Responding to the New IRS Audit Partnership Audit Procedures

Transcription

1 ABA Section of Taxation ABA Business Law Section Responding to the New IRS Audit Partnership Audit Procedures Panelists: George A. Hani, Miller & Chevalier Kevin M. Johnson, Pepper Hamilton LLP Warren P. Kean, Shumaker, Loop & Kendrick John Johnny F. Lyle III, Adams and Reese LLP January 20,

2 Overview Summary of New Partnership Audit Rules Open Issues Drafting Considerations in Partnership Agreements 2

3 Bipartisan Budget Act of 2015 Congress repealed and replaced the 1982 Tax Equity and Fiscal Responsibility Act (TEFRA) unified partnership audit procedures and the electing large partnership rules with a new regime for partnership adjustments and audits focused on partnership-level determinations and assessments. Game changer that is going to force most partnerships to amend partnership agreements to take into account the potential partnership entity level assessments. Effective Dates: Effective for partnership tax years beginning after 2017 Partnerships may elect to have the rules apply earlier (to tax years beginning after November 2, 2015). 3

4 Purpose of the Bipartisan Budget Act of 2015 TEFRA - IRS did not have the resources or capability to audit large partnerships and multi-tiered partnerships because of the complexity of allocating adjustments to ultimate partners and assessing tax. - The use of partnerships and LLCs has increased dramatically, but IRS audits of partnerships have not increased to keep up with these trends because administrative burdens in auditing partnerships prevented the IRS from increasing partnership audits. Electing Large Partnership Rules - Enacted to provide an elective alternative regime for large partnerships that avoids some of the administrative complexities was unsuccessful as less than 1% of large partnerships elected to be subject to these rules. New rules estimated to generate $10 billion in tax revenue. Take away: is this the end of complacency as federal government mines for $10 billion by auditing partnership returns? 4

5 Highlights of New Partnership Audit Procedures Audit and Litigation. Like TEFRA, requires partnership-level resolution of all items of partnership income, deduction, gain, loss or credit. Assessment. Unlike TEFRA, default rule is that the partnership is assessed tax liability on the Imputed Underpayment Amount based on the highest applicable federal income tax rate. - Treasury/IRS instructed to adopt procedures to demonstrate that tax should be lower (corporate partners or individual partners subject to lower capital gains or dividend rate). - Imputed Underpayment Amount can be reduced to the extent partners file amended returns and pay the tax under procedures to be adopted by Treasury/IRS. - Partnership can elect to file statements (equivalent to amended K-1s) to each partner for the reviewed year, but resulting tax will be subject to a higher interest rate. 5

6 Election Out for Small Partnerships Partnerships with 100 partners or less can opt out of the entity-level partnership determination. Partners must be individuals, C corporations, S Corporations or estates of deceased partners (no upper-tier partnerships). - S Corp. shareholders counted for purposes of 100 partner test. If election is made, IRS must make determinations at the partner level (just like pre-tefra). Query whether 100 partners is still too large and will still impose an administrative burden on the IRS. Drafting Points: - Should agreement mandate or preclude this election or revocation of election? Should agreement restrict transfers so this election remains available? Should agreement require the partnership to provide the partners the information they may reasonably request to respond to the audit of partnership items? 6

7 Partnership Level Determination and Assessment: Definitions Reviewed Year -- Partnership tax year or return under audit Adjustment Year -- Year in which the adjustment for the reviewed year : - Becomes final under a court decision; - Year in which an adjustments is made pursuant to a request for administrative adjustment (partnership files a request for administrative adjustment); - Year in which final partnership adjustment is mailed. Imputed Underpayment Amount -- Net non-favorable adjustments to the partnership tax year multiplied by the highest applicable tax rates under sections 1 and 11. Partnership Representative -- Party selected to represent the partnership before the IRS and to make tax decisions on behalf of the partnership. 7

8 Partnership Level Determination All partners are bound by a final resolution in the partnership proceeding. - Unlike TEFRA, partners do not have the right to participate in the proceeding or receive notice of the proceedings from the IRS although partner has right to file notice of inconsistent position. Tax assessment is made for the Adjustment Year; not the Reviewed Year. Penalties determined at the partnership level; no partner level defenses to penalties. Only partnership-level statute of limitations is relevant partner statute of limitations no longer taken into account (e) (6-year statute of limitations for substantial omissions of income) determined at partnership instead of partner level. 8

9 Drafting Points Should partners seek to include in the agreements rights similar to those that they had under TEFRRA, such as: - notice rights of beginning of administrative proceeding and final partnership administrative adjustment (former 6223(a)); - TMP is required to keep each partner informed of all administrative and judicial proceedings of partnership items (former 6223(g)); - right to participate in the proceeding (former 6624); - petition for judicial review (former 6626); - petition for an administrative adjustment (former 6627). Should there be different rights depending on whether the partnership will pay the tax under a 6226 or 6225(c)(2) election made to cause the partners to pay the tax? Extend to former as well as current partners? Partners need for information to file amended returns and to pay their shares of the tax? To address when partners enter or exit, should the agreement include indemnification, escrow, or other provisions to address potential tax liabilities from prior years? Should transferor partner or transferee partner or both (joint and several) be liable to the partnership for the share of tax attributable to their interest? 9

