The BBA Partnership Audit Rules. What you need to know today to prepare for the new partnership audit regime under the BBA

Transcription

1 What you need to know today to prepare for the new partnership audit regime under the BBA

2 Disclaimer This presentation is provided solely for the purpose of enhancing knowledge on tax matters. It does not provide tax advice to any taxpayer because it does not take into account any specific taxpayer s facts and circumstances. These slides are for educational purposes only and are not intended, and should not be relied upon, as accounting advice. The views expressed by the presenters are not necessarily those of Ernst & Young LLP. This presentation is 2018 Ernst & Young LLP. All Rights Reserved. EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. EY refers to the global organization, and may refer to one or more, of the member firms, of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com. Ernst & Young LLP is a client-serving member firm of Ernst & Young Global Limited operating in the US. Page 2

3 Presenters Jeff Erickson Partner (Washington, D.C.), Ernst &Young LLP Phone: (202) Matt Cooper Senior Manager (Washington, D.C.), Ernst & Young LLP Phone: (202) Ben Mower Senior Manger (Houston, TX), Ernst & Young LLP Phone: (713) Page 3

4 Today s agenda Background Final and proposed regulations Additional considerations for partnership agreements Financial accounting considerations Page 4

5 Background New partnership rules and procedures enacted by the Bipartisan Budget Act of 2015 (Budget Act) Budget Act partnership rules affect: Audit procedures Who pays tax How much tax is paid Joint Committee on Taxation (JCT) estimates the provisions will raise almost $10 billion over a 10-year period Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) is generally the current regime for auditing most partnerships but IRS has had trouble administering New rules replace TEFRA and electing large partnership (ELP) rules Page 5

6 Many open questions Proposed regulations published on June 14, 2017 providing general guidance on Budget Act rules Proposed regulations published on November 30, 2017 concerning the application of certain international tax rules Proposed regulations published on December 19, 2017 regarding push-out election under section 6226 Final regulations published on January 2, 2018 on electing out of centralized partnership audit regime Proposed regulations published on February 2, 2018 on addressing how partnerships and their partners adjust tax attributes to take into account partnership adjustments Questions are still unanswered and possibility for technical corrections to be enacted by Congress in 2018 Page 6

7 Effective date Budget Act rules apply generally to partnership tax years beginning after December 31, A partnership may elect to apply the new procedures to earlier years: temporary and proposed regulations on optin election issued on August 4, Effective date for opt-in election applies to tax years beginning after November 2, 2015 and before January 1, Timing: Election must be made within 30 days of the date that the IRS first notifies the partnership in writing that a partnership return for an eligible tax year has been selected for examination. Election also could be made with administrative adjustment request filed after December 31, Election must be in written form and include specific language. Page 7

8 Tax Technical Corrections Act of 2016 (TTCA) TTCA was not passed by Congress but possible it could be re-introduced sometime in If re-introduced and enacted, TTCA would provide additional rules under BBA with respect to: Treatment of tiered structures A new pull-in method Determination of imputed underpayments Definition of partnership-related items Authority to issue special enforcement rules Page 8

9 IRS partnership audits The IRS will examine the partnership s tax year (the reviewed year). Adjustments are taken into account by the partnership in the year that the audit or any judicial review is completed (the adjustment year). Default rule: Partnership pays imputed underpayment on income it omits or misallocates (the imputed underpayment) For overpayments, partnership reduces income in the year of adjustment to correct prior over reporting Options to avoid or reduce partnership-level imputed underpayment resulting from an IRS notice of proposed partnership adjustment: Partner(s) amend returns under modification procedures. Also, partner attributes may reduce imputed underpayment amount (e.g., taxexempt partners). After final notice of partnership adjustment issued partnership-level imputed underpayment is avoided by the filing of a Section 6226 Push Out Election to require reviewed year partners to pay additional tax owed based on their allocable share of the IRS adjustment. Page 9

