DALLAS BAR ASSOCIATION TAX SECTION DECEMBER 4, 2017 DALLAS, TX NEW PARTNERSHIP AUDIT RULES: WHAT THEY MEAN TO PARTNERSHIPS AND TAX PROFESSIONALS Presented by: CHARLES D. PULMAN, J.D., LL.M., CPA MATTHEW L. ROBERTS, J.D., LL.M. 901 Main Street, Suite 3700 Dallas, Texas 75202 Main (214) 744-3700 Fax (214) 747-3732 (800) 451-0093 www.meadowscollier.com E-Mail: cpulman@meadowscollier.com, mroberts@meadowscollier.com Blog: MC Talks Tax www.meadowscollier.com/?p=7664 Follow Us on: Copyright Meadows, Collier, Reed, Cousins, Crouch & Ungerman, L.L.P. All rights reserved.
TABLE OF CONTENTS Page I. Overview... 1 A. Background...1 B. Effective Date...2 C. Repeal of Old Sections and Addition of New Sections...4 II. Applicability (Section 6221)... 4 A. General Rule Regarding Determinations and Applicability to All Partnerships...4 B. Option to Elect Out for Certain Partnerships with 100 or Fewer Partners...6 III. Consistency Requirement (Section 6222)... 8 A. Consistency Generally Required...8 B. Failure to Be Consistent...8 IV. Partnership Representative (Section 6223)... 9 A. Designation...9 B. Eligibility...10 C. PR Designation, Resignation, and Revocation...10 D. IRS Designation...12 E. Binding Effect of PR...13 V. Partnership Adjustments (Section 6225)... 13 A. Imputed Underpayment...13 B. Non-Imputed Underpayment Adjustments...20 C. Alternative to Payment of Imputed Underpayment Amount by Partnership ( Push Out Election ) (Section 6226)...21 VI. Administrative Adjustment Requests (Section 6227)... 26 A. General...26 B. Adjustment...26 C. Period of Limitations...27 D. Where NOAPP Issued...27 E. Form...27 F. Partner Modification...27 G. Push Out Election...28 H. No Imputed Underpayment Amount...28 VII. Notice of Proceedings (Section 6231)... 29 A. General Notice Requirements...29 B. Timing...29 C. Address for Notices...29 VIII. Assessment and Collection (Section 6232)... 30 i
A. Method for Assessing and Collecting...30 B. Timing...30 C. Mathematical or Clerical Adjustments...30 D. Mathematical or Clerical Errors for Upper-Tier Partnerships...30 E. Partnership Waivers...30 F. Interest and Penalties (Section 6233)...31 IX. Judicial Review of Partnership Adjustment (Section 6234)... 31 A. Lawsuit to Challenge FPA...31 B. District Court and Court of Federal Claims...31 C. Interest...32 D. Scope of Judicial Review...32 E. Appeals...32 F. Effect of Dismissal...32 X. Statute of Limitations (Section 6235)... 33 A. Statute of Limitations - Three Time Periods...33 B. Agreements to Extend...33 C. Exceptions...33 D. Suspension of Statute of Limitations...34 E. Bankruptcy Proceeding...34 XI. Other Special Provisions (Section 6241)... 34 A. Partnership Payments Non-Deductible...34 B. Partnership Ceases to Exist...35 C. Entities Filing Partnership Return...36 D. Information Returns...36 E. Appealing IRS Determination under PAR...36 A. Partnership Agreement...37 B. Other Affected Agreements...39 TEFRA Partnership Criteria Flowchart... 40 PAR Flowchart... 41 ii
THE NEW IRS PARTNERSHIP AUDIT RULES: WHAT THEY MEAN TO PARTNERSHIPS AND TAX PROFESSIONALS JOEL N. CROUCH, J.D. CHARLES D. PULMAN, J.D., LL.M., CPA MATTHEW L. ROBERTS, J.D., LL.M. A. Background I. OVERVIEW On September 18, 2014, the Government Accountability Office ( GAO ) issued a report to Congress relating to the IRS s effectiveness in auditing large partnerships, which were defined as those partnerships with $100 million or more in assets and 100 or more direct and indirect partners. The report found substantial disparities in the IRS s audit rates of large partnerships and comparable large C corporations with $100 million or more in assets. Specifically, the GAO found that although the number of large partnerships in operation from 2002 through 2011 had nearly tripled, the IRS audit rate of those partnerships in 2012 was 0.8%. In contrast, the GAO found that the IRS audit rate of large C corporations was 27.1% in 2012 notwithstanding a significant 22% decrease in the number of large C corporations in operation from 2002 through 2011. In the report, the IRS identified several potential reasons for the disparity in audit rates. First, the IRS indicated that it was difficult to identify the appropriate partnership to audit when the partnership was part of a complex tiered-partnership structure. Second, the IRS indicated that the complexities in the TEFRA audit procedures made it more difficult to timely assess tax related to the partnership within the general 3-year statute of limitations period. Third, the IRS indicated that the TEFRA audit procedures resulted in burdensome time and costs to the IRS because after the IRS determined adjustments of tax items at the partnership level, the IRS was required to recalculate the tax liability