Editor: Howard Wagner, CPA
The Coronavirus Aid, Relief, and Economic Security (CARES) Act, P.L. 116-136, designed to speed relief to the pandemic-affected economy, contains several tax provisions that are retroactive, allowing taxpayers to claim refunds to increase current cash flow. For instance, taxpayers can claim bonus depreciation for qualified improvement property placed in service in 2018, 2019, and later years, and there is a five-year carryback for losses arising in 2018, 2019, and 2020. As a result, many taxpayers will be amending returns to take advantage of these provisions. Partnerships that wish to do so should be aware of an important deadline at the end of September 2020.
Generally, partnerships subject to the centralized partnership audit procedures under the Bipartisan Budget Act of 2015 (BBA), P.L. 114-74, cannot file an amended return or amended Schedules K-1, Partner's Share of Income, Deductions, Credits, etc., but rather must file an administrative adjustment request (AAR) to adjust a partnership return that has already been filed. The rules regarding AARs are complex and relatively untested. In addition, the AAR process generally delays a partner's realization of tax benefits and potentially puts those benefits at risk of not being able to be realized at all. In the case of retroactive CARES Act tax benefits claimed on an AAR, partners would likely have to wait until 2021 to get a refund attributable to those benefits and even then might not receive the refund if there is no overpayment of tax for that year.
To speed up the receipt of the relief intended by the CARES Act, on April 8, 2020, the IRS published Rev. Proc. 2020-23, which allows BBA partnerships a limited opportunity to file amended returns and amended Schedules K-1 for tax years beginning in 2018 and 2019 to take advantage of retroactive tax benefits under the CARES Act, rather than having to file an AAR. Partnerships must file the amended partnership returns before Sept. 30, 2020, as discussed more fully below. While the ability to temporarily file amended returns is welcome by many BBA partnerships, some unanswered questions remain about the consequences of doing so, and in some circumstances filing an AAR could be preferable. This item discusses these issues.
Overview of BBA
The BBA is effective for partnership tax years beginning on or after Jan. 1, 2018, though a partnership may elect into the regime early for tax years beginning after Nov. 2, 2015, and before Jan. 1, 2018. All partnerships are subject to the BBA, except that certain partnerships with 100 or fewer partners can elect out of the regime. A partner's return for the tax year must be consistent with the partnership's return for that year. Any tax due by the partner as a result of the inconsistency can be immediately assessed under math error procedures unless the partner files a notice of inconsistent treatment with the return. A notice of inconsistent treatment is made by attaching to the partner's inconsistent return a Form 8082, Notice of Inconsistent Treatment or Administrative Adjustment Request (AAR).
A BBA partnership must annually designate a partnership representative who has sole authority to bind the partnership and the partners with respect to the BBA regime. The partnership representative must have a substantial presence in the United States (i.e., generally have a U.S. taxpayer identification number (TIN), address, and phone number and be available to meet with the IRS). If the partnership representative is an entity, the partnership must also appoint a designated individual to act on behalf of the partnership representative.
Under the BBA, adjustments to partnership-related items are made at the partnership level. Assessment and collection of any tax due as a result of these adjustments also is imposed at the partnership level. Adjustments to partnership-related items can either be made by the IRS during an audit or by the partnership by filing an AAR. "Partnership-related item" is broadly defined as essentially any item or amount with respect to the partnership that is relevant in determining the tax liability of any person under Chapter 1, and any partner's distributive share of any such item or amount (Sec. 6241(2)(B)).
Under the BBA, the tax imposed on a partnership attributable to the adjustments to partnership-related items under the BBA is an "imputed underpayment." Generally, the imputed underpayment is determined by appropriately netting all partnership adjustments for the year under audit (reviewed year), multiplying the appropriately netted adjustments by the highest rate of tax for the reviewed year under Sec. 1 or 11, and then increasing or decreasing that product by applying adjustments to credits and creditable expenditures, as applicable. One can think of the imputed underpayment as an amount that represents the tax consequences that would result if all direct and indirect reviewed-year partners took into account their allocable share of the adjustments. Certain modifications to the imputed underpayment may be available to reduce the tax due.
