Editor: Catherine Stanton, CPA
As states have begun to address changes in the federal partnership audit rules, this column has considered the federal and state procedures for partnership audits at the federal level (see Jensen, Sherr, and Stanton, "Developing a Uniform State Approach to the New Federal Partnership Audit Regime," 48 The Tax Adviser 888 (December 2017), and the Multistate Tax Commission's (MTC's) Model Uniform Statute and Regulation for Reporting Adjustments to Federal Taxable Income and Federal Partnership Audit Adjustments (MTC model statute) (see Stanton and Sherr, "A Uniform State Approach to the New Federal Partnership Audit Regime,"The Tax Adviser 836 (December 2018). The MTC formally adopted the MTC model statute (available at www.mtc.gov in January 2019. This column covers federal and state developments in 2019, AICPA tax advocacy efforts, the helpful provisions of the MTC model statute and why states should adopt it, and what is expected to happen in 2020 in the states with partnership audit legislation and guidance.Background
Federal guidance issued and expected
Important changes in the federal income tax treatment of partnership audits began to apply for tax years beginning Jan. 1, 2018, for many partnerships (enacted as part of the Bipartisan Budget Act of 2015, P.L. 114-74). With extended 2018 partnership returns timely filed by Sept. 15, 2019, the IRS is expected to begin to conduct audits using the new partnership audit regime in 2020. In anticipation of increased partnership audit activity by the IRS, states are starting to react and enact (or at least consider) legislation regarding the new federal partnership audit process.
The IRS has issued the following guidance on the new partnership audit regime (see the AICPA webpage "Partnership Audit and Adjustment Rules," available at www.aicpa.org:
- July 25, 2019: Extension for superseding Form 1065, U.S. Return of Partnership Income (Rev. Proc. 2019-32);
- Feb. 27, 2019: Final regulations on revisions to Chapter 63 for Technical Corrections 2018 (T.D. 9844, 255-page preamble) (finalized reproposed regulations on general rules and procedures (REG-136118-15), reissued for proposed regulations on: (1) Tax attributes (REG-118067-17); (2) push-out election by tiered structures/administrative and judicial review rules (REG-120232-17 and REG-120233-17); (3) international provisions (REG-119337-17); and (4) election out of regime (REG-136118-15));
- Dec. 20, 2018: Guidance on special enforcement (Notice 2019-06);
- Aug. 6, 2018: Final regulations on partnership representatives (T.D. 9839, finalizes proposed regulations (REG-136118-15));
- Jan. 2, 2018: Final regulations on election out of the new partnership audit regime (T.D. 9829, finalizes proposed regulations (REG-136118-15)); and
- Aug. 5, 2016: Temporary and proposed regulations on procedures and early election (T.D. 9780 and REG-105005-16).
Treasury and the IRS are expected to issue more guidance by June 30, 2020, in these areas:
- Final regulations on adjustments to tax bases and capital accounts (to finalize proposed regulations (REG-118067-17));
- Regulations on failure to pay imputed underpayment (under Sec. 6232(f)); and
- Regulations on definitions and special rules (under Sec. 6241).
The AICPA submitted comments to Treasury and the IRS on the following matters:
- Comments, available at www.aicpa.org, and testimony, available at www.aicpa.org, from Oct. 9, 2018, on proposed regulations issued by the IRS on Aug. 17, 2018 (REG-136118-15);
- Comments on May 16, 2018, available at www.aicpa.org, on adjusting tax attributes (REG-118067-17);
- Comments on Aug. 14, 2017, available at www.aicpa.org, and testimony on Sept. 18, 2017, available at www.aicpa.org, on general rules; and
- Comments on Oct. 7, 2016, available at www.aicpa.org, on general issues.
The AICPA submitted the following comments to Congress:
- Jan. 4, 2018: Request to delay the effective date, available at www.aicpa.org; and
- Nov. 17, 2016: Proposed technical corrections, available at www.aicpa.org.