of each partner based on the partnership adjustment. The GAO report recommended several legislative proposals to increase the IRS s audit rates of large partnerships. The most significant legislative proposal in the report was to require large partnerships to pay any tax due at the partnership level. The GAO noted that such a change would save the... [IRS s] resources that are now devoted to the paper driven, labor intensive process of passing adjustments through to large numbers of partners. On February 2, 2015, President Obama submitted his fiscal year 2016 budget proposal to the United States Congress. In his budget proposal, President Obama recommended repealing the existing TEFRA and electing large partnership audit procedures because those audit procedures were inefficient and more complex than those applicable to other large entities. In their place, President Obama recommended enactment of a new partnership audit regime where the IRS would audit the partnership and make adjustments at the partnership level. 1
Congress responded to the GAO report with several legislative proposals. Most notably, in June 2015, Rep. Renacci (R-OH) and Rep. Kind (D-WI) introduced H.R. 2821, the Partnership Audit Simplification Act. The Act sought to replace the existing TEFRA and electing large partnership audit rules with rules that would require partnerships to be audited and tax collected at the partnership level. On November 2, 2015, President Obama signed into law H.R. 1314, the Bipartisan Budget Act of 2015 ( BBA ), which adopted many of the revised partnership audit rules in H.R. 2821 as new Sections 6221 to 6241 of subchapter C of chapter 63 of the Internal Revenue Code of 1986, as amended. BBA was further amended by the Protecting Americans from Tax Hikes Act of 2015 ( PATH Act ). Congress estimates that the new partnership audit rules will bring in an additional $13.4 billion in tax revenue over the next 10 years. The Joint Committee on Taxation issued General Explanation of Tax Legislation Enacted in 2015 dated March 2016 ( Blue Book ), discussing the new partnership audit rules in Title XI, pages 51 to 83. On January 18, 2017, Proposed Regulations were issued (REG-136118-15). On June 14, 2017, Proposed Regulations were reissued with minor changes. B. Effective Date 1. Generally: The Revised Partnership Audit Rules ( PAR ) apply to returns filed for partnership taxable years beginning after December 31, 2017. PAR applies to an entity taxed as a partnership for federal tax purposes, such as a limited partnership and a limited liability company. Section 6231. 2. Administrative Adjustments Requests ( AAR ): In the case of an AAR, the PAR apply to requests with respect to returns filed for partnership taxable years beginning after December 31, 2017. Prop. Reg. 301.6227-1(i). 3. Earlier Application Election: A partnership may elect (at the time and in such form as the Secretary may prescribe) for the PAR (other than Section 6221(b) which provides for the opt-out election for partnerships with 100 or fewer partners) to apply to any return of the partnership filed for taxable years beginning after the date of the enactment of the PAR (November 2, 2015) and before January 1, 2018. Section 1101(g)(4) of the BBA. a. An election may only be made for partnership tax returns filed for tax years beginning after November 2, 2015. b. A partnership may not elect into the new rules for purposes of electing out. (This prevents partnerships subject to TEFRA from avoiding both TEFRA and the new rules, thereby forcing the IRS to audit each partner individually.) 2
c. Once the election is made for a tax year, it cannot be revoked without IRS consent. d. An election will not be valid if it frustrates the purpose of the new audit rules. (One example is where the partnership is not liquid enough to pay the entity level tax.) e. To make the election, the partnership must submit a written statement within 30 days of the IRS first notifying the partnership that its return for an eligible tax year has been selected for audit. Alternatively the partnership may make an election with the filing of an AAR in the manner to-be-prescribed by the IRS (i.e., new form). f. Among other things, the statement must include identifying information about the partnership, the person signing the statement and his or her authority to do so, and the person designated as the partnership representative. g. The statement must include several representations regarding the partnership s intent and liquidity, including that: (i) the partnership is not insolvent nor does it anticipate becoming insolvent, (ii) the partnership is not currently pursuing bankruptcy nor anticipating a bankruptcy filing, and (iii) the