Filing an administrative adjustment request under the BBA

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

The Bipartisan Budget Act of 2015 (BBA), P.L. 114-74, introduced a new centralized partnership 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 correcting a prior-year Form 1065 and its Schedule K-1, Partner’s Share of Income, Deductions, Credits, etc. For tax years beginning in 2018 and after, partnerships subject to the BBA regime that seek to adjust a partnership-related item reflected on an original Form 1065 or Schedule K-1 generally must file an administrative adjustment request (AAR) under Sec.  6227.  This item briefly summarizes the BBA rules, discusses the requirements and forms for filing an AAR under Sec.  6227, and addresses the effects of filing an AAR on the partnership’s partners.

BBA at a high level

The BBA procedures apply to partnership tax years beginning on or after Jan. 1, 2018.  As a default rule, the BBA procedures provide that the partnership, not its partners, must pay any tax attributable to adjustments made by the IRS or reflected on an AAR.  This amount is referred to as an “imputed underpayment.” Very generally, the imputed underpayment is determined by multiplying the total amount of netted partnership adjustments by the highest rate of tax.

The partnership may elect an alternative to payment of the imputed underpayment and “push out” the adjustments to its partners, with the result that the partners pay the tax attributable to any partnership adjustments. However, rather than reporting that tax on an amended return for the reviewed year (i.e., the year subject to the adjustment), the partner includes the tax due (or reflects the tax benefit) on the partner’s next-filed income tax return.  Different rules apply for partners that are passthrough entities, as described below.

Basic rules when filing an AAR under the BBA

A partnership filing an AAR under the BBA must determine whether the adjustments made to the original return result in an imputed underpayment.  If an adjustment 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 certain “modification” procedures to reduce the imputed underpayment amount by, for instance, demonstrating adjustments are allocable to a tax-exempt investor or to a C corporation partner taxable at a lower rate.

If the adjustment does not result in an imputed underpayment but instead results in a “favorable adjustment,” the partnership must push out that favorable adjustment to the partners from the reviewed year.  For example, if the AAR adjustment increases an amount of credit (i.e., a favorable adjustment), that additional amount of credit must be pushed out to the reviewed-year partners.

The determination of whether an adjustment results in an imputed underpayment is made on an item-by-item basis, and netting of favorable adjustments with unfavorable adjustments generally is not permitted.  The imputed underpayment calculation effectively disregards any “negative adjustment,” e.g., any adjustment that increases a deduction or credit or decreases an item of income.  As a result, each “positive adjustment,” e.g., an adjustment that increases an item of income or decreases an item of deduction or credit, is added together, and the sum of the positive adjustments is multiplied by the highest rate of tax in effect for the reviewed year to arrive at the imputed underpayment amount. For this purpose, adjustments to “nonincome” items, i.e., those items that are not income, gain, loss, deduction, or credit, are treated by the regulations as positive adjustments.  In certain cases, a positive adjustment may be treated as “duplicative” of another positive adjustment and thus be treated as zero for purposes of the imputed underpayment calculation.

A partnership generally has three years from the date of the filing of the original return to file an AAR.  In the case of a foreign tax redetermination, the regulations under Sec.  905(c) provide that the partnership must file an AAR to notify the IRS of the foreign tax redetermination even if the normal three-year period to file an AAR has expired.  (In that case, the AAR is limited to the adjustments required to be made under Sec.  905(c).)  Once the IRS mails a Letter 5893, Notice of Administrative Proceeding, with respect to a partnership tax year, Sec.  6227(c) provides that a partnership may no longer file an AAR for that tax year.

In addition, the regulations provide that no partner may take a position inconsistent from the partnership for the partnership tax year for which the Letter 5893 is issued.  Lastly, but perhaps most important, the filing of an AAR by a BBA partnership restarts the period of limitation under Sec.  6235 for the IRS to adjust partnership-related items for that tax year.

Forms for filing AARs under the BBA

The form used to file an AAR under the BBA depends on whether a partnership is filing on paper or electronically. To file on paper, the partnership uses Form 1065-X, Amended Return or Administrative Adjustment Request (AAR).  To file electronically, the partnership files a revised Form 1065, with the “Amended Return” box checked, and includes a Form 8082, Notice of Inconsistent Treatment or Administrative Adjustment Request (AAR), identifying each change being made to the original Form 1065.  The instructions to Form 1065-X and Form 8082 each provide that the partnership must include with the AAR a computation of the imputed underpayment amount that results from the AAR adjustments.  Although the instructions provide a seven-step process for calculating the imputed underpayment, there is no prescribed form or schedule for this calculation. The imputed underpayment computation is required by the instructions regardless of whether the partnership is paying the imputed underpayment or pushing out the adjustments.

