Administrative adjustment requests under the BBA

Editor: Mary Van Leuven, J.D., LL.M.

The Bipartisan Budget Act of 2015 (BBA), P.L. 114-74, repealed the partnership audit provisions under the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) and introduced a new centralized audit regime for IRS audits of entities required to file Form 1065, U.S. Return of Partnership Income. The BBA procedures also fundamentally changed the process for amending Form 1065 and its Schedule K-1, Partner’s Share of Income, Deductions, Credits, etc. For tax years beginning in 2018, partnerships that are subject to the BBA regime and that seek to adjust an item or amount reflected on an original Form 1065 or Schedule K-1 must file an administrative adjustment request (AAR) under Sec. 6227. This item briefly summarizes the BBA rules, discusses the requirements for filing an AAR under Sec. 6227, and addresses the effects of filing an AAR on certain types of partners.

(Note that on April 8, 2020, the IRS released Rev. Proc. 2020-23, which allows eligible partnerships to file an amended return and issue amended Schedules K-1, in lieu of filing an AAR, for certain 2018 and 2019 tax years. Eligible partnerships must file the amended return by Sept. 30, 2020 to take advantage of this relief. See Rev. Proc. 2020-23 for more information.)

BBA overview

The BBA procedures generally apply to partnership tax years beginning on or after Jan. 1, 2018. Certain partnerships may elect into the BBA procedures for tax years beginning after Nov. 2, 2015 and before Jan. 1, 2018. (This election may be made in conjunction with filing an AAR under Sec. 6227.) As a default rule, the BBA procedures provide that the partnership, and not its partners, must pay any tax attributable to adjustments reflected on an AAR.

This tax amount is referred to as the “imputed underpayment” and, very generally, is determined by multiplying the total amount of netted partnership adjustments by the highest rate of tax in effect for the reviewed year (i.e., the year to which the adjustments relate).

The partnership may also elect an alternative to payment of the imputed underpayment by pushing out the adjustments to its partners with the result that the partners themselves would pay the tax attributable to any partnership adjustments. However, rather than reporting that tax on an amended return for the reviewed year, the partners would generally report the tax on their return for the year in which the partnership furnishes the push-out statements, described below, to its partners.

Requirements for partnerships filing AARs under the BBA

To file an AAR under Sec. 6227, a partnership may either file Form 1065-X, Amended Return or Administrative Adjustment Request (AAR), or electronically file Form 8082, Notice of Inconsistent Treatment or Administrative Adjustment Request (AAR), with an accompanying revised Form 1065. Because the current version of Form 1065-X cannot be electronically filed, the partnership must use Form 8082 to file the AAR if the partnership was required to electronically file its original Form 1065. Depending on whether the partnership is pushing out the AAR adjustments, the partnership may also need to file as part of the AAR a Form 8985, Pass-Through Statement — Transmittal/Partnership Adjustment Tracking Report, in addition to a Form 8986, Partner’s Share of Adjustment(s) to Partnership-Related Item(s),for each of its partners that is required to take into account the AAR adjustments.

An AAR must be filed by the partnership representative (PR) for the partnership. If no PR was designated on the original Form 1065, one will need to be identified using Form 8979, Partnership Representative Revocation, Designation, and Resignation Form. The partnership may also use Form 8979 to revoke the current PR and designate a new one. An AAR may be filed for a tax year only if the partnership has already filed an original partnership return for that year. The partnership generally must file the AAR within three years of the date the original return was filed or the due date of the partnership’s return (excluding extensions), whichever is later. Once the IRS mails a Letter 5893, Notice of Administrative Proceeding, with respect to a tax year, however, the partnership generally can no longer file an AAR for that tax year. Unlike AARs filed under the TEFRA procedures, and also unlike amended returns filed by taxpayers not subject to the BBA (e.g., Form 1040X or Form 1120X), the filing of an AAR by a BBA partnership restarts the statute-of-limitation period for the IRS to make adjustments to the tax year affected by the AAR for all items with respect to that tax year.

A partnership filing an AAR must determine whether the adjustments requested to the original return result in an imputed underpayment. This determination is made on an item-by-item basis, and netting of most adjusted items generally is not permitted. Very generally, “positive adjustments,” i.e., adjustments that increase an item of income or decrease an item of deduction or credit as reported on the original partnership return, will be netted to arrive at an imputed underpayment amount. Negative adjustments, i.e., adjustments that increase a deduction or credit amount or decrease an amount of income, generally will be adjustments that do not result in an imputed underpayment.

