Dallas Bar Association Tax Section December 4, 2017 New Partnership Audit Rules: What They Mean to Partnerships and Tax Professionals Copyright All rights reserved. Presented By: Charles D. Pulman, J.D., LL.M., CPA Matthew L. Roberts, J.D., LL.M. Overview of PAR The Bipartisan Budget Act of 2015 (BBA) was signed into law on 11/02/15. The BBA was amended by the Protecting Americans from Tax HikesAct (Path Act) of 2015. In March 2016, the Joint Committee on Taxation issued General Explanation of Tax Legislation Enacted in 2015, which discusses the new Revised Partnership Audit Rules (PAR). On 01/18/17, Proposed Regulations were issued with respect to PAR. These Regulations were later withdrawn but reissued on 06/14/17 with minor changes. The Proposed Regulations have not been finalized and many questions remain about PAR and its application. 2 1
Partnership Audit Rules History Deficiency procedures at partner level (Pre- 1982) TEFRA (1982) Electing Large Partnership Rules (1997) PAR (2018) Next? 3 Application PAR apply to partnership returns filed for partnership taxable years beginning after 12/31/17 unless the partnership has made a valid opt-out election. PAR apply to any entity taxed as a partnership for federal income tax purposes, e.g., limited partnerships and LLCs, regardless of whether the entity in question has correctly filed a partnership return. In the case of an Administrative Adjustment Request (AAR), PAR apply to requests with respect to returns filed for partnership taxable years beginning after 12/31/17. Centralized system of audit, assessment, and collection of tax at partnership level. 4 2
5 Filing of Partnership Return Initial Issues: Should an opt-out election be made if qualify? Who should serve as partnership representative? Should the partnership representative be a partner or nonpartner? If make opt-out election, should a partnership representative be designated? Is this permitted? 6 3
The Partnership Representative The partnership representative has sole authority to act on behalf of the partnership, including all actions during examination and judicial proceedings. Partners may not participate in or contest results of the examination nor participate in judicial proceedings. Partners are bound by all decisions made by the partnership representative during the examination or judicial proceedings. There may be only one designated partnership representative for a partnership taxable year. Any person is eligible to serve as a partnership representative, provided the person has a substantial presence in the U.S. and capacity to act. An entity may serve as partnership representative only if designated individual meets the substantial U.S. presence and capacity requirements is appointed through which the entity will act. 7 The Partnership Representative Partnership representative may change in three instances: Resignation; Revocation; or The IRS determines that a partnership representative designation is not in effect. Resignation or revocation effective only if an AAR is filed or a NOAPP has been issued. 8 4
The Partnership Representative Query: What address should the partnership use for purposes of designating the partnership representative? What happens if the partnership representative dies, is incarcerated, or is otherwise incapacitated and the IRS issues a NOAPP to the partnership representative? What happens if the partnership fails to designate a partnership representative? How does the partnership limit the decisions of the partnership representative after a resignation or revocation, given that the partnership representative resignation or revocation is not effective until 30 days has elapsed? 9 Opt-Out Election Partnerships with 100 or fewer partners can opt-out if all of the partners are eligible partners and timely election on the partnership return. Eligible partners are individuals, C corps, foreign entities treated as C corps for U.S. tax purposes, S corps, and estates of deceased individuals. Election and notice to partners must be made annually. 10 5
Opt-Out Election Section 6221(b)(2)(C) The Bluebook seems to suggest that Congress envisioned other entities as eligible partners, such as disregarded entities, trusts, and certain tiered partnerships with 100 or fewer indirect partners. Bluebook at 60. The IRS has not chosen to expand the list of eligible partners. Partnerships, LLCs, trusts, IRAs, qualified pension, profit-sharing and stock bonus plans disqualify the partnership from making an opt-out election. 11 Effect of an Opt-Out Election If a valid opt-out election is made, deficiency proceedings conducted at the partner level to adjust items, resolve issues, and assess and collect any tax. Each partner-level deficiency proceeding will be subject to its own statute of limitations and venue, which may result in inconsistent determinations among different partners. Proposed Regulations indicate that an opt-out election is valid unless the IRS determines the election is invalid. See Prop. Reg. 301.6221(b)-1(c). If a partnership is subject to PAR and its partnership-partner opts-out of PAR, the partnership-partner is subject to PAR for purposes of any PAR adjustments to the partnership. See PAR Flowchart. 12 6