10 Partnerships subject to Budget Act rules Budget Act rules are mandatory when partnership: Has more than 100 partners, or A partner is other than an individual, C corp, S corp or estate A flow-through partner (other than S corps) is an ineligible partner under proposed regulations. For partnerships eligible to elect out: Default rule is that the Budget Act rules apply. Election out of Budget Act rules must be made each year. Thus a partnership could be subject to different audit regimes in different years. If the Budget Act rules do not apply, the pre-1982 non-tefra rules apply. IRS would need to make adjustments to each partner separately in separate proceedings. Page 10

11 The partnership representative New role of Partnership Representative (PR) replaces tax matters partner. PR is the sole person with authority to act on behalf of the partnership and its partners. The PR may be any person, including an entity, and need not be a partner. If an entity is designated the partnership must also appoint and identify an individual to act on the entity s behalf. Difficult to change who the PR is once designation is made. The role of the PR is more powerful than administrative role held by tax matters partner. Eligible persons: any person with a substantial presence in the United States Under the proposed regulations substantial presence means the PR must: Be able to meet with the IRS in the US at a reasonable time and place as necessary Be reachable during normal business hours at a US street address and have a phone number with a US area code Have a US Taxpayer Identification Number (TIN) Page 11

12 Proposed and Final regulations Page 12 The BBA Partnership BBA Partnership Audit Rules

13 Proposed June 2017 regulations Proposed regulations re-released on June 14, 2017 has 277 pages. No significant changes from proposed regulations released and withdrawn in January Provides additional guidance on the applicable procedures, the determination of the amount of taxes, interest, and penalties owed, and other consequences of an adjustment to a partnership tax return. Page 13

14 Proposed June 2017 regulations: Include additional guidance on: The scope of partnership items covered by the new rules Determining amounts owed by a partnership or its partners from adjustments following a partnership exam Filing of a push-out election for reviewed year partners to take exam adjustments into account Filing of administrative adjustment requests Page 14

15 Proposed June 2017 regulations: scope Determined and adjusted at partnership level: all items and information required to be shown, or reflected, on the partnership s return and any information in the partnership s books and records. Including: Any effect the character or value of the partnership s assets has on the sale or exchange of an interest in the partnership (for example, for purposes of Section 751(a)), and Items relating to transactions between a partnership and any person including disguised sales, guaranteed payments, and transactions to which Section 707 applies. Page 15

16 Proposed June 2017 regulations: scope Sale of partnership interest Partnership might owe underpayment amount if selling partner misreports the character of its gain or loss Should selling partner be obligated to indemnify the partnership? Selling partner might have paid too much tax Disguised sale of property to a partnership Check terms in the partnership agreement and the purchase and sale agreement Page 16

17 Proposed June 2017 regulations: error in character There are two different adjustments that are not netted together. $100 of capital gain was omitted Result: imputed underpayment based on $100 of income $100 too much ordinary income as reported Result: partnership omits $100 of its income from the year the adjustment is made Doesn t matter whether partners already paid too much tax Differs from what would have happened had the partnership reported everything Only way to get the correct result: all partners amend their returns as part of the modification process Not clear that indemnity or push-out election always produce the correct result Page 17

18 Proposed June 2017 regulations: groupings of adjustments Requires examination adjustments to be grouped as follows: Step 1: Separate the adjustments in the Notice of Proposed Partnership Adjustment (NOPPA) into four groupings and unlimited number of subgroupings. Credit grouping Creditable expenditure grouping Reallocation grouping Residual grouping Step 2: Combine and net any subgroups that are permitted to be combined and netted. Step 3: Set aside all net negatives (i.e., increases in loss). Step 4: Multiply each net positive by the highest tax rate in effect in the reviewed year. Step 5: IRS may group adjustments together to determine a specific imputed underpayment based on those adjustments. Remaining adjustments form basis for general imputed underpayment. Page 18

19 Proposed June 2017 regulations: modification of imputed underpayment Partnership representative may request a modification within 270 days of NOPPA mailing based upon: Partner filed amended return(s) and paid everything due for all affected years Partner entered into closing agreement with IRS and paid everything due Partner is tax-exempt and would be exempt from tax on allocated amount Partner is C corp or (for capital gain or qualifying dividend) individual Specified passive activity loss of a publicly traded partnership (PTP) Deficiency dividends for a regulated investment company (RIC) or real estate investment trust (REIT) Other Must submit: Detailed description of structure, allocations, ownership (including changes) and partners The partnership agreement If indirect partners are relevant, similar information for each tier as IRS requests Page 19