If an adjustment to the original return results in an imputed underpayment, the partnership must pay the imputed underpayment when it files the AAR or, alternatively, may elect to push out the adjustment to the partners from the reviewed year. If paying the imputed underpayment, the partnership may use authorized “modification” procedures to reduce the imputed underpayment amount, for instance, by demonstrating certain adjustments were allocable to a tax-exempt partner.

If, on the other hand, the adjustment does not result in an imputed underpayment, the partnership must push out the adjustment to the partners from the reviewed year. As an example, if the only adjustment on the AAR is an adjustment increasing an amount of credit, the adjustment would not result in an imputed underpayment, and it must be pushed out to the reviewed-year partners. (Note that this rule differs in the audit context in which, as a general matter, adjustments that do not result in an imputed underpayment are taken into account by the adjustment-year partners — the partners from the year in which the adjustments become final.)

When the partnership pushes out AAR adjustments — either because the partnership is electing to push out or because there are adjustments not resulting in an imputed underpayment — the partnership must furnish a push-out statement on Form 8986to each reviewed-year partner required to take into account an AAR adjustment. In addition, a Form 8986 with respect to each reviewed-year partner must be included with the AAR and filed with the IRS. A partnership that properly elects to push out the adjustments may still be subject to withholding and reporting obligations under Chapter 3 or 4 of the Internal Revenue Code, and a foreign partner that receives a push-out statement is generally required to file a U.S. income tax return even if that partner would not otherwise be required to file.

Effect on partners that are furnished a Form 8986 push-out statement

Passthrough partners: The push-out process under the BBA is designed to ensure that adjustments are tracked as they flow from the partnership filing the AAR (AAR partnership) through each tier in the partnership structure and ultimately to any individual partners and taxable entities. As part of this design, the BBA rules require any passthrough partner that is furnished a push-out statement to file a “partnership adjustment tracking report” (tracking report) with the IRS on Form 8985. (Note that this is the same Form 8985 the AAR partnership must file as part of the AAR if pushing out any of the adjustments.) For these purposes, a passthrough partner includes not only a partnership, but also an S corporation, a trust (other than a grantor trust), and a decedent’s estate. In the case of an S corporation that is a passthrough partner, the shareholders are treated in the same manner as partners for purposes of the push-out, and for a trust or an estate, the beneficiaries are treated in the same manner as partners.

On the Form 8985 tracking report, the passthrough partner must indicate whether it will pay an imputed underpayment with respect to its share of the AAR adjustments or whether it will push out the adjustments to its own “affected partners” using Form 8986. An affected partner is a person that held an interest in a passthrough partner at any time during the tax year of the passthrough partner to which the adjustments in the Form 8986 relate. Similar to the AAR partnership, a passthrough partner must push out to its affected partners any adjustments that did not result in an imputed underpayment. In the event that a passthrough partner fails to timely push out its adjustments and provide the required push-out statements, it must compute and pay an imputed underpayment, together with any penalties and interest, with respect to the relevant adjustments on the push-out statement it received.

Passthrough partners must file Form 8985 (and accompanying Forms 8986) with the IRS and must furnish Forms 8986 to affected partners no later than the extended due date for the return for the adjustment year of the AAR partnership. For this purpose, the adjustment year is the year in which the AAR is filed. For example, if an AAR is filed in 2020 by a calendar-year partnership, the adjustment year will be 2020, and all Forms 8985 (including any appropriate Forms 8986) must be filed (and furnished) by each passthrough partner within the structure on or before Sept. 15, 2021.

Individuals and taxable entities: Individuals or taxable entities that are furnished a Form 8986 — either as a reviewed-year partner from the AAR partnership or as an affected partner of a passthrough partner — generally must pay any tax due with respect to their share of the AAR adjustments by determining their “additional reporting year tax.” In general, the additional reporting-year tax is computed by determining for each year, beginning with the partner’s first affected year (the year that includes the end of the partnership’s reviewed year), the amount by which the partner’s tax under Chapter 1 (income tax) would have increased or decreased, and adjusting attributes appropriately as they would have been adjusted had the AAR adjustments been properly reported on the partner’s first affected-year return, including any amended first-affected-year return. The sum of these amounts computed for each year through the “reporting year” is then reflected as an increase or decrease in Chapter 1 tax on the partner’s income tax return for the reporting year. Interest will also be due, based on any increases that were calculated and not taking into account any decreases, and the partner must pay any applicable penalties.

The “reporting year” is the partner’s tax year that includes the date on which the AAR partnership furnished Forms 8986 to its reviewed-year partners. (Because the regulations require Form 8986 to be furnished simultaneously with the filing of the AAR, this date should normally be the same date as the date the AAR is filed.) For example, if on Aug. 1, 2020, a calendar-year partnership files an AAR to adjust a 2018 return and furnishes Forms 8986 to its reviewed-year partners, the reporting year will generally be 2020 for any reviewed-year partners that are individuals or calendar-year taxable entities.