The AICPA developed and shared with the state CPA societies the following partnership audits state legislative resources:
- AICPA position paper on state conformity to federal state partnership audit rules, available at www.aicpa.org;
- AICPA state conformity to federal partnership audit rules, available at www.aicpa.org;
- Bullet points on states adopting the MTC model act on partnership audits, available at www.aicpa.org; and
- AICPA "Partnership Audit and Adjustment Rules" webpage, available at www.aicpa.org.
The AICPA continues to act as a resource to state CPA societies as each state considers partnership audit legislation. The AICPA held two partnership audit state legislation webinars for state CPA societies in December 2018 and July 2019, and the AICPA will likely provide another such webinar in 2020.
In addition, the AICPA has participated in state partnership audit legislation presentations to state CPA societies and at the National Conference of State Legislatures Task Force on State and Local Taxation (NCSL SALT) meeting in November 2019. Also, over the past year, the following professional services associations have provided updates on the MTC model statute at conferences: the American Bar Association (ABA) State and Local Taxes Committee, the Energy Infrastructure Council (EIC) (formerly the Master Limited Partnership Association), and the National Association of State Bar Tax Sections.Why states need to enact the MTC model statute in 2020
States incorporate the Internal Revenue Code (IRC) "tax base" into their tax laws in various ways. However, states' conformity to the IRC's assessment and refund laws varies widely, with most states adopting their own independent assessment and refund laws that are distinctly separate from those in the IRC. Therefore, almost every state that imposes an individual and/or corporate income tax needs to amend its federal adjustment reporting laws to account for the new federal partnership audit regime procedures for the process to work fairly, both for the state and for taxpayers who hold interests in impacted partnerships.
For example, the laws of many states do not allow for the direct assessment of partnerships, as these entities are not taxpayers upon which the state may assess, collect, or levy a tax. In other states, the partnership itself is the taxpayer; thus, the impact is less significant because individual assessment against a partner is not permitted, as the state may not subject its partners (e.g., individuals) to state income taxation on the income earned by a partnership. However, most states assess partners directly; therefore, many states will need to enact legislation that allows them to also assess the partnership, following the new federal regime. State tax authorities will need to issue guidance to explain how the states will implement any changes.
The MTC model statute provides states with a reasonable method to collect revenue for their share of liabilities flowing from an IRS audit of a partnership or multimember limited liability company (LLC) under the new federal partnership audit regime and not face substantial legal and administrative concerns.
The MTC model statute, approved by the MTC in January 2019, was developed and is supported by the "interested parties," which include the AICPA and several other organizations involved with state tax policy, including the Council On State Taxation (COST), the Tax Executives Institute, the ABA State and Local Taxes Committee, the Institute for Professionals in Taxation, and the EIC.
The MTC model statute addresses reporting federal changes for all taxpayers and addresses issues with taxpayers reporting adjustments under the new federal partnership audit regime. The MTC model statute was designed to provide states with a uniform, simplified method to apply the results of a partnership audit conducted by the IRS under the new federal procedures in effect for tax years beginning Jan. 1, 2018 (partnerships could opt in earlier, but few did). One of the stated goals of the new federal regime is to improve the process of reporting of federal audit adjustments to the states. This new federal partnership audit process change also creates a unique opportunity to improve the overall process for all taxpayers to report federal changes to the states (and, as applicable, local governments).
In addition, many CPAs and their clients are structured as partnerships and operate in many states and, thus, are directly subject to the new federal and state partnership audit regimes.
Until all affected states adopt the MTC model statute, CPAs and their clients could face complications and burdensome compliance challenges from the inconsistent requirements across states for reporting their federal audit adjustments to state tax authorities.Overview of the many helpful provisions in the MTC model statute
The MTC model statute makes the following general improvements over current state tax procedural laws for all taxpayers:
- Provides a clear definition of "final determination" based on all issues for a tax year being final at the federal level, including taxpayers that are members of a combined/consolidated filing group;
- Establishes that taxpayers have at least 180 days to report changes (interest still accrues until paid);
- Absent a waiver, imposes a limitation on changes after the state's general statute of limitation expires for both the state and the taxpayer to the federal audit changes; and
- Introduces equal and clearly stated assessment and refund periods.