partnership has sufficient assets, and reasonably expects to have sufficient assets, to pay any tax liability ultimately determined. h. Either the Tax Matters Partner or an individual authorized to sign a partnership return is authorized to make the election. i. Perhaps most significant, the statement must include a representation, signed under penalties of perjury, that the individual signing the statement is duly authorized to make the election and that to the best of his or her belief, the statement is true, correct and complete. j. On August 5, 2016, the IRS issued Temporary Regulations set forth in 301.9100-22T to address the rules for a partnership to elect to apply PAR to taxable years beginning after November 2, 2015, and before January 1, 2018. k. The Temporary Regulations expire on August 5, 2019. l. The Blue Book at page 83 suggests a reason for making this election is to obviate the need to furnish amended Schedules K-1 to correct a partnership-level error or for partners to file amended Federal and State income tax returns. 3
C. Repeal of Old Sections and Addition of New Sections PAR repeal entirely subchapter C of Chapter 63 which includes the audit rules under the Tax Equity and Fiscal Responsibility Act of 1982, Pub. L. No. 97-248 (referred to herein as TEFRA ), and subchapter D of Chapter 63 which provides audit rules for electing large partnerships. The repeal of these sections is effective for tax years beginning after December 31, 2017. 1. Old Rules: Taxable years prior to December 31, 2017, will continue to be governed by old Sections 6221-6234, 6240-6242, 6245-6248, 6251-6252, and 6255. 2. New Rules: Taxable years after December 31, 2017, will be governed by new Sections 6221, 6222, 6223, 6225, 6226, 6227, 6231, 6232, 6233, 6234, 6235, and 6241. 3. Proposed Regulations: Proposed Regulations (REG-136118-15, 26 CFR Part 301) under PAR were issued for Sections 6221, 6222, 6223, 6225, 6226, 6227, and 6241. Proposed Regulations have not been issued for Sections 6231, 6232, 6233, 6234 and 6235. All Section references in this Outline are to the Internal Revenue Code of 1986, as amended and amended by PAR, unless otherwise indicated. II. APPLICABILITY (SECTION 6221) A. General Rule Regarding Determinations and Applicability to All Partnerships 1. New Law: Section 6221 provides a general rule that the following shall be determined at the partnership level: a. any adjustment to items of income, gain, loss, deduction, or credit of a partnership for a partnership taxable year (and any partner s distributive share thereof); b. the assessment and collection of any tax attributable thereto; and c. the applicability of any penalty, addition to tax, or additional amount which relates to an adjustment to any tax item or share thereof. 2. Existing Law: Under TEFRA, the tax treatment of any partnership item (and the applicability of any penalty, addition to tax, or additional amount which relates to an adjustment of a partnership item) is determined at the partnership level. 4
3. Items Covered by PAR: Prop. Reg. 301.6221(a)-1(b)(1) defines items broadly to include the following of the partnership: a. character, timing, source and amount of income, etc., items; b. character, timing and source of partnership activities; c. contributions and distributions; d. bases and value of assets; e. amount and character of liabilities; f. category, timing, and amount of foreign tax expenditures; g. elections; h. transactions; i. partnership terminations; and j. capital accounts. 4. Items Not Covered by PAR: Prop. Reg. 301.6221(a) 1(b)(3) defines tax as tax imposed by chapter 1. Therefore, PAR does not cover the following: a. self-employment tax (chapter 2); b. unearned income Medicare contribution (chapter 2A); c. withholding on NRA or foreign corporation (chapter 3); d. taxes to enforce foreign accounts (chapter 4); and e. consolidated returns (chapter 6). 5. Defenses: Prop. Reg. 301.6221(a) 1(c) provides that only the partnership can raise defenses under PAR to a penalty, addition to tax or additional amount, including partner-level defenses. After the adjustments are determined in partnership s proceeding under PAR, no penalty defense can be raised or taken into account with respect to any person. 5