Default Rules/No Opt Out See PAR Flowchart Scope of PAR Section 6221(a) Any adjustment to items of income, gain, loss, deduction, or credit of a partnership (and any partner s distributive share) determined at the partnership level. Proposed Regulations interpret terms income, gain, loss, deduction, or credit broadly. See Prop. Reg. 301.6221(a)-1. No longer a distinction between partnership items, affected items, and non-partnership items as per TEFRA. 14 7
Scope of PAR Income, gain, loss, deduction, or credit includes: All items and information required to be shown, or reflected, on a partnership return, IRS forms, and any information in the partnership s books and records; The character, timing, source, and amount of the partnership s income, gain, loss, deductions, and credits; Contributions and distributions to and from the partnership; The partnership s basis in its assets, the character and type of the assets, and the value of the assets, including any effect the character or value of the partnership s assets has on the sale or exchange of an interest in the partnership; The amount and character of partnership liabilities, including whether a liability is recourse or nonrecourse and any changes to those liabilities from the preceding tax year; Any elections made by the partnership and the consequences or effects of those elections, including a Section 754 election, any election referenced in Section 703(b), a Section 761 election, and an election under Sections 6221(b) or 6226(a). Partner capital accounts. See Prop. Reg. 301.6221(a)-1 15 Penalties Section 6221(a) Applicability of any penalty, addition to tax, or additional amount which relates to an adjustment also determined at the partnership level. Partnership representative required to raise any partner-level penalty defenses during examination or judicial proceedings otherwise, penalty defenses are waived. Prop. Reg. 301.6221(a)- 1(c). 16 8
Adjustment Year: Key PAR Terms If a proceeding under Section 6234 (i.e., judicial review of a partnership adjustment), the tax year the court decision is final; If an AAR is filed under Section 6227, the tax year in which the AAR is made; or In all other cases, the tax year in which the Notice of Final Partnership Adjustment ( FPA ) is mailed under Section 6231. Section 6225(d)(1). 17 Key PAR Terms Reviewed Year: Tax year to which the tax item adjusted relates, i.e., the year audited by the IRS. Section 6225(d)(1). Imputed Underpayment Amount: Amount of tax owed by the partnership, which is computed as the total netted Net Positive Adjustments multiplied by the highest tax rate applicable to individuals or C corps for the Reviewed Year. Section 6225; Treas. Reg. 301.6225-1(c). 18 9
Key PAR Terms - Grouping Reallocation Grouping: Adjustment that reallocates an item among 1 or more partners. Credit Grouping: Adjustment to items the partnership claimed or could have claimed as a credit. Residual Grouping (Catch-All): All other adjustments to items the partnership claimed or could have claimed on the partnership s tax return. Creditable Expenditure Grouping: Regs. Reserved in Prop. Sub-grouping: Adjustments made on account of the item s character or to account for preferences, sources, categories, limitations or other restrictions. Prop. Reg. 301.6225-1(d)(2). 19 Key PAR Terms Net Positive Adjustments: The sum of the adjustments in any one grouping or sub-grouping, as applicable, results in a potential increase in tax. Net Non-Positive Adjustments: The sum of the adjustments in any one grouping or sub-grouping, as applicable, results in a potential decrease in tax. Total Netted Partnership Adjustment: The sum of all Net Positive Adjustments in the residual grouping plus the sum of all Net Positive Adjustments in the reallocation grouping. Prop. Reg. 301.6225-1(d)(3). 20 10
Imputed Underpayment Amount Step 1: IRS adjustments are placed in one or more of the following groupings: (i) reallocation; (ii) credit; and (iii) residual. Step 2: IRS adjustments in each grouping are further divided in subgroupings, e.g., ordinary items, capital gains, qualified dividends. Step 3: Net the items in each grouping or subgrouping to determine whether netted items result in Net Positive or Net Non-Positive adjustments. Step 4: If the amount results in a total netted partnership adjustment, i.e., only net positives, multiply such amount by the highest applicable tax rate for individuals or C corps for the Reviewed Year. Step 5: If there is a credit grouping, make corresponding adjustments to the Imputed Underpayment Amount; however, in the event the credit grouping results in zero or no tax, there is no Imputed Underpayment Amount. 21 Net Non-Positive Adjustments If there is a Net Non-Positive Adjustment, then the adjustment is taken into account by the partners in the Adjustment Year as a reduction in non-separately stated income or gain or separately stated income or gain under Section 702 or an increase in non-separately stated deduction or loss or separately stated deduction or loss under Section 702, as applicable. An adjustment in a credit is a separately stated item. Prop. Reg. 301.6225-3(b). 22 11
