The IRS reissued proposed regulations (REG-136118-15) that implement the centralized partnership audit regime enacted by Section 1101 of the Bipartisan Budget Act of 2015, P.L. 114-74, and amended by the Protecting Americans From Tax Hikes Act of 2015, P.L. 114-113. The IRS initially posted these proposed regulations in January and they were scheduled to be published in the Federal Register, but they were never officially published as a result of the regulatory freeze announced by the White House on Jan. 20 (available at s3.amazonaws.com).
The reissued rules, which assess and collect tax at the partnership level, replace the cumbersome unified audit procedures that were enacted by the Tax Equity and Fiscal Responsibility Act of 1982, usually called TEFRA, and the electing large partnership rules. The new audit regime applies to partnership tax years beginning after Dec. 31, 2017, but partnerships can elect to apply them early. In a letter dated the same day the proposed regulations were reissued, the AICPA asked Treasury and the IRS to work with Congress to postpone this effective date by a year.
The new rules require that any tax due on partnership adjustments made by the IRS (the imputed underpayment) must be paid by the partnership. However, a partnership can elect to instead have the partners in the partnership tax year to which the adjustments relate (the reviewed year) take into account the adjustments made by the IRS and pay any tax due as a result of the adjustments.
Another change from the TEFRA rules replaces the tax matters partner with a partnership representative. This representative does not have to be a partner and may be any person with a substantial presence in the United States. The IRS may select any person as a partnership representative if the partnership does not have a designation in effect. The proposed rules explain how the IRS's designation works and prohibit the partnership from revoking the IRS's designation of a partnership representative without the IRS's consent.
The partnership representative may be an entity, but, if the partnership chooses an entity, the proposed rules require the partnership to identify and appoint an individual to act on the entity's behalf. The rules permit a partnership to designate a partner or a nonpartner, including the partnership's management company, as the partnership representative, provided the person otherwise qualifies. The proposed rules have detailed procedures for designating the partnership representative on the partnership's tax return and for changing it.
The proposed rules provide that the partnership representative has the sole authority to act on behalf of the partnership and all of its partners on the following matters: agreeing to settlements, agreeing to a notice of final partnership adjustment, making a Sec. 6226 election to pay the partnership liability at the partner level, and agreeing to a Sec. 6235 extension of the limitation period for making partnership adjustments. Even partners that have elected out of the centralized audit regime are bound. And there is no requirement that the IRS communicate with anyone but the partnership representative, placing the burden on the partnership to notify partners of any IRS proceedings.
Partnerships that are required under Sec. 6031(b) to furnish 100 or fewer Schedules K-1, Partner's Share of Income, Deductions, Credits, etc., and whose partners are individuals, corporations (including certain types of foreign entities), or estates can elect out of the new partnership-level audit regime. If a partnership furnishes more Schedules K-1 than required under Sec. 6031(b), any Schedules K-1 that are not required to be issued under Sec. 6031(b) are not taken into account when determining if the partnership meets the threshold. The proposed rules explain how to make the election out of the regime.
Special rules determine the number of partners when a partner is an S corporation. Under the proposed rules, the number of shareholders of the S corporation partner are taken into account in determining the 100-or-fewer threshold. Another provision counts partners who are married as two separate partners because Sec. 6221(b) does not require them to be treated as one partner.
The proposed regulations define the term "eligible partner" as any person who is an individual, C corporation, eligible foreign entity, S corporation, or an estate of a deceased partner. The preamble states that the IRS rejected suggestions made in response to Notice 2016-23 that the IRS exercise its regulatory authority to expand the types of entities that could qualify as eligible partners.
The proposed rules explain that the imputed underpayment is calculated by multiplying the total netted partnership adjustment by the highest rate of federal income tax in effect for the reviewed year under Sec. 1 or 11 (the individual or corporate rates). The product of that amount is then increased or decreased by any adjustment made to the partnership's credits. If the result of this summation is a net positive adjustment, the resulting amount is the imputed underpayment, and, if it is a net nonpositive amount, there is no imputed underpayment. The proposed regulations provide rules regarding the grouping and netting of adjustments in calculating the imputed underpayment.
The proposed regulations provide rules for multiple imputed underpayments. The preamble states that the option to create multiple imputed underpayments provides flexibility for the partnership, the partners, and the IRS to address fact-specific issues that may arise as part of the administrative proceeding at the partnership level.
Under the proposed rules, a partnership that has received a notice of proposed partnership adjustment (NOPPA) can request a modification, but only the partnership representative may do so. However, if the NOPPA does not have an imputed underpayment, the partnership may not request an adjustment. However, if the NOPPA sets forth an imputed underpayment, the partnership may request a modification for adjustments that do not result in an imputed underpayment.
These regulations are proposed to apply, when final, to partnership tax years beginning after Dec. 31, 2017 (which is the effective date of the centralized audit rules), and to partnerships that elect to have the rules apply early.
The AICPA's letter, signed by Annette Nellen, chair of the AICPA Tax Executive Committee, urged Treasury and IRS leaders to work with Congress to revise the Bipartisan Budget Act to delay the audit regime's effective date by one year, generally to apply to partnership tax years beginning after Dec. 31, 2018. Noting the rules' "significant departure from previous law," the AICPA argued that the short period between the scheduled hearing on the proposed regulations (Sept. 18) and the effective date as enacted leaves scant time for Treasury and the IRS to assess public comments and for taxpayers to make the many far-reaching decisions required. Moreover, the proposed regulations when withdrawn contained significant gaps, the AICPA said, reserving on critical questions, such as adjustments to partners' outside basis and capital accounts, as well as partnership basis and book values (which remained reserved in the reissued regulations).
Also, the AICPA said, accounting rulemaking bodies will need more time to resolve questions of accounting treatment of current assessments and potential future examinations and assessments under the new regime. The audit regime's coordination with those of state taxing authorities also remains unclear.
Finally, "virtually every partnership currently operating in the United States . . . regardless of size, will need to amend its partnership agreement" to reflect the new regime in numerous ways, as well as replace its tax matters partner with the new partnership representative, all before Jan. 1, 2018. "There is near unanimous agreement in the tax practitioner community that this time frame is simply not feasible," the letter stated.