B. Option to Elect Out for Certain Partnerships with 100 or Fewer Partners 1. General Opt Out Election: Section 6221(b) states that PAR does not apply with respect to any partnership for any taxable year if: a. the partnership elects out for such taxable year; b. for such taxable year, the partnership is required to furnish 100 or fewer statements under Section 6031(b) with respect to its partners (i.e., Schedule K-1s); c. each of the partners of such partnership is an individual, a C corporation, any foreign entity that would be treated as a C corporation were it domestic, an S corporation, or an estate of a deceased partner (Section 6221(b)(1)(c)); d. the election is made with a timely filed return for such taxable year and includes a disclosure of the name and taxpayer identification number of each partner at any time during the taxable year of such partnership; and e. the partnership notifies such partners of such election within 30 days of making the election (Prop. Reg. 301.6221(b) 1(c)(3)). The opt-out election is binding unless the IRS determines the election is invalid. Prop. Reg. 301.6221(b) 1(e). Thus, an invalid election remains binding unless the IRS determines the election is invalid. The Proposed Regulations do not provide for a time frame for the IRS to determine if the election is invalid. Under Prop. Reg. 301.6221(b) 1(b)(3), the following are not eligible entities: trusts, partnership, non-c corp. foreign entity, disregarded entity, nominee or estate of non-deceased individual. Several professional organizations have suggested eligible entities be expanded to include single member LLC, trusts, IRA, qualified plans, and exempt organizations. The Blue Book gives examples of a partnership with a partner including a disregarded entity, a trust, a grantor trust or a partnership partner electing out of PAR, thus indicating that Congress contemplated these entities may be eligible entities. Blue Book at 60. 2. Special Rules for S Corporation Partners: For any partner that is an S corporation, the partnership must disclose the name and taxpayer identification number of each S corporation shareholder for the taxable year of the S corporation ending with or within the partnership taxable year for which the election to opt out is made. The statements such S corporation is required to furnish shall be treated as statements furnished by the partnership for purposes of applying the 100 partner rule. Prop. Reg. 301.6221(b) 1(c)(2). 6
3. Spouse Partners. Under the Proposed Regulations, a Schedule K-1 issued to one spouse owning a community property interest in the partnership is considered as one Schedule K-1. If both spouses each own a community property interest and receive separate Schedules K-1, then the number of Schedules K-1 for this purpose is two. See Prop. Reg. 301.6221(b)-1(b)(2)(iii), Ex. 1-2. 4. Tax-Exempt Partners. The Proposed Regulations do not specifically address this point. However, the preamble to the Proposed Regulations indicate that a taxexempt organization should be treated as a C corporation for purposes of PAR, provided the tax-exempt organization is not classified as a trust for federal income tax purposes. 5. Tiered Partnerships: Under Prop. Reg. 301.6221(b) 1(d), if partnership (P1) is a partner in another partnership (P2) and P1 opts out, P1 is subject to the same rules under PAR with respect to its interest in P2 as any other partner in P2. 6. Foreign and Other Partners: The Secretary may provide for alternative identification of any foreign partners. The Secretary may by regulation or other guidance prescribe rules similar to the rules above with respect to any partners not described above. Section 6221(b)(2)(B), (C). 7. Existing Law: Under TEFRA, a partnership is defined to exclude small partnerships. A small partnership for these purposes refers to any partnership having 10 or fewer partners each of whom is an individual (other than a nonresident alien), a C corporation, or an estate of a deceased partner. A small partnership may for any taxable year elect not to be treated as a small partnership and, therefore, be subject to the TEFRA provisions. Old Section 6231(a). 8. Consequences of Opting Out: IRS audit, deficiency, assessment and collection proceedings conducted at each partner level under pre-tefra procedures and rules, including statute of limitations and venue. Observation: The purpose for the enactment of TEFRA was to eliminate duplicative litigation and inconsistent treatment among partners. Because partnerships with a large number of partners will be eligible to opt out, this would appear to have the opposite effect. Specifically, a partnership with up to 100 qualifying partners could elect out and very likely would. This would mean that, if the IRS wanted to audit that partnership, it would have to open an audit for all 100 partners. Moreover, each partner should be able to litigate the adjustments against him/her separately, potentially in different courts, creating the potential for inconsistent results on identical issues. In addition, a successful audit at the partner level will largely depend on the partnership s cooperation in providing information and documentation. Failure to do so could be very detrimental to a partner. The partners may want to have their partnership agreement include language requiring the partnership to cooperate in a partner-level audit. 7