The imputed underpayment is a separately stated nondeductible expense of the partnership that is allocated to the adjustment-year partners. In the case of an IRS audit, the adjustment year generally is the year in which the adjustments are finally determined. In the case of an AAR, the adjustment year is the year the AAR is filed. Adjustments that do not result in an imputed underpayment are allocated to adjustment-year partners in the case of an IRS audit and to the reviewed-year partners in the case of an AAR.
Instead of paying the imputed underpayment, a partnership can elect to pass the adjustments through to the reviewed-year partners (push-out election). If a partnership makes a push-out election, the imputed underpayment liability is extinguished and the partners for the reviewed year are liable for tax resulting from taking into account their allocable share of the adjustments.
As part of a push-out election, the partnership must file statements with the IRS showing each reviewed-year partner's allocable share of the adjustments and furnish each partner a copy of the statement. Form 8986, Partner's Share of Adjustment(s) to Partnership-Related Item(s), is the push-out statement. The due date for filing and furnishing statements is 60 days after the adjustments are finally determined in the case of an IRS audit or, in the case of an AAR, the date the AAR is filed. Each partner takes its allocable share of adjustments into account in the reviewed year and any intervening year; determines the tax, penalties, and interest due for each of those years; and includes the total amount on its return for the year the statement is furnished (the reporting year) as additional (or negative) Chapter 1 tax (additional reporting-year tax).
If there is a reduction in Chapter 1 tax, the tax liability on the partner's tax return for the reporting year is reduced. If the reduction reduces the partner's tax liability below zero, the partner can only get a refund of that amount if the partner overpaid tax for that year, taking into account the partner's tax liability net of the negative Chapter 1 tax. If there is no overpayment, the tax benefit resulting from taking the adjustments from the partnership into account will never be realized (Regs. Sec. 301.6227-3(b)(2)(ii)).
A passthrough partner (a partner that is itself a partnership, an S corporation, and in certain cases, a trust or estate) that receives a push-out statement must either determine and pay the imputed underpayment as a result of taking into account its allocable share of the adjustments shown on the statement or push out the adjustments to its partners for the reviewed year. The passthrough partner files a Form 8985, Pass-Through Statement — Transmittal/Partnership Adjustment Tracking Report, with the IRS, and either pays the imputed underpayment or files and furnishes push-out statements if the push-out election is made. Each partner of a passthrough partner that is itself a passthrough partner must go through this same process. Each partner of a passthrough partner that is not a passthrough partner must take its allocable share of adjustments into account and report any additional (or negative) Chapter 1 tax on its return for the reporting year. All passthrough partners must push or pay by the extended due date of the adjustment year of the partnership under audit or the partnership filing the AAR (source partnership).
In summary, a push-out election provides the allocable share of adjustments to the partners for the correct year. However, those partners have to wait to get the benefit of any adjustments until a later year. If the partner does not have an overpayment in the later year, this deferred benefit cannot be claimed. Finally, a push-out election by the source partnership (or any passthrough partner) forces partnerships, S corporations, and certain estates and trusts in upper tiers to bear the burden of making a determination of whether to push out adjustments or pay the imputed underpayment.
Under Sec. 6227, a partnership filing an AAR can either pay any imputed underpayment due as a result of taking the adjustments into account or push out the adjustments to the reviewed-year partners as described above. Any adjustment on an AAR that does not result in an imputed underpayment must be pushed out to the reviewed-year partners. The imputed underpayment is generally determined under Sec. 6225, except that some of the modifications that can reduce the imputed underpayment during an IRS audit cannot be used to reduce the imputed underpayment resulting from an AAR. In addition, unlike during an IRS audit where modifications cannot be taken without IRS consent, no IRS consent is needed to take modifications into account to reduce an imputed underpayment resulting from an AAR. The rules for passthrough partners discussed above apply, but passthrough partners may not take advantage of modifications.
