of the MTC issue list to the proposed Montana legislation.

The AICPA supports efforts by state CPA societies that want to work with policymakers for a fair, reasonable, and administrable state partnership audit process that minimizes the complexities and burdens to taxpayers and state tax authorities alike.

To assist in this effort, in March 2017, the AICPA developed and shared with the state CPA societies anAICPA position paper, State Conformity to Federal Partnership Audit Rules (available at www.aicpa.org, and a one-page summary on the issue (available at www.aicpa.org. While waiting until the federal rules are further clarified, state CPA societies should start analyzing the impact of the new federal rules on their current state partnership audit rules and developing options to address these issues. To assist in this process, the AICPA provided recommendations that state CPA societies may want to consider as they work with their state legislatures and tax authorities.

In addition, in March 2017, the AICPA developed and shared with the state CPA societies and the MTC a related issue paper, the AICPA position paper on RAR (revenue agent's report), Reporting to State Tax Authorities of Federal Tax Examination Adjustments and Their Effect on State Tax Liability (available at www.aicpa.org, along with a one-page summary (available at www.aicpa.org. Currently, there is no consistent method for reporting to state tax authorities federal tax examination adjustments and their effect on state tax liability. The states have not adopted a uniform notification period for reporting federal adjustments. This RAR issue is especially relevant due to the likelihood that states will consider changes related to the reporting of federal audit adjustments to accommodate the new federal partnership audit process.

The AICPA presented the AICPA RAR paper to the MTC Uniformity Committee at its meeting on March 8, 2017. The AICPA encourages state CPA societies to work with policymakers to adopt guidelines and procedures to provide taxpayers with certainty and consistency. The AICPA supports the draft updated proposed Model Uniform (RAR) Statute for Reporting Adjustments to Federal Taxable Income (available at www.mtc.gov that was submitted by the multi-organization task force to the MTC at its Dec. 14, 2016, meeting. The updated model RAR bill has now been incorporated into the draft model bill on partnership audits and RAR issues.

The second part of the column in the March 2018 issue will provide more details on the draft model bill on partnership audits and RAR issues.   

Footnotes

¹See Georgia (H.B. 283 and then a revised substitute H.B. 283 that did not contain the partnership audits provision that was in the original bill), Minnesota (H.F. 1227), Missouri (S.B. 521), and Montana (H.B. No. 47). In all those states, the state CPA societies were engaged in discussions on the bills and assisted with efforts to delay action until there is clarity at the federal level.

²The Montana Society of CPAs testified at the hearing. Information on the bill and hearing, including an audio archive, is available at laws.leg.mt.gov. See also the Multistate Tax Commission's comparison of its issue list to the proposed Montana legislation, available at www.mtc.gov.

³The Georgia Society of CPAs was actively engaged in discussions that resulted in the substitute House Bill 283, available at www.legis.ga.gov.

⁴The Minnesota Society of CPAs was actively engaged in discussions that resulted in the provision dealing with partnership audits being dropped from the bill.

⁵The Missouri Society of CPAs was actively engaged in discussions on the legislation, which is available at www.senate.mo.gov. The bill failed in committee on March 9, 2017.