Sections 6225 & 6226: Partnership Audit Adjustments/Imputed Underpayments/Alternative

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1 Carolyn Lee Senior Director, Tax Policy April 14, 2016 Internal Revenue Service CC:PA:LPD:PR (Notice ) Internal Revenue Service Room 5203 P.O. Box 7604 Ben Franklin Station Washington, D.C Submitted Electronically: RE: Notice Dear Ms. Gerdy Zogby: The National Association of Manufacturers (NAM) the largest manufacturing association in the United States representing manufacturers in every industrial sector and in all 50 states appreciates the opportunity to provide the following comments on the implementation of the new partnership audit regime enacted as part of the Bipartisan Budget Act of 2015 (P.L ) (BBA). Nearly two thirds of manufacturers are pass-through entities, including a significant number of partnerships that are impacted by the new rules in the BBA. Sections 6225 & 6226: Partnership Audit Adjustments/Imputed Underpayments/Alternative Discussion The new partnership audit regime in the BBA is designed to improve IRS ability to collect tax underpayments from partnerships by simplifying procedures and reducing the government s audit costs. Thus, the statute requires the designation of a partnership representative and binds partners to the actions of the partnership and implements procedures to ensure the amount of tax collected is as closely as possible to the actual tax due in the reviewed year. 1 More specifically, Section 6225 provides the general rules for audit adjustments under a new centralized system for partnership audit, adjustment, assessment, and collection of tax. Under Section 6225(a), a partnership is required to pay the imputed underpayment amount for partnership audit adjustments. Section 6225(b) generally provides that the imputed underpayment amount is equal to the net partnership adjustment multiplied by the highest individual or corporate tax rate in effect for the reviewed year. Section 6225(c) directs Treasury to establish procedures to modify imputed underpayments, including through filing amended returns by reviewed year partners and taking into account certain partner attributes, including the tax exempt status of a partner, a lower applicable tax rate due to a partner s status as a C corporation or an individual; and a passive activity loss allocable to a partner in a publicly traded partnership. After making the tax payment, the partnership presumably would 1 The JCT description states that the function of the modification provisions is to determine the amount of tax due as closely as possible to the tax due if the partnership and partners had correctly reported and paid while at the same time to implement the most efficient and prompt assessment and collection of tax attributable to the income of the partnership and partners. Leading Innovation. Creating Opportunity. Pursuing Progress th Street, NW Suite 700 Washington, DC P F

2 collect from the partners the capital needed to replenish the cash position of the partnership before the adjustment. Alternatively, Section 6226 gives a partnership the ability to push out the economic burden of the partnership adjustment to the reviewed year partners, with the partner s liability based on the partner s actual share of any adjustment to income, gain, loss, deduction, or credit. This push-out alternative is highly attractive to virtually all partnerships because it is an easier method for the partnership and it shifts the collection burden from the tax-matters partner to the government. In addition, this alternative method appears to be more equitable since it appears to limit the liability for the adjustment to partners of the partnership for the reviewed year and those partners reviewed-year attributes, thus addressing situations where the partnership in the adjustment year has new partners, fewer partners, or partners whose partnership interests have changed between the reviewed year and the adjustment year. This alternative also appears to avoid creating liabilities for any new partners that may have joined the partnership between the reviewed year and the adjustment year. Finally, if the government believes that reviewed year partners no longer with the partnership in the adjustment year owe tax, the collection of that tax under the alternative method is a matter between the government and the exited partner, leaving the partnership and the remaining partners unaffected. For all these reasons, the alternative is a very attractive option. Indeed, capital markets may demand that the partnership in its partnership agreements always elect application of Section 6226 in the event of any partnership adjustment so that new partners are not saddled with tax liabilities of former partners. The benefits of the alternative method in Section 6226 relative to the assessment mechanism in Section 6225 likely will limit the potential simplification benefits to the government of the new partnership audit regime under Section Therefore, we recommend that Treasury exercise its regulatory authority to make Section 6225 an easier and more equitable option for taxpayers. Congress recognized that the imputed underpayment modification procedures in Section 6225(c) may need to be augmented to minimize taxpayer use of the Section 6226 alternative. To that end, Section 6225(c)(6) states that the Secretary may provide for additional procedures to modify imputed underpayment amounts on the basis of such other factors as the Secretary determines are necessary or appropriate to carry out the purposes of this subsection (emphasis added). Recommendation The NAM recommends that Treasury exercise its authority under Section 6225(c)(6) to allow partnerships to treat the partnership adjustment as if it arose during the adjustment year and take adjustment year tax attributes of partners into account in modifying imputed underpayments. 2 Specifically, Treasury rules should allow a partnership to modify the imputed underpayment to reflect the amount determined by treating the partnership adjustment as if it arose during the adjustment year for purposes of determining amounts allocated to its partners. The partnership would be required to demonstrate the amount of the imputed underpayment taking into account the partnership adjustment in the adjustment year and the tax attributes of adjustment year partners based on each partner s taxable year in which the adjustment year ends. 2 This would produce an imputed underpayment amount that would be similar to the results under the Section 6242 Electing Large Partnership rules, except the actual adjustment would not flow through to the partners. Instead, unlike the Section 6226 alternative, it would allow the government to collect the tax directly from the audited partnership.