20 Proposed June 2017 regulations: push-out election Alternative to the general rule that the partnership pays the imputed underpayment Reviewed year partners pay 45-day period to make election after Notice of Final Partnership Adjustment (FPA) Partnership must send 6226 statement to each reviewed year partner and to IRS If partnership meets all requirements for valid push-out, reviewed year partners required to pay and partnership is 100% off the hook Any penalties, additions to tax, or additional amounts are determined at the partnership level, and the reviewed year partners are liable for their share Interest determined at the partner level If partner has filed an amended return or entered into closing agreement already, there is coordination Push-out elections for tiered partnerships not addressed Page 20

21 Proposed June 2017 Regulations: Administrative adjustment requests Administrative Adjustment Requests (AAR) allowed to be filed within three years from the filing of original partnership return AAR must be signed by Partnership Representative AARs resulting in imputed underpayments: Partnership may pay imputed underpayment with the filing of the AAR Partnership allowed to request modification of imputed underpayment with the AAR filing Alternatively, partnership may elect to have reviewed year partners take the adjustments into account Partnership issues statements to partners; similar to 6226 statements Partner must compute amount owed by looking at tax impact in adjustment year and any intervening year(s) Partners report tax due from AAR adjustment in reporting year Page 21

22 Proposed June 2017 Regulations: Administrative adjustment requests AARs resulting in other than imputed underpayments: Must be taken into account by those who were partners in the year being corrected Partnership issues statements similar to 6226 statements to partners Computation rules under Section apply with some modifications Partners may reduce chapter 1 tax for the reporting year (year statement is furnished) resulting from the AAR adjustment or if no chapter 1 tax is owed the partner may make a claim for refund Page 22

23 Proposed December 2017 Regulations: Push- Out Election and Tiered Partnerships Under the proposed regulations, at each tier, a passthrough partner may choose either to pay tax with respect to an adjustment or to push it out to its partners, shareholders or beneficiaries. For pass-through partners choosing to further push an adjustment out to the next tier, the new proposed regulations include rules regarding the furnishing of statements to the next-tier partners and the information to be included therein. Removes safe-harbor statement in proposed June 2017 regulations. Page 23

24 Final January Regulations: Electing out of Budget Act The final regulations generally declined to adopt recommendations that statements furnished to certain types of partners (for example, statements furnished to pass-through entities and disregarded entities) should not be taken into account for purposes of determining whether the partnership is required to furnish 100 or fewer statements. The term eligible partner does not include partnerships, trusts, foreign entities that are not eligible foreign entities, disregarded entities, persons that hold an interest on behalf of another person, and estates that are not estates of a deceased partner. The election must be made on a timely-filed partnership return (including extensions) for the tax year to which the election relates. The partnership must provide the name, correct U.S. taxpayer identification number (TIN) and federal tax classification of each partner and each shareholder of a partner that is an S corporation. Page 24

25 Proposed February Regulations: Adjustment of Partnership/Partner Attributes Section 6225 rules relating to partnership adjustments resulting in imputed underpayment: Proposed regulations include rules for -- 1) adjusting partnership asset basis and book value, (2) creating notional items, (3) allocating these notional items under Section 704(b), (4) defining successors in situations in which reviewed year partners are not adjustment year partners, (5) determining the impact of notional items on tax attributes in certain situations, and (6) allocating any partnership expenditure related to the imputed underpayment. Section 6225 rules relating to partnership adjustments that do not result in imputed underpayment: the rules under subchapter K apply Page 25