The MTC model statute provides uniformity and:
- Incorporates changes needed for states to conform in a manner that considers state tax issues and best approaches;
- Establishes more uniform standards across all the states for reporting all federal audit adjustments for all taxpayers to state-level tax authorities;
- Addresses significant changes made to federal audit procedures by the new federal partnership audit regime that affect state-specific issues; and
- Addresses taxpayer, practitioner, and state tax authority concerns.
The MTC model statute also:
- Covers the role and authority of the partnership representative, adopting the federal partnership representative procedure, while also allowing for a partnership to choose a state partnership representative that is different from the representative chosen for the federal (or another state's) partnership audit regime reporting process;
- Allows a state-level partnership election that can differ from the election made for federal purposes (e.g., to "push out" the assessment to the partners or to let the partnership pay the adjustment directly);
- Provides modifications of imputed underpayments;
- Addresses unique state tax issues, such as apportionment/allocation or nexus and residency issues, that Congress did not need to consider in enacting the new federal partnership audit regime;
- Covers tiered partnership structures (where partnerships own other partnerships) — tiered partners, if applicable, can make a different state election and file 90 days after the federal due date for tiered partner returns at the federal level;
- Provides a clear definition of final determination — the trigger for reporting changes;
- Considers timing of reporting obligations, providing 180 days to report after the final determination;
- Allows estimated payments to reduce interest with a refund if estimated tax is overpaid;
- By mutual agreement of the partnership representative and the state, allows different reporting and payment of tax by a partnership and its partners;
- Grants partnerships with over 10,000 partners at least a 60-day automatic filing extension;
- Provides that past the normal state statute of limitation, changes are limited solely to federal tax changes; and
- Provides an equal statute of limitation for assessment/refund and absent fraud, a six-year maximum period for tax assessment (even if no return is filed, absent fraud).
With IRS audits under the new regime likely to start in 2020, states need to enact legislation conforming to the MTC model statute.Map of impacted states
The map "States Impacted by the Federal Regime Change" (below) shows the state-by-state effect of the federal audit changes.
Map and status of state action
The map "States Adopting the MTC Model Partnership Audit Act" (below) illustrates the status of states' enactment of partnership audits legislation.
States that enacted legislation
Legislation that most closely follows the MTC model statute was enacted in Georgia — H.B. 849, enacted May 3, 2018. Georgia is the best example for other states to follow because it most closely follows the MTC model statute.
Some other states that enacted legislation generally following the MTC model statute are:
- California: S.B. 274, enacted Sept. 23, 2018. California's S.B. 790 amends the 2018 enacted legislation. It makes minor tweaks to a partnership's ability to make a state entity-level audit adjustment election that differs from its election for federal purposes, modifying provisions enacted with 2018's S.B. 274. S.B. 790 was enacted Sept. 20, 2019.
- West Virginia: H. 2798/S. 499, enacted March 25, 2019.
- Oregon: H. 2101, enacted May 22, 2019. The Oregon Department of Revenue on Oct. 25, 2019, issued proposed amendments (available at www.oregon.gov to its partnership composite return and withholding regulations to adhere to the provisions of 2019's H.B. 2101, which imposes certain reporting requirements for partnerships subject to new federal audit procedures.
- Ohio: H.B. 166, enacted July 18, 2019. Unlike the MTC model statute, Ohio's partnership audit law allows a partner to file for a refund even if the partnership elects to pay the tax for its partners. Ohio also allows it municipalities to separately impose income taxes (e.g., net profits tax). The Ohio Legislature has yet to consider amendments to the municipal laws to reflect the new federal partnership audit regime or to conform to the MTC model statute.