III. CONSISTENCY REQUIREMENT (SECTION 6222) A. Consistency Generally Required Section 6222 sets forth the general requirement that a partner treat each item of income, gain, loss, deduction, or credit attributable to a partnership in a manner which is consistent with the treatment of such income, gain, loss, deduction, or credit on the partnership return. Prop. Reg. 301.6222-1(a)(1) adds that consistency includes amount, timing and character of the item and is measured by the partnership return actually filed. In addition, these rules apply to a partnership (P1) who is a partner in another partnership (P2) without regard to whether P1 has opted out of PAR. If a partnership return is not filed, a partner s treatment of items is per se inconsistent. Prop. Reg. 301.6222-1(a)(3). B. Failure to Be Consistent 1. Underpayment of Tax: Prop. Reg. 301.6222-1(b) gives the IRS the power to adjust the partner s return to make the return consistent with the partnership s return and to determine the underpayment of tax. The underpayment of tax is assessed and collected in the same manner as if such underpayment were on account of a mathematical or clerical error appearing on the partner s return. Id. 2. No Abatement of Assessment: Section 6222(b) states that paragraph (2) of Section 6213(b) (abatement of assessment request) does not apply to an assessment treated as a mathematical or clerical error under PAR (unless an exception applies). Observation: As a practical matter, the above provisions permit the IRS to make an assessment resulting from an inconsistent position on a summary basis without affording the taxpayer any administrative or judicial relief, if none of the exceptions below apply. 3. Notice and Adjustment of Inconsistency: a. Statement of Inconsistent Treatment: The consistency requirement and assessment provisions do not apply if the partner files with the Secretary a statement specifically identifying the inconsistent item on the partnership return according to forms, instructions and other guidance prescribed by the IRS. Prop. Reg. 301.6222-1(c)(1). These rules apply even if the partnership does not file a return; however, it is not clear what information would be included in the statement in this case. Section 6222(c). However, this exception does not apply to the treatment of an item binding on the partner under Section 6223, i.e., actions taken by the partnership under PAR (i.e., AAR or Push-Out) or a final decision in a proceeding under PAR. Prop. Reg. 301.6222-1(a)(3). 8
b. Incorrect Partnership Statement: A partner is treated as satisfying the statement of inconsistency if the partner demonstrates that the treatment of the item on the partner s return is consistent with the treatment of the item on the statement, schedule or other IRS form furnished to the partner by the partnership and the partner elects to have Section 6222 apply. Prop. Reg. 301.6222-1(d). The time, substance and manner of the election are set forth in this Prop. Reg. The election must be made within 60 days after the IRS notifies the partner of the inconsistency. If the inconsistency is not clear, the election must explain how the partner s treatment is consistent. c. Adjustments: If a partner properly and timely notifies the IRS of an inconsistency and the IRS disagrees, the IRS can commence a proceeding to adjust or contest the item in question. Prop. Reg. 301.6222-1(c)(4)(ii). In that proceeding, the IRS can also adjust any item on the partner s return, including items that are not attributable to the partnership. Id. Example 2 of this Proposed Regulation clarifies that the proceeding is under subchapter B of Chapter 63 (i.e., the normal assessment and deficiency proceedings). d. Partnership Not Bound: Any final decision with respect to an inconsistent position identified under these exceptions to which the partnership is not a party is not binding on the partnership. A. Designation IV. PARTNERSHIP REPRESENTATIVE (SECTION 6223) 1. General: Section 6223 requires that each partnership designate a partner (or other person) with substantial presence in the United States and capacity to act as the partnership representative ( PR ) who shall have the sole authority to act on behalf of the partnership for purposes of PAR. One PR can be designated per taxable year. Prop. Reg. 301.6223-1. Observation: Note that any person may be designated to serve as PR. The person does not have to be a partner. This is a departure from existing law. See Old Section 6231(a)(7). In addition, it is not clear if a partnership making the opt out election should or may designate a PR. 2. Entity PR: An entity can be a PR provided an individual is appointed who has substantial presence in the U.S. and has capacity to act. Prop. Reg. 301.6223-1(b)(3). 9