Net Positive and Net Non-Positive Adjustments For any one tax year, there may be both Net Positive and Net Non-Positive Adjustments based on the groupings and subgroupings. The Net Positive and Net Non-Positive Adjustments may not be netted together for any one tax year nor may they be netted together for different tax years. If the tax year has both Net Positive and Net Non-Positive Adjustments, the Net Positive Adjustments result in an Imputed Underpayment Amount. The Imputed Underpayment Amount must be paid in the Adjustment Year unless the partnership representative pushes out the adjustments to the Reviewed Year partners. The Net Non-Positive Adjustments must be taken into account by the Adjustment Year partners unless the partnership representative pushes out the adjustments with an Imputed Underpayment Amount to the Reviewed Year partners. A push out election may not be made if the adjustments only result in Net Non- Positive Adjustments; stated differently, a push out election may only be made if there is also an Imputed Underpayment Amount. 23 PAR Notices Under PAR, IRS issues three notices: Notice of Administrative Partnership Proceeding (NOAPP). Notice of Proposed Partnership Adjustment (NOPPA). Notice of Final Partnership Adjustment (FPA). All notices go to the partnership and partnership representative. See PAR Flowchart. 24 12
Notice of Administrative Partnership Proceeding (NOAPP) Initiates partnership-level examination of Reviewed Year. No AAR may be filed. 25 Notice of Proposed Partnership Adjustment (NOPPA) Sets forth the underlying adjustments to the partnership s return. May consist of Net Positive Adjustments resulting in an Imputed Underpayment Amount, Net Non-Positive Adjustments, or a combination of the two, as discussed before. 26 13
Modification Procedures Partnership may request modification of Imputed Underpayment after NOPPA. Request for modification must be made and all necessary information must be provided within 270 days after NOPPA; however partnership representative may request an extension. IRS has discretion to accept or reject the requested modification. If NOPPA has only Net Non-Positive Adjustments, may not request a modification. See PAR Flowchart. 27 Modification of Imputed Underpayment Amended returns by partners. Tax-exempt partners. Modification of applicable highest rate. Passive losses of publicly-traded partnerships. Catch-all. 28 14
Amended Returns by Partners Modification of the Imputed Underpayment Amount if Reviewed Year partner(s) files amended returns and pay any tax and penalties related to the Reviewed Year and other affected years adjustments. The amended return includes the Imputed Underpayment items and the Net Non-Positive Adjustment items. If the result of including all adjustments is a refund for the Reviewed Year, the normal 3-year statute of limitations for refund claims under Section 6511 is waived. If the adjustment results in a reallocation, all partners affected must file amended return. The amended return modification procedures appear to be the only method for Reviewed Year partners to obtain a refund of tax. The Reviewed Year partners may not obtain a refund of tax with respect to a Push Out election. 29 Amended Returns by Partners Query: If the IRS denies the requested modification, what relief will taxpayers have for refund of tax (either administrative or judicial)? Proposed Regulations permit indirect partners to request modification via the amended return procedures. How elaborate will substantiation be in these instances? What happens if the Reviewed Year partners file amended returns and pay the tax but the IRS fails to accept the requested modification? 30 15
Modification of Applicable Highest Rate A modification may be requested for a lower tax rate applicable to partners which are C corporations or, in the case of a capital gain or qualified dividend, individuals. If a partner has varying percentage interests in partnership items of income, gain, loss, deduction or credit, the partner s percentage share of the Imputed Underpayment Amount to which the lower rate applies is determined by reference to the amount of the partner s distributive share of net gain or loss arising out of a hypothetical sale of all partnership assets at their fair market as of the close of the Reviewed Year. Bluebook at 67; Prop. Reg. 301.6225-2(b)(3)(iii). Query: How will the fair market value be determined? Will the IRS require an appraisal? 31 Catch All Modification Proposed Regulations permit the partnership to request a modification not otherwise provided for in the Proposed Regulations. In such a case, the IRS will determine whether the requested modification is accurate and appropriate. Prop. Reg. 301.6225-2(d)(9) 32 16
Notice of Final Partnership Adjustment (FPA) Must be issued more than 270 days from the date the NOPPA is issued. May contain Imputed Underpayment Amount, i.e., net positive adjustments, Net Non-Positive Adjustments, or a combination of the two. 33 Notice of Final Partnership Adjustment If the FPA contains only Net Non-Positive Adjustments, Imputed Underpayment Amount must be taken into account in the Adjustment Year by the Adjustment Year partners. If the FPA contains an Imputed Underpayment Amount (with or without Net Non-Positive Adjustments), partnership representative has three options: (i) accept the adjustments in the FPA, which will be assessed at the partnership level; (ii) file a petition with the U.S. Tax Court, U.S. District Court, or U.S. Court of Federal Claims; or (iii) Push Out the adjustments to the Reviewed Year partners. See PAR Flowchart. 34 17