In addition, four other states have enacted legislation that affects partnership audits but does not follow the MTC model statute. These states will likely need to amend their new partnership audit statutes to collect tax revenues in response to adjustments reported under the new federal partnership audit regime. These states are:
- Arizona: S.B. 1288, enacted May 11, 2016. Arizona's legislative language does not reflect the principles outlined in the MTC model statute and does not take into account the IRS guidance issued since then. Arizona simply incorporated by reference the federal provisions into its state law, creating some significant enforcement ambiguities, considering its existing state tax procedures. Arizona eventually will need to amend its enacted law to reflect subsequent events and should consider adopting the MTC model statute.
- Hawaii: S.B. 2821, enacted June 13, 2018. The impact of the bill on partnerships subject to a federal audit is unclear. It is possible that the state Legislature will need to amend the statute.
- Maine: L.D. 1819, enacted June 18, 2019. Maine's law technically appears to not allow partnerships to elect to push out the assessment to partners at the state level, and it does not follow the MTC model statute.
- Rhode Island: H.B. 5151 Substitute A, Article 5, enacted July 5, 2019. Rhode Island's law does not incorporate the MTC model statute and, in particular, does not follow the MTC model statute's common definitions and procedures for all taxpayers to use in reporting standard federal adjustments, including Federal Partnership Audit Adjustments. The AICPA is working with the Rhode Island Society of CPAs on possible 2020 legislation to amend the Rhode Island law.
States that considered but have not yet enacted partnership audits legislation that follows the MTC model statute
In addition to the above states that enacted legislation regarding partnership audits, the following states in 2019 considered but did not enact legislation yet regarding partnership audits:
- Hawaii: H.B. 1041/S.B. 1267, which are just IRC conformity bills and do not appear to allow the state to assess and collect revenue based on the federal audit.
- Minnesota: Legislation dropped the partnership audit provision due to a conflict in two proposed versions: H.F. 1486/S.F. 1522, which followed the MTC model statute and was supported by the Minnesota Society of CPAs, and H.F. 2169/S.F. 2555, which was the Minnesota Department of Revenue's version. It is likely that the Minnesota Legislature will consider state partnership audit legislation again in 2020.
- Missouri: MO H.B. 477/S. 220, which closely follows the MTC model statute.
Minnesota (H.F. 1227, H.F. 3411) and Missouri (S.B. 521, S.B. 897) also considered partnership audits legislation in 2017 and 2018 but did not take any action. In 2017, Montana (H.B. No. 7) considered but did not enact legislation regarding partnership audits as the federal guidance and MTC model legislation were still being developed when its legislative session concluded.
Outlook for 2020 state legislation
Based on reports from AICPA members, state CPA societies, and others, many states (Alabama, Delaware, Indiana, Louisiana, Kentucky, Maryland, Michigan, Minnesota, Missouri, New York, South Dakota, and Wisconsin) are likely to consider proposed state partnership audit legislation that will hopefully follow the MTC model statute. Many of the state CPA societies in these states are aware of and involved in the legislative process and have reached out to the AICPA as a resource. It is hoped that other states will consider adopting the MTC model statute in 2020 as well.
In addition, the four states that previously adopted their own partnership audit legislation (Arizona, Hawaii, Maine, and Rhode Island) may amend their statutes to more closely follow the MTC model statute.
The AICPA will continue to act as a resource and support state CPA societies as their states consider partnership audits legislation and implementing guidance.
Eileen Reichenberg Sherr, CPA, CGMA, MT, is a senior manager—AICPA Tax Policy & Advocacy. Catherine Stanton, CPA, is a partner and the National Leader of State & Local Tax (SALT) Services with Cherry Bekaert LLP in Bethesda, Md. Ms. Stanton is the chair of the AICPA State & Local Tax Technical Resource Panel. For more information about this column, contact firstname.lastname@example.org.