B. Eligibility 1. Substantial Presence in the U.S.: A PR must have a substantial presence in the U.S. Under the Proposed Regulations, a PR has substantial presence in the U.S. if all of the following requirements are met: a. Available to Meet with IRS: The person is available to meet in person with the IRS in the U.S. at a reasonable time and place, as is necessary and appropriate, as determined by the IRS; b. U.S. Street Address: The person has a street address that is in the U.S. and a telephone number with a U.S. area code where the person can be reached during normal business hours; c. U.S. TIN: The person has a U.S. TIN. Prop. Reg. 301.6223-1(b)(2). 2. Capacity to Act: A PR does not have capacity to act in the event of: (i) death; (ii) certain court orders determining the person lacks capacity or enjoining the person from acting on behalf of partnership or entity PR; (iii) incarceration; (iv) liquidation or dissolution of entity PR; or (iv) any similar situation the IRS determines the person lacks capacity to act. Prop. Reg. 301.6223-1(b)(4). C. PR Designation, Resignation, and Revocation 1. Designation of PR: The partnership designates the PR annually on its partnership return. Prop. Reg. 301.6223-1(c). 2. Resignation of PR: A PR may resign by notifying the partnership and the IRS in writing of the resignation. Prop. Reg. 301.6223-1(d). a. Successor PR. The notification to the IRS may include a successor PR designation, which is effective 30 days from the date on which the IRS receives the written notification. If the resigning PR fails to designate a successor PR, the IRS will determine that no designation is in effect, and the partnership will have an opportunity to designate a successor PR. If the partnership fails to designate a successor PR after the IRS notice, the IRS will designate a PR for the partnership. Prop. Reg. 301.6223-1(d)(1). b. Time for Resignation: A PR may only resign: (i) simultaneously with the filing of an AAR; (ii) after receipt of a notice of administrative partnership proceeding ( NOAPP ); or (iii) at such other time as prescribed by the IRS in other guidance. A partnership may not file an AAR solely for the purpose of permitting a PR to resign. Prop. Reg. 301.6223-1(d)(2). 10
3. Revocation of PR: A partnership may revoke the designation of a PR by notifying the PR and IRS in writing, which is effective 30 days from the date on which the IRS receives the written notification. Prop. Reg. 301.6223-1(e)(1). a. Time for Revocation: A partnership may revoke a PR designation by: (i) filing an AAR; (ii) after receipt of an NOAPP; or (iii) at such other time as prescribed by the IRS in other guidance. A partnership may not file an AAR solely for the purpose of revoking a PR designation. Prop. Reg. 301.6223-1(e)(2). b. Revocation Requirements: i. General Partner Signature: A revocation must be signed by a person who was a general partner at the close of the taxable year for which the PR designation is in effect. A partner in the partnership during the taxable year who was not a general partner may sign the revocation only if, at the time the revocation is signed, each general partner of the partnership eligible to sign the revocation is no longer a partner or no longer has capacity to act. For purposes of these requirements, a member-manager of an LLC is treated as a general partner and a member of an LLC who is not a member-manager is treated as a partner other than a general partner. Prop. Reg. 301.6223-1(e)(3). ii. Form: The notification of revocation must include: 1. A certification under penalties of perjury that the person signing the form meets the General Partner Signature requirement and has provided a copy of the revocation to the partnership and to the PR whose designation is being revoked; 2. A statement that the person signing the form is revoking the designation of the PR; and 3. A subsequent designation of the PR in accordance with IRS instructions. Prop. Reg. 301-6223-1(e)(3)(ii). c. Multiple Revocations: If the IRS receives multiple revocations within a 90-day period, the IRS may determine that a designation is not in effect. Prop. Reg. 301.6223-1(e)(4). 11