3 Allowing a partnership to take the tax attributes of its partners into account in the adjustment year would be consistent with the general policy underlying Section 6225 of imposing tax on the partnership in the adjustment year, which results in adjustment year partners bearing the liability for the imputed underpayment. It would also provide partnerships with a reasonable alternative to having its reviewed year partners file amended returns under Section 6225(c)(2), or preparing and sending adjustment statements to reviewed year partners under Section At the same time, it would preserve the administrative benefits to the government of assessing and collecting the tax directly from the audited partnership. Moreover, allowing for consideration of adjustment year partner attributes is consistent with past Treasury pronouncements on the optimal way to maximize collections and reduce administrative burdens associated with partnership audits and collections. In a proposal submitted to the House Ways and Means Committee in 1990, Treasury said that a partnership ought to be treated as the taxpayer with respect to any partnership shortfall. 3 The partnership would pay tax and interest subject to tax at the highest rate applicable. The income adjustment, however, would be deemed to have arisen in the adjustment year, so that all partners during the year of adjustment would share the income. Any tax paid by the partnership with respect to such shortfall would be treated as tax paid by such partners, effectively treating the tax paid by the partnership as a credit allowable to the partners. Thus, although the tax would be withheld at the maximum rate, the tax would actually be imposed at the marginal rates of the partners in the year the final adjustment is made. By doing so, the tax deficiency at the partnership level is essentially borne by the adjustment year partners, as opposed to the review year partners. Furthermore, in the 1990 Proposal, Treasury described in great detail the tools at its disposal to address any abusive situations that could theoretically arise as a result of its preferred methodology. Congress was aware of the 1990 Proposal and presumably gave Treasury the broad authority in Section 6225(c)(6) so that Treasury would implement the new law consistent with 1990 Proposal. To that end, in the 1990 Proposal, Treasury asks for a broad swath of regulatory authority to implement effectively any new partnership audit rules that Congress legislates: Our recommended approach would permit the Service to proceed against both current and former partners to collect the amount owed, but would also take into account the partners' tax status in determining ultimate liability.. A procedure should also be established to take into account the partners' individual tax status. This might be accomplished, for example, by having the partners add their share of the deficiency to their income for the year of the final determination or a subsequent year, and allowing a refund to the extent their payment exceeded the amount of tax owed on that income computed at their actual marginal tax rate. 4 Section 6221(b): Election Out for Certain Partnerships with 100 or Fewer Partners Background Section 6221(b) allows partnerships to elect-out of the new centralized system for partnership audit, adjustment, assessment and collection of tax if the partnership issues 100 or 3 See Fred T. Goldberg and Kenneth W. Gideon, Widely Held Partnerships: Compliance and Administration Issues: A Report to the Congress (March 30, 1990) (hereinafter referred to as 1990 Proposal ). 4 See 1990 Proposal, Section V.D.4 ( Insolvent Partnerships ) (emphasis added); see also Section V.D.6, footnote 129 ( As discussed in section V(D)(4) above, we recommend that procedures be adopted to collect from current and former partners when the partnership is unable to satisfy a deficiency. ) (demonstrating liability of current partners and need for regulatory authority to establish the procedures).