The Push Out Alternative to Partnership Payment (The Push Out ) The Reviewed Year partners pay their share of tax due or safe harbor amount : Election made not later than 45 days after date of FPA and the partnership furnishes required statements to the IRS and each partner. A push out election, once made, is revocable only with IRS consent. Section 6226(a). IRS will not grant extension of 45-day period. Push Out can be for any or all of Imputed Underpayment Amount. See PAR Flowchart. 35 The Push Out Query: Can the partnership push-out the Imputed Underpayment Amount to indirect partners? Proposed Regulations have reserved on this issue. IRS Officials have indicated that they are working on Proposed Regulations for tiered-partnership pushouts. IRS Aiming to Propose Basis, Capital Account Rules by Year s End, Tax Mgmt. Weekly Report (11/13/17). 36 18
Judicial Review Permits the partnership representative to file a lawsuit challenging the FPA in: (i) the United States Tax Court; (ii) United States District Court; or (iii) United States Court of Federal Claims. Petition must be filed within 90 days after the date on which the FPA mailed. If the petition filed in the United States District Court or the United States Court of Federal Claims, the partnership representative must deposit with the IRS, on or before the date the petition is filed, the Imputed Underpayment Amount as provided in the FPA. 37 Administrative Adjustment Requests See PAR Flowchart 19
Administrative Adjustment Requests (AAR) The AAR provisions of PAR describe the procedures for amending partnership returns and filing related refund claims. See Section 6227. A partnership may file an AAR with respect to one or more items of income, gain, loss, deduction or credit. A partnership may not file an AAR more than 3 years after the later of: (i) the date on which the partnership return for such year is filed, or (ii) the last day for filing the partnership return for such year (determined without regard to extensions). In addition, a partnership may not file an AAR after a NOAPP has been issued. Once Schedule K-1 issued, cannot be further amended. 39 Administrative Adjustment Requests (AAR) If the AAR results in only Net Non-Positive Adjustments and no Imputed Underpayment Amount, the adjustment must be taken into account by the Reviewed Year partners. If the AAR results in an Imputed Underpayment Amount with or without Net Non-Positive Adjustments, the partnership has three options: Modification allowed of Imputed Underpayment Amount except amended return modification procedures do not apply. Take the adjustments into account in the Adjustment Year; or Make a Push Out election and push the adjustments out to the Reviewed Year partners. 40 20
Statute of Limitations The Statute of Limitations for IRS adjustments expires on later of: Date which is 3 years after the later of the date on which the partnership return for the Reviewed Year was filed, the return due date for the taxable year, or the date on which the partnership filed an AAR with respect to such year; In the case of a modification request, the date that is 270 days (plus the number of days of any extension consented to by the IRS) after the date on which everything required to be submitted to the IRS is submitted; or In the case of a NOPPA, the date that is 330 days (plus the number of days of any extension consented to by the IRS). Section 6501 does not apply. 41 Taxation Without Representation? PAR seems to contemplate that partners of the partnership, particularly Reviewed Year partners, may be subject to tax notwithstanding their lack of notice and participation in the examination or judicial proceedings. Two constitutional concerns with PAR: No notice requirements to partners of administrative or judicial proceedings; No right to participate in administrative or judicial proceedings. Constitutional? 42 21
Due Process Concerns Federal courts held that TEFRA provisions did not deny partners due process: Kaplan v. U.S., 133 F.3d 469 (7 th Cir. 1998) (no denial of due process where less than 1-percent partners were not provided notice). Walthall v. U.S., 131 F.3d 1289 (9 th Cir. 1997) (no denial of due process where indirect partners not provided notice). 1993 Western Reserve Oil & Gas Co., Ltd. v. Commissioner, 95 T.C. 51 (1990) (noting that no denial of due process where not every partner is permitted to notice or to file petition). 43 Due Process Concerns Walthall v. United States We must determine whether... [TEFRA] is reasonably calculated, under the circumstances, to give indirect partners an opportunity to contest tax return adjustments. TEFRA ruled constitutional because it requires TMP to keep all partners informed of administrative proceeding and requires pass-through partners to forward notices of proceedings to indirect partners. See Old Section 6223(g), (h)(2). 44 22