D. IRS Designation 1. IRS Determination that Designation is not in Effect: If the IRS determines that a PR designation is not in effect for a partnership taxable year, the IRS will notify the partnership and the most recent PR. The determination that a PR designation is not in effect is effective on the date the IRS mails the notification. Generally, the partnership has 30 days from the date of the IRS notification to designate a successor PR. Prop. Reg. 301.6223-1(f). a. The IRS may determine that a designation is not in effect in the following circumstances: i. multiple revocations within a 90-day period; ii. iii. iv. the partnership failed to make a valid designation; the PR lacks a substantial presence in the U.S. or lacks capacity to act; the partnership failed to appoint a designated individual of an entity PR; v. no successor designation was made when the PR resigned; or vi. the partnership fails to designate the successor PR in accordance with instructions or forms of IRS. Prop. Reg. 301.6223-1(f)(2), (3). 2. Multiple Revocations: In the event the IRS determines that the PR designation is not in effect due to multiple revocations, the partnership will not be provided an opportunity to designate a successor PR. Prop. Reg. 301.6223-1(f)(4). 3. Designation by IRS: The IRS may designate a PR if the IRS determines that a PR designation or successor designation is not in effect. The IRS designates a PR by notifying the partnership of the name, address, and telephone number of the new PR. The designation of a PR by the IRS is effective on the date on which the IRS mails the notice of the designation to the partnership. In addition, the IRS will mail a copy of the notice to the new PR. Prop. Reg. 301.6223-1(f)(5)(i). 4. IRS Factors in Designation: The IRS may designate any person to be the PR. In addition to other relevant factors, the IRS will consider whether there is a suitable partner of the partnership, either from the Reviewed Year or at the time the partnership designation is made. The IRS will additionally consider the following factors: (i) the views of the majority interest partners; (ii) the general knowledge of the person in tax matters and administrative operation of the partnership; (iii) 12
the person s access to the books and records of the partnership; and (iv) whether the person is a U.S. person. Prop. Reg. 301.6223-1(f)(5)(ii). E. Binding Effect of PR 1. Binding Effect of Actions of Partnership and PR: The actions of the partnership and PR and any final judicial decision bind the partnership, all partners of the partnership, and any other person whose tax liability is determined in whole or in part by taking into account adjustments as determined under the PAR. Prop. Reg. 301.6223-2(a). 2. Sole Authority to Act: The PR has sole authority to act on behalf of the partnership. No other partner or any other person may participate in a partnership examination or other proceeding involving the partnership without IRS permission. Prop. Reg. 301.6223-2(c)(1). 3. Existing Law: Gives any partner the right to participate in any administrative proceeding relating to the determination of partnership items at the partnership level. In addition, under old Section 6224, a tax matters partner has authority to enter into a settlement agreement with the Internal Revenue Service. A. Imputed Underpayment V. PARTNERSHIP ADJUSTMENTS (SECTION 6225) If the IRS makes an adjustment ( Partnership Adjustment ) for the Reviewed Year (defined below) in the amount of any item of income, gain, loss, deduction, or credit of a partnership, or any partner s distributive share of such item, the following applies: 1. Payment By Partnership: Imputed Underpayment Amount (defined below) is paid by the Partnership in the Adjustment Year as if it were a tax. Prop. Reg. 301-6235-1(a)(1). a. The Reviewed Year is the tax year to which the tax item adjusted relates i.e., the year audited by the IRS. Section 6225(d)(1). b. The Adjustment Year under Section 6225(d)(2) is defined as: i. if a proceeding under Section 6234 (i.e., judicial review of a partnership adjustment), the tax year the court decision is final; ii. if an Administrative Adjustment Request ( AAR ) under Section 6227, the tax year in which the AAR is made; or 13
iii. in other cases, the tax year in which Notice of Final Partnership Adjustment ( FPA ) is mailed under Section 6231. c. The term Partnership Adjustment is defined in Section 6241. 2. Other Adjustments: An adjustment by the IRS that is not an Imputed Underpayment Amount must be taken into account by the partnership in the Adjustment Year (Section 6235(a)(2)): a. Non-credit items: If a non-credit item, the adjustment is a reduction in non-separately stated income or an increase in non-separately stated loss (whichever is appropriate) under Section 702(a)(8); or b. Credit items: If a credit item, the adjustment is a separately stated item. Observation: The requirement that the tax is paid by the partnership is a dramatic change in policy. Historically, any tax attributable to partnership adjustments has been accounted for, and paid at, the partner level. PAR creates an entity level tax. In addition, the partners in the Adjustment Year will be the partners that bear the economic consequences of additional tax owed, not the partners in the Reviewed Year, unless the Push-Out Election is made (see below). 