26 Proposed February Regulations: Adjustment of Partnership/Partner Attributes Section 6226 Push-Out rules: The new proposed regulations provide that the reviewed year partners or affected partners must take into account items of income, gain, loss, deduction or credit with respect to their share of the partnership adjustments as contained on the statements in the reporting year. The allocation of a pushed-out item will be deemed to be in accordance with the partners interests in the partnership if it is allocated in the adjustment year in the manner in which the item would have been allocated under the rules of Section 704(b). Adjustments to partnership-level tax attributes are calculated with respect to each year beginning with the reviewed year, followed by subsequent tax years, concluding with the adjustment year. Page 26

27 Additional considerations for partnership agreements Page 27 The BBA Partnership BBA Partnership Audit Rules

28 Treatment of tax payment and indemnification Consider special allocation of imputed underpayment cost Payment is a partnership expense, not a distribution, for income tax purposes Numerous provisions can be affected (e.g., distribution provisions, definition of net income or loss, tax allocations) Treatment of indemnity payment by a former partner is unclear Potentially taxable income for the partnership Unclear how former partner would treat payment Unclear if former partner remains a tax partner Structure to reduce risk Page 28

29 Election out If the partnership can and wants to elect out, consider restricting: Number of partners Types of partners No disregarded entities or trusts No nominees Changes to tax status that would render a partner ineligible Each partner would be audited separately Partners will need access to the partnership s books and records, even after they are no longer partners Page 29

30 Cooperation Require partners to cooperate? Require partners to indemnify the partnership if they don t cooperate? Amended returns might have to be filed, and additional taxes paid, before partnership adjustments are final Require the partnership to cooperate when a partner might be entitled to a refund? Might reduce amount of tax owed by a partnership Might enable a partner to obtain a refund Page 30

31 General principles Flexibility Control over or limitations on actions of partnership representative Notice Cooperation No one size fits all fix Page 31

32 Financial accounting considerations Page 32 The BBA Partnership BBA Partnership Audit Rules

33 IRS partnership audits Financial accounting considerations Accounting implications? ASC 740 income tax accounting rules do not apply to partnership level payment of an imputed underpayment resulting from an IRS partnership audit conducted under the BBA rules. Partnerships should evaluate under other accounting guidance (i.e., ASC450 or other) to determine whether their particular facts and circumstances warrant recording a balance sheet liability with a corresponding offset to partners capital for IRS audits. Page 33

34 Summary of Top 10 procedural changes TEFRA vs. BBA Page 34 The BBA Partnership BBA Partnership Audit Rules

35 Top 10 procedural changes TEFRA vs. BBA 1. How tax is paid TEFRA: Partners pay tax; year under audit is adjusted and IRS charged with computing partner level adjustments. BBA: Partnership pays imputed underpayments as a default rule. Current year partners bear economic burden. 2. Treatment of small partnerships TEFRA: Automatic exclusion for qualified small partnerships (10 or fewer eligible partners). BBA: Default rule BBA applies to all partnerships. Small partnerships (100 or fewer eligible partners) must file annual election-out of the BBA rules on a timely filed return (including extensions) no 9100 relief available. 3. Notifications and participation during IRS exam TEFRA: IRS provides Notice of Beginning of Administrative Proceeding (NBAP) and Final Partnership Administrative Adjustment (FPAA) to Notice Partners; partners have participation rights. BBA: Partners have no rights to notice of the audit and no participation rights. Page 35

36 Top 10 procedural changes TEFRA vs. BBA 4. Designated representative TEFRA: Tax Matters Partner (TMP) designated by partnership. Must be a general partner. Plays an administrative role, providing notification to partners of examination proceeding, signing power of attorney form, signing statute extensions. No authority to bind partners to settlement unless partnership had more than 100 partners and partner had less than 1% interest. Required to be a partner in the partnership. BBA: Partnership Representative (PR) designated by partnership. Not required to be a partner. Must have substantial presence in the United States defined as a US address, phone #, TIN; and must be available to meet with IRS during normal business hours. Must have capacity to act. PR has sole authority to act on behalf of the partnership and partners in an IRS proceeding. Partnership Representative sole person to sign IRS audit adjustment agreements binding both the partnership and partners (direct and indirect) to IRS audit adjustments. Authority to sign statute extensions. Page 36