This timing rule for determining the reporting year also extends to any affected partners that are furnished a push-out statement by a passthrough partner. This could lead to some affected partners’ receiving push-out statements after the time the reporting-year return, and payment of the additional reporting-year tax, would normally be due. Continuing the example from above, if on Aug. 1, 2020, the AAR partnership furnishes a push-out statement to a reviewed-year partner that is a passthrough partner (UTP), UTP will have until Sept. 15, 2021 (the extended due date of the AAR partnership’s adjustment year return) to furnish its own push-out statements to its affected partners. Assume that on Aug. 1, 2021, UTP furnishes push-out statements to its two partners, both of whom are individuals — A and B. In determining their reporting year, A and B look to the tax year that includes the date the push-out statement was furnished by the AAR partnership to UTP (in this case Aug. 1, 2020), rather than the date A and B were furnished their own push-out statements (Aug. 1, 2021). Therefore, even though A and B receive their push-out statements in August 2021, their reporting year is still 2020, and payment of the additional reporting-year tax, as well as the reporting-year return, would be due April 15, 2021 (i.e., before A and B received their push-out statements).

The regulations appear to recognize this issue by providing no addition to tax under Sec. 6651 will be imposed if an affected partner reports and pays the additional reporting-year tax within 30 days of the extended due date of the AAR partnership’s adjustment-year return. Pursuant to this regulation, no late payment penalty would apply if A and B paid any additional reporting-year tax by Oct. 15, 2021. This rule is helpful if A and B have a valid extension to file in place and do actually timely file a return by Oct. 15, 2021, and timely pay the additional reporting-year tax (although interest will still be imposed).

Assume B had already filed her 2020 return by the time B’s push-out statement was furnished on Aug. 1, 2021. It is not clear how B would report and pay the additional reporting-year tax in that circumstance. Generally speaking, there is no requirement to file an amended return, and the BBA rules do not impose a separate obligation to file an amended return. The IRS may choose to assess the additional reporting-year tax using its math error procedures (i.e., without first conducting an audit of B’s return) on the ground that B reported inconsistently with the push-out statement (even though B was not aware of the statement when B filed her 2020 return). The IRS website provides a procedure for individual partners to make “prepayments” for a push out. It is not clear whether that system could be used by B to submit payment after the reporting-year return is filed.

When a partner does file a reporting-year return reflecting the additional reporting-year tax, the partner should use Form 8978, Partner’s Additional Reporting Year Tax, and Form 8978, Schedule A, Partner’s Additional Reporting Year Tax (Schedule of Adjustments). A positive amount of additional reporting-year tax will increase the partner’s tax for the reporting year. In contrast, a negative additional reporting-year tax will operate in a manner similar to a nonrefundable credit in that it may decrease the partner’s reporting-year tax to zero (or below), thereby allowing the refund of any overpayment for the reporting year. However, it does not appear that a negative additional reporting-year tax can independently generate a refund as a refundable credit would. Using the example from above, if the pushed-out AAR adjustment causes a $500 decrease in tax for 2018 and A’s 2020 tax is $100, A would appear to be entitled to a refund of any amounts above zero that were paid in for 2020, but the 2018 decrease would not independently create a refund of $400. Furthermore, it appears there is no ability to carry forward or back the portion of the decrease in 2018 tax that is effectively unused on A’s 2020 return. Therefore, whether a partner will benefit from an AAR adjustment that may result in a tax overpayment at the partner level (for example, an increased amount of deduction or credit) depends on that partner’s particular facts and circumstances.

Facts and circumstances are crucial

The issues faced by individual partners A and B in the example above are among the many types of tough issues partners may face when a BBA AAR is filed. Partnerships will need to grapple with thorny questions of their own, too. While this item discusses the general requirements for filing an AAR and highlights some of the effects filing an AAR may have, the facts and circumstances will dictate the application of the AAR rules to a particular partnership or partner.

For more on the BBA’s implications at the state level, see Bossert, “State Considerations When Amending BBA Partnership Returns,” also in this issue.

EditorNotes

Mary Van Leuven, J.D., LL.M., is a director, Washington National Tax, at KPMG LLP in Washington, D.C.

For additional information about these items, contact Ms. Van Leuven at 202-533-4750 or mvanleuven@kpmg.com.

Unless otherwise noted, contributors are members of or associated with KPMG LLP.

These articles represent the views of the author(s) only, and do not necessarily represent the views or professional advice of KPMG LLP. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.