When pushing out the adjustments, the partnership must furnish a Form 8986, Partner’s Share of Adjustment(s) to Partnership-Related Item(s), to each reviewed-year partner that is allocated a share of the AAR adjustments.  A copy of the Form 8986 must be included with the AAR and filed with the IRS.  The partnership must also file as part of the AAR a Form 8985, Pass-Through Statement — Transmittal/Partnership Adjustment Tracking Report, that shows the aggregate amount of adjustments reflected on the Forms 8986. If the partnership is paying the imputed underpayment and requesting modifications to the imputed underpayment amount, the partnership must include with the AAR a Form 8980, Partnership Request for Modification of Imputed Underpayments Under IRC Section 6225(c).

An AAR must be filed and signed by the partnership representative (PR) as designated on the original reviewed-year return.  When the partnership is pushing out the adjustments, the instructions to Form 8082 provide that a PR should “manually sign” the Form 8082 to attest that all Forms 8986 have been issued to the reviewed-year partners.  If no PR was designated on the original Form 1065, one will need to be identified using a Form 8979, Partnership Representative Revocation, Designation, and Resignation, and attaching that Form 8979 to the AAR. The partnership may also use Form 8979 to revoke the current PR and to designate a new one (e.g., when the PR designated on the original return has retired or left the company).  A partner from the reviewed year must sign the Form 8979, attesting that the partner has the authority to revoke the PR and designate a new PR for the reviewed year.

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

Passthrough partners: Assume a lower-tier partnership files an AAR (AAR partnership) and pushes out the adjustments to an upper-tier partnership. The push-out process is designed to allow for the AAR adjustments to flow up from the AAR partnership through each tier in the partnership structure and ultimately reach partners that are individuals or taxpaying entities. To accomplish this flow of adjustments, the BBA rules require any “passthrough partner” that receives a Form 8986 from a lower-tier entity to issue its own Forms 8986 to its “affected partners.” The passthrough partner must file a copy of these Forms 8986 with the IRS together with a “partnership adjustment tracking report” on Form 8985.  For these purposes, a “passthrough partner” includes an upper-tier partnership, an S corporation, an estate of a deceased partner, and a trust (other than a grantor trust).  An “affected partner” is a person that held an interest in the passthrough partner at any time during the passthrough partner’s tax year to which the adjustments in the Form 8986 relate.

In lieu of pushing out the adjustments, the passthrough partner may choose to pay an imputed underpayment with respect to any adjustments that are not favorable.  That imputed underpayment is calculated using the highest rate of tax, and a passthrough partner cannot use any modifications to reduce that imputed underpayment. Similar to the AAR partnership, a passthrough partner must push out to its affected partners any AAR adjustments that are favorable, such as an increase in an amount of a deduction or credit.

In some cases, a passthrough partner that is itself a BBA partnership may find that the adjustments pushed up from a lower-tier partnership change the partner’s own items in the reviewed year or subsequent years.  For example, an adjustment increasing income may cause the passthrough partner’s own allocations to change, or the increase in income may release a previously unused deduction or affect gain reported on a disposition of an interest in the lower-tier entity.  In these cases, the passthrough partner may determine it needs to file its own AAR while simultaneously pushing out the adjustments from the lower-tier entity.

A passthrough partner has until the extended due date for the return for the adjustment year of the AAR partnership to file and issue its own Forms 8986. For example, if an AAR is filed in 2024 by a calendar-year partnership, the adjustment year will be 2024, and all Forms 8986 must be filed and furnished by each passthrough partner within the structure on or before Sept. 15, 2025.  (The Sept. 15, 2025, deadline applies even if the AAR partnership did not actually obtain an extension for the 2024 tax year.)  The instructions to Forms 8985 and 8986 require incoming and outgoing tracking numbers to be included on each Form 8985 and Form 8986 as the adjustments flow up through the tiers.