37 Top 10 procedural changes TEFRA vs. BBA 5. Push-out election TEFRA: Not required. IRS required by statute to compute partner level adjustments. BBA: For reviewed year partners to be liable, PR must make a timely election to push-out audit adjustments resulting in imputed underpayment. Partnership must issue statement to reviewed year partner. Consistent treatment requirement applies to the adjustments in the statements issued to partners as a result of an AAR being filed. Page 37

38 Top 10 procedural changes TEFRA vs. BBA 6. Liability of partners TEFRA: Only partners for year under exam responsible for any additional tax owed. BBA: Current year partners bear the burden of partnership payment of imputed underpayment. In addition, if partnership fails to pay imputed underpayment and IRS determines that partnership ceased to exist, then former partners are liable for tax owed. Push-out election required to have only reviewed year partners liable. 7. Treatment of partnership favorable audit adjustment TEFRA: All adjustments are taken into account at partner level for tax year under exam; both favorable and unfavorable adjustments. IRS charged with computing partner level adjustments. Refunds are possible at partner level. BBA: Favorable adjustments not resulting in an imputed underpayment must be taken into account by the partnership and reported on the partnership s current year tax return. No refunds to reviewed year partners for the reviewed year. Page 38

39 Top 10 procedural changes TEFRA vs. BBA 8. Reallocation adjustments TEFRA: IRS allowed to process the reallocation and correct all partner accounts impacted by the reallocation regardless of whether adjustment was favorable or unfavorable. BBA: May be corrected by partnership filed AAR prior to audit notice. Each impacted partner issued a statement; reports adjustments with current year return. Reallocation adjustment during IRS Exam all impacted partners must file amended returns during the 270-day modification process to correct. Closing Agreement might also be an option. Otherwise current year reporting of the portion of the allocation that does not result in imputed underpayment is required. 9. Statute of limitations TEFRA: Three-year partnership level assessment statute of limitations applies to the tax year under audit. Separate three-year partner level assessment statutes may also be considered. Form 872-P signed to extend partnership level statute of limitations. BBA: Any amount of tax owed is paid and assessed in the adjustment year as part of the adjustment year tax return filing. During an audit the IRS must issue the FPA within three years from the date the partnership return was filed. Parties may agree to extend the date to issue the FPA. No extension of the reviewed year assessment statute of limitations is required. No separate partnership level statute of limitations for assessment of tax. Page 39

40 Top 10 procedural changes TEFRA vs. BBA 10. Administrative adjustment requests (AARs) TEFRA: TMP filed AAR on behalf of entire partnership or partners allowed to file partner level AARs. For a TMP-filed AAR, IRS could choose to take no action forcing partnership to file suit in order to have adjustments in AAR allowed. For accepted AAR, the IRS is generally not computing refunds and is requiring partner level amended returns. For a partner level AAR, the IRS could allow and process the AAR for that partner only, disallow the partner level AAR forcing the partner to file suit or open a partnership level audit. Okay to file AAR while audit ongoing but not after FPAA. BBA: Only partnership level AAR allowed to be filed. Partnership may choose to pay any imputed underpayment due or elect to issue statements to partners for reviewed year. AAR not required to first be accepted by the IRS; partners who receive statements are to make adjustments in the reporting year when statements are furnished. Consistent treatment rule applies. Partnership not allowed to file AAR after notice of audit issued (except for early elections into BBA for eligible years before Page 40

41 A few unanswered procedural questions 1. IRS Appeals where do appeal rights arise in the administrative process? Audit Notice of Proposed Partnership Adjustment 270-day modification period Notice of Final Partnership Adjustment 45-day period for 6226 push-out election and partnership issues statements 90-day period to file court petition 2. The 270-day modification process how will this work if taxpayer wants to go to Appeals? Who will consider modifications? Appeals? Or will the case go back to Exam? Most likely will need to extend the 270-day period if seeking Appeals consideration. Page 41

42 One-minute recap Page 42

43 Summary New rules are very complicated Much uncertainty Generally apply to tax years that begin after 2017 Stay tuned! Page 43