10 Partnership Representative Each partnership must designate a Partnership Representative (PR) (Replaces the Tax Matters Partner under TEFRA). - Open Issue: Procedures for when a partnership designates a PR (on the return?) or how frequently a partnership can change its PR designation. PR is not required to be a partner in the partnership. PR must be a person with substantial U.S. presence. Under 7701(a)(1), the term person includes, an individual, trust, estate, partnership, association, company, or corporation - if an entity is designated as the PR, a responsible person (corporate officer, partner, trustee, etc.) must act on behalf of the PR. IRS will appoint a PR if the partnership does not designate one. Drafting Points: How should agreements address selection, removal, replacement of the PR and the PR s authority, duties and liability? 10

11 Partnership Tax Assessment Imputed Underpayment Amount Computation of Imputed Underpayment Amount - All adjustments to income, gain, deduction, and loss are netted and multiplied by the highest rate in Code Section 1 or Any increase or decrease in loss is treated as a decrease or increase in income. - After the Imputed Underpayment Amount is calculated, changes in credits are taken into account as a increase or decrease in the Imputed Underpayment Amount, as appropriate under the circumstances. Drafting Points: - How should agreements address allocation of tax payments to the adjustment-year partners? How should those payments be treated for capital account maintenance? - Should partners (former as well as current) be obligated to pay the partnership their share of the liability? Need for distributions to cover tax and costs to be incurred by partners? 11

12 Partnership Tax Assessment Imputed Underpayment Amount Computation of Imputed Underpayment Amount - Under procedures to be adopted, partnership can submit evidence to show partners are tax exempt entities. - Partnership can submit evidence to modify Applicable Highest Tax Rate Partner receiving ordinary income is a C corporation subject to 35% maximum tax rate. Partner receiving allocation of capital gains and dividends is an individual subject to reduced tax rates. Applicable rate is always the highest rate with respect to the income. Secretary is authorized to issue regulations or other guidance for additional modifications to the Imputed Underpayment Amount. 12

13 Partnership Tax Assessment Imputed Underpayment Amount Imputed Underpayment Amount Partner Amended Tax Returns - Partners who were partners during the Reviewed Year file amended returns taking into account their distributive share of partnership adjustments and pay the applicable tax (notwithstanding statute of limitations issues with respect to the partners return). - Partnership is permitted to reduce the Imputed Underpayment Amount by such applicable tax attributable to the partners filed amended returns. - Reduction in Imputed Underpayment Amount is based on the partners distributive share of partnership adjustments. Open Issue: What procedures will be adopted to reduce the Imputed Underpayment Amount by taxes paid by the partners on amended returns? 13

14 Partnership Tax Assessment Imputed Underpayment Amount Imputed Underpayment Amount Time for Submission of Documents and Evidence - Partnership has 270 days from the date Notice of Proposed Adjustment is mailed to the partnership (pursuant to Code Section 6231) to file any documents or evidence to have the Imputed Underpayment Reduced. Drafting Points: should agreements: - require current and former partners to provide the partnership the information it may need under these new rules to make elections under 6226? - allow the partnership to require partners to file, or prohibit them from filing, amended returns under 6225(c)(2)? 14

15 Alternatives to Partnership-Level Assessment: Amended Statements Partnership Election to Issue Amended Statements - A partnership may elect to issue partnership statements (essentially amended K-1s) to the partners who were partners during the reviewed year. - Election must be made within 45 days of receiving the FPAA. - Partnership must then issue amended K-1s for each partner for the reviewed year. - Partners subject to tax in the year of the statement (not the Reviewed Year). - Partners liable for penalties. - Interest is charged at higher rate (2 percentage points higher than rate in Section 6621(c) (interest charged from due date of partnership return). - Partners have no right to an administrative or judicial review; bound by partnership-level determination. Drafting Points: - Should agreements mandate this election? - If not, should internal procedures be established for deciding whether to make election? - Should agreements require partners and former partners to provide the partnership with information required by the election? 15

16 Open Issues: Election to Issue Amended Statements How will the election to issue amended statements work in a tiered setting? - E.g. will the election apply to a partnership tier such that the partnership is required to issue amended statements or can it pay the entity-level assessment? - What if one of the tiers from the Reviewed Year has terminated before the Adjustment Year? 16

17 Additional Drafting Points Existing partnership/operating agreements: - What if anything should be done? Direct and indirect liability considerations. - No election, partnership pays, i.e., adjustmentyear partners indirectly pay (b) election. Reviewed-year partners pay election. Reviewed-year partners pay (c)(2) amended return election. Reviewedyear partners pay. Other. See accompanying template with commentary. 17

18 Partnership Requests for Administrative Adjustment Partnership Request for Administrative Adjustment - Partnership mechanism for requesting adjustments to tax year (no more amending returns). - Filed within 3 years from the later of: The date that the partnership return was filed, and The due date of the partnership return. 18

19 Partnership Requests for Administrative Adjustment Partnership Request for Administrative Adjustment - If AA requests shows Imputed Underpayment Amount then Partnership must pay the Imputed Underpayment Amount when filing the requests, OR Partnership issues amended K-1s similar to the procedures in Section If there is no Imputed Underpayment Amount then the partnership merely issues amended K-1s to the partners. 19

20 Open Issues: Election to Apply New Partnership Audit Rules Now Procedure to elect to have the new partnership audit rules apply now - In what circumstances would a partnership want to have the new partnership audit rules apply now? 20

21 Questions? George A. Hani, Miller & Chevalier - ghani@milchev.com Kevin M. Johnson, Pepper Hamilton LLP - johnsokm@pepperlaw.com Warren P. Kean, Shumaker, Loop & Kendrick - wkean@slk-law.com John F. Lyle III, Adams & Reese LLP - Johnny.Lyle@arlaw.com 21