4 fewer statements (i.e., K-1s) and if the partners are either individuals, C corporations, S corporations or estates of deceased partners. In the case of an S corporation, each K-1 statement issued by the S corporation is counted for this purpose. To be eligible to elect out of the new rules, the partnership must provide a disclosure with the name and taxpayer identification number of each partner and each shareholder of any partner that is an S corporation. Manufacturers urge Treasury to exercise its authority under Section 6221(b)(2)(C) to provide rules similar to those that apply to S corporations to other types of partners. As outlined in the section below, manufacturers support three approaches to address this change ranging from the most broad to most narrow. Recommendation Manufacturers believe that the best approach and the broadest solution would provide rules similar to the rules for S corporations for partners that are partnerships, disregarded entities, or trusts, i.e., treating similarly situated partners equally. Specifically, Treasury guidance should provide that a partnership with one or more direct or indirect partners that is a partnership, disregarded entity, or trust is eligible to make the election under Section 6221(b) if the partnership discloses the name and taxpayer identification number of each recipient of a partnership s K-1, each trustee or deemed owner of a trust, and each person that is the single owner of a disregarded entity, each of whom is taken into account as a statement recipient for purposes of the 100-or-fewer statement criterion. The policy of allowing partnerships with 100 or fewer partners to elect out of the new partnership audit regime should apply where one or more partners is a partnership, disregarded entity, or trust. The ability to consider the owners of a pass-through partnership should not be limited to S corporations. If the partnership provides identifying information for all indirect partners, the IRS would be in the same position to audit, assess, and collect at the partner level as it would be if these partners were direct partners of the partnership. Alternatively, a narrower approach would provide rules similar to the rules for S corporations for partners that are direct or indirect partners of closely-held partnerships. Under this approach, guidance should allow a partnership with one or more direct or indirect partners that is a disregarded entity, trust, or partnership to make the election under Section 6221(b) if (i) the partnership is whollyowned, directly or indirectly, by five or fewer persons, each of whom is an individual, a C corporation or similar foreign entity, an S corporation, or an estate of a deceased partner; and (ii) the partnership discloses the name and taxpayer identification number of each of the five ultimate owners and each direct and indirect partner of the partnership, each of whom is taken into account as a statement recipient for purposes of the 100-or-fewer statement test. The policy of allowing partnerships with 100 or fewer partners to elect out of the new partnership audit regime should apply where a partnership is closely-held, even if one or more partners is a partnership, disregarded entity, or trust. The ability to consider the owners of a passthrough partner should not be limited to S corporations, particularly in a closely-held context. If the partnership provides identifying information for the five ultimate partners and all other direct and indirect partners, the IRS would be in the same position to audit, assess, and collect at the partner level as it would be if such partners were direct partners of the partnership. Any concerns about prompt and efficient tax collection that may be associated with tiered partnerships would be addressed by limiting the application to closely-held partnerships.

5 Finally, the most narrowly tailored recommendation would allow rules similar to the rules for S corporations for partners that are direct or indirect partners of a corporate consolidated groupowned partnership. In this case, guidance should provide that a partnership with one or more direct or indirect partners that is a disregarded entity, trust, or partnership is eligible to make the election under Section 6221(b) if (i) the partnership is wholly-owned, directly or indirectly, by members of the same affiliated group of corporations filing a consolidated return under Section 1501 for the taxable year; and (ii) the partnership discloses the name and taxpayer identification number of the parent corporation and each direct and indirect partner of the partnership, each of whom is taken into account as a statement recipient for purposes of the 100-or-fewer statement criterion. Allowing partnerships with 100 or fewer partners to elect out of the new partnership audit regime should apply where a partnership is wholly-owned by a corporate consolidated group, even if one or more partners is a partnership, disregarded entity, or trust. The ability to consider the owners of a pass-through partnership should not be limited to S corporations, particularly in a corporateowned context. If the partnership provides identifying information for the parent corporation and all direct and indirect partners, the IRS would be able to audit the partnership as part of its audit of the corporate consolidated group. Further, having a single audit of the consolidated group would promote prompt and efficient tax collection. Conclusion NAM members appreciate the Treasury Department s willingness to seek input as you begin to draft guidance implementing the partnership audit provisions in the BBA. These matters of tax administration have a significant impact on our manufacturers ability to compete and we support tax rules that are pro-growth, pro-competitiveness, fair, clear, and predictable. Thank you in advance for considering our comments. If you have any questions, please feel free to contact me at (202) or clee@nam.org. Sincerely,