A failure to push out the adjustments timely (or to pay the imputed Underpayment timely) will make the passthrough partner liable for an imputed underpayment based on its share of the AAR adjustments.  Interest will be due on the imputed underpayment, starting with the return due date for the passthrough partner’s reviewedyear return.  Unless the passthrough partner can demonstrate reasonable cause existed for the filing failure, the passthrough partner also is liable for penalties under Sec.  6698 for the failure to file the Form 8985, under Sec. 6651(i) for the failure to pay the imputed underpayment timely, and under Sec.  6722 for the failure to timely furnish the Forms 8986.  Therefore, in a multitiered passthrough structure, timely pushing out the adjustments is critical so that each passthrough partner has sufficient notice and time to push out the adjustments at its level, lest it be subject to an imputed underpayment liability and associated interest and penalties.

Individuals and taxable entities: A partner that is an individual or taxable entity (a “taxpaying partner”) that is furnished a Form 8986 — either as a reviewed-year partner of the AAR partnership or as an affected partner of a passthrough partner — generally must pay any tax due or use any tax benefit arising from the AAR adjustments on the partner’s reporting-year return.  The “reporting year” is the partner’s tax year that includes the date on which the AAR partnership filed the AAR and furnished Forms 8986 to its reviewed-year partners (i.e., the date reported in Part II, Item G, on Form 8986).

Example 1: On Aug. 1, 2024, a calendar-year partnership files an AAR to adjust a 2022 return and furnishes Forms 8986 to its reviewed-year partners.  The reporting year will be 2024 for all taxpaying partners in the chain of ownership (including reviewed-year partners and any affected partners) that operate on a calendar-year basis.  This is the case even if an affected partner receives its Form 8986 from a passthrough partner in 2025.  (Recall that a passthrough partner generally has until Sept. 15 of the year following the year in which the AAR is filed to issue its own Forms 8986.)

A taxpaying partner determines the tax due or tax benefit arising from the AAR adjustments by determining the “additional reporting-year tax.” In general, the additional reporting-year tax is computed by determining for each tax year affected by the adjustments a “correction amount,” starting with the partner’s first affected year (the year that includes the end of the partnership’s reviewed year) and ending with the tax year preceding the reporting year.  The correction amount is the amount by which the partner’s Chapter 1 income tax would have increased or decreased, taking into account any necessary adjustments to partner-level attributes (e.g., a loss carryforward), had the AAR adjustments been properly reported on the partner’s first affectedyear return (including any amended return filed for the first affected year).

The correction amounts are summed together to arrive at the additional reporting-year tax.  A partner reflects the additional reporting-year tax on Form 8978, Partner’s Additional Reporting Year Tax, with the adjustments themselves appearing on Form 8978, Schedule A, Partner’s Additional Reporting Year Tax (Schedule of Adjustments). The instructions to Form 8978 provide that the partner should include a statement showing the partner’s calculation of the correction amounts and the additional reporting-year tax.

A positive amount of additional reporting-year tax generally will increase the partner’s Chapter 1 tax for the reporting year.  In contrast, a “negative” amount of additional reporting-year tax operates similar to a nonrefundable credit in that it may decrease the partner’s reporting-year tax to zero, thereby allowing the refund of any overpayment for the reporting year.  However, it is the IRS’s position that a negative additional reporting-year tax cannot independently generate a refund as a refundable credit would.

Example 2: Partner A receives a Form 8986 reflecting an AAR adjustment that would cause a $500 decrease in A’s Chapter 1 tax for 2022. Partner A’s 2024 reporting year is 2024, and A’s Chapter 1 tax is $100.  The $500 decrease reduces A’s 2024 Chapter 1 tax to zero, allowing A to claim a refund of any amounts paid toward Chapter 1 tax for 2024.  However, the IRS’s position is that the remaining $400 left over of the 2022 decrease in tax does not give rise to a refund of $400 for the 2024 tax year. Furthermore, the IRS takes the position that there is no ability to carry back or forward that leftover decrease in 2022 tax, creating a stranded overpayment in the amount of $400.

Effects on partners can be varied

This item discusses the general requirements and forms used for filing an AAR and highlights some of the effects filing an AAR may have on the partnership’s partners.  However, the facts and circumstances will dictate the application of the general AAR rules to a particular partnership or partner. Careful consideration should be given to both the general rules discussed above and the facts specific to a particular taxpayer when determining the steps for filing an AAR and the consequences on the partnership’s partners.

Editor notes

Mary Van Leuven, J.D., LL.M., is a director, Washington National Tax, at KPMG LLP in Washington, D.C. Contributors are members of or associated with KPMG LLP. For additional information about these items, contact Van Leuven at mvanleuven@kpmg.com.