A BBA partnership has three years from the later of the date a return is filed or the last day for filing that partnership return (determined without regard to extensions) to file an AAR. However, an AAR may not be filed after the IRS provides formal notification that the partnership has been selected for a BBA audit, referred to as a notice of administrative proceeding (NAP).In addition, the IRS will generally have three years from the date the AAR is filed to make adjustments.
The AAR is signed by the partnership representative for the tax year to which the AAR relates. An AAR may be used by the partnership to revoke a partnership representative designation and designate a successor, provided the AAR also includes adjustments to partnership-related items for the year to which the AAR relates (i.e., the partnership cannot file an AAR solely for the purpose of revoking a designation of a partnership representative and designating a successor).
A partnership required to electronically file its return for the adjustment year must file its AAR electronically using a Form 1065, U.S. Return of Partnership Income, with a Form 8082 attached. If the partnership was not required to electronically file in the adjustment year, the partnership uses a Form 1065X, Amended Return or Administrative Adjustment Request (AAR), to paper-file the AAR or a Form 1065 with a Form 8082 if it chooses to file the AAR electronically. If the partnership was not required to, but did, electronically file its return for the adjustment year, the partnership may paper-file an AAR for the adjustment year.
Rev. Proc. 2020-23
On April 8, 2020, the IRS issued Rev. Proc. 2020-23 to make it easier for partnerships to claim the CARES Act benefits for 2018 and 2019. Under the revenue procedure, BBA partnerships that filed partnership returns and furnished all required Schedules K-1 for tax years beginning in 2018 or 2019 before April 8, 2020 (the date the revenue procedure was issued) can file amended returns and amended Schedules K-1 before Sept. 30, 2020, instead of filing AARs.
To file an amended return under the revenue procedure, the partnership must use a Form 1065 with the "Amended Return" box checked, not the Form 1065X. The partnership must write "filed pursuant to Rev. Proc. 2020-23" at the top of the amended return and attach a statement with each Schedule K-1 sent to its partners with the same notation. An amended return under the revenue procedure may be filed electronically or on paper.
What's a partnership to do?
Being able to submit an amended return to claim CARES Act tax benefits for prior years provides relief to many BBA partnerships that do not want to file an AAR either because the AAR process is cumbersome and untested or because the BBA partnership wants to ensure that its partners can claim the benefits on prior-year tax returns where higher tax rates will maximize those benefits. Allowing partners to file amended returns also avoids partners' having to wait until 2021 (the year they file 2020 returns) to realize the flowthrough CARES Act tax benefits and prevents partners from losing those benefits if they do not have a sufficient overpayment on their 2020 return.
Another advantage of amending a partnership return over filing an AAR is that it is often unclear what the state requirements are when a federal AAR is filed. Many states have yet to enact legislation to address the BBA rules, and there is little consistency among states that have enacted legislation. Under a draft Model Uniform Statute for Reporting Adjustments to Federal Taxable Income and Federal Partnership Audit Adjustments, partnerships are generally required to notify the state and partners of the partners' allocable share of adjustments unless the partnership elects to pay the state any tax due as a result of the adjustments.
But amending partnership returns has some downsides, too, including requiring the partners to file amended federal and state returns. If the partnership files an AAR instead, the partners will realize the CARES Act tax benefits on their 2020 return, eliminating the need for partners to amend federal and state returns.
In addition, there are unanswered procedural questions about how the amended return will be treated if the partnership is selected for audit for 2018 and 2019.
BBA partnerships should consider these issues as they decide how to adjust items for 2018 and 2019.
Howard Wagner, CPA, is a partner with Crowe LLP in Louisville, Ky.
For additional information about these items, contact Mr. Wagner at 502-420-4567 or email@example.com.
Contributors are members of or associated with Crowe LLP.