Due Process Concerns Kaplan v. United States [The Kaplans] challenge Section 6223(b)(1), which cuts off personal notice for partners who own less than one-percent shares in partnerships comprised of more than one hundred partners. Although we agree that notice is the heart of due process... the Constitution does not require personal notice in every situation in which the Government action impacts a person s life, liberty, or property. Rather, due process is flexible and calls for such procedural protections as the particular situation demands. TEFRA ruled constitutional because it requires the tax matters partner to keep all other partners informed of FPAA s or administrative proceedings. 45 46 23
Points to Remember Partnership representative has broad and exclusive authority. Adjustment Year partners are those in year adjustment becomes final, not partners in year audit starts. Partnership Representative for Reviewed year gets notice of audit. Can Push Out Imputed Underpayment to Reviewed Year partners and allocate Net Non- Positive Adjustments to Adjustment Year partners. 47 Points to Remember If Modification is Reallocation of Tax Item, all affected partners must file amended returns to be effective. If Modification is Rate Adjustment, must use hypothetical sale at fair market value if partners have varying percentage share of tax items. Can Push Out any or all Imputed Underpayment Amounts and have partnership pay tax on amounts not pushed out. If no Push Out, Imputed Underpayment Amount paid by partnership and Net Non-Positive Adjustments allocated to Adjustment Year partners as part of their Schedule K- 1 (no offset). 48 24
Points to Remember Push Out Adjustment cannot result in a reduction of Section 1 tax otherwise payable by Reviewed Year partners. A tax refund as a result of Adjustments can only be obtained through the Amended Return Modification procedure or the AAR procedure. If partnership-partner opts out of PAR and receives a push out from another partnership, the partnership-partner cannot use AAR on the push out. 49 Points to Remember Use AAR to push out a Push Out provided the limitations period for the AAR is still open. PAR is the exclusive procedure for determining, litigating, and finalizing partnership adjustments, assessment, and collection. PAR is extremely complex and not intuitive. 50 25
Where are We Now? Because the TEFRA partnership provisions blend the two theories, subtitle F (with respect to partnerships), like subchapter K, is distressingly complex and confusing. Rhone- Poulenc v. Comm r, 114 T.C. 533 (2000). PAR statutory language and Proposed Regulations any less complex and confusing? 51 phone (214) 749-2447 toll-free (800) 451-0093 fax (214) 292-2347 cpulman@meadowscollier.com Charles D. Pulman Partner Mr. Pulman s practice concentrates on tax planning, real estate, and corporate. His tax planning practice includes federal, state, and international tax planning for businesses and individuals seeking to minimize tax obligations while accomplishing objectives. His real estate practice includes representing clients in the purchase and disposition of improved and unimproved property, development of property, structuring ownership entities, tax-free and like-kind exchanges, and negotiation of all types of loans. Mr. Pulman s corporate practice involves representing clients in the acquisition and disposition of businesses, mergers, and business entity planning including partnerships, limited liability companies, and corporations. Mr. Pulman is Board Certified in Tax Law by the Texas Board of Legal Specialization. He is a Certified Public Accountant and has a LL.M. in Taxation from NYU. Mr. Pulman frequently speaks on a number of tax topics. He is active in numerous charitable, political, and civic organizations. Mr. Pulman was admitted to practice in Texas in 1976. 52 26
phone (214) 749-2409 toll-free (800) 451-0093 fax (214) 747-3732 mroberts@meadowscollier.com Matt L. Roberts Associate Mr. Roberts practices in the areas of Income Tax Litigation, Estate and Gift Tax Litigation, White Collar and Government Regulatory Litigation, and State Tax Planning and Litigation. Mr. Roberts practice also includes both domestic and international Income Tax and Business Planning. He represents individuals, estates, partnerships, closely-held businesses, and large corporations in all states of a tax dispute, including IRS examinations, administrative appeals, and litigation in U.S. Tax Court, Federal District Court, and the Court of Federal Claims. Mr. Roberts practice also concentrates on resolving white collar criminal investigations and representing taxpayers in disputes with the Texas Comptroller of Public Accounts and other state tax agencies. Mr. Roberts was admitted to practice law in Texas in 2015 and in Mississippi in 2011. He was admitted to practice before the United States Tax Court in 2012. From 2012-2015, Mr. Roberts was an Attorney-Advisor for The Honorable Chief Judge Michael B. Thornton, United States Tax Court in Washington, DC. 53 DISCLAIMER The information included in these slides is for discussion purposes only and should not be relied on without seeking individual legal advice. 54 27