3. Application of Preferences, etc.: Prop. Reg. 301.6225-1(a)(2) provides that all amounts determined under Section 6225, i.e., Imputed Underpayment, netting, and adjustments, are determined, unless IRS determines otherwise in its discretion, by applying all preferences, restrictions, limitation and conventions to disallow or limit any adjustment that increases a loss, deduction or credit or decreases income or gain as if the item was reported originally in most beneficial manner to the partners. 4. NOPPA: The Imputed Underpayment is set forth in the NOPPA without regard to permitted modifications. 5. Other Adjustments: If a Partnership Adjustment does not result in an Imputed Underpayment, that Adjustment is taken into account in the Adjustment Year. 6. Computation of Imputed Underpayment Amount: The Imputed Underpayment Amount is determined under Prop. Reg. 301.6225-1(c) as follows: a. Generally: Multiplying Partnership Adjustments of by the highest rate of tax in effect for the Reviewed Year under Sections 1 or 11. Section 6225(b)(1). b. Credits: Increase or decrease the amount in (a) by net increase or net decrease in credits under the Partnership Adjustment. 14
c. Total Netted Partnership Adjustments: The sum of all net positive adjustments in Residual Group and in Reallocation Group. Prop. Reg. 301.6225-1(c)(3). d. Distributive Share Reallocation Adjustments: Disregarded under Prop. Reg. 301.6225-1(d)(2)(ii) and net non-positive adjustments under Prop. Reg. 301.6225-1(d)(3) do not result in Imputed Underpayment. e. Netting of Adjustments: Not permitted between years. Prop. Reg. 301.6225-1(c)(4). f. Grouping: Prop. Reg. 301.6225-1(d) requires Partnership Adjustments be grouped as follows: i. Reallocation Group: Adjustments that reallocate distributive share of an item between and among partners or allocation of item to a partner. ii. iii. Credit Group: Adjustments to items claimed or could be claimed as a credit. Creditable Expenditure Group: (Reserved) iv. Residual Group: Other adjustments not described above and further subject to subgrouping per limitations or restrictions imposed on adjustment items, such as character or holding period. g. Netting of Adjustments: Netting only within each Group or Subgroup as net positive or net non-positive adjustment; no netting between Groups or Subgroups or between tax years. Prop. Reg. 301.6225-1. h. Total Netting Adjustments: Sum of all net positive adjustments in Residual Grouping and in Reallocation Grouping. Only net positive adjustments in Group taken into account. Id. i. Imputed Underpayment Amount: (i) Total Netted Partnership Adjustments times highest rate under Section 1 or Section 11 plus or minus (ii) net decrease or increase in Credit Group. j. Subgroups Adjustments within each Group are further subgrouped based on preferences, limitations, restrictions, and conventions, such as source, character, holding period or restrictions applicable to each item. Prop. Reg. 301.6625-1(d)(1). k. Reallocation Grouping: A reallocation of the distributive share of an item from one partner to another or an allocation of an item to a particular 15
partner that results in net decreases in items of income or gain or net increases in items of deduction, loss or credit are disregarded in computing Imputed Underpayment Amount. Each allocation or reallocation of an item is a separate subgroup for purposes of netting. If a partner has more than one adjustment within a reallocation group, the adjustments may be combined or further subdivided into subgroups. Any net non-positive adjustments are disregarded and do not result in an Imputed Underpayment. Net positive adjustments are included in the calculation of Total Netted Partnership Adjustment. l. Netting Within Each Group or Subgroup: Partnership Adjustments within a Group or Subgroup are netted together within each Group or Subgroup and are not cross-netted. Only net positive adjustments are taken into account in calculating Total Netted Partnership Adjustment. Net Non- Positive Adjustments within a Group or Subgroup are disregarded and do not result in an Imputed Underpayment. m. Treatment of Adjustments: An increase in gain or decrease in loss is treated as an increase in income. A decrease in gain or an increase in loss is treated as a decrease in income. n. Multiple Imputed Underpayments: The IRS has the discretion to determine the Partnership Adjustments resulting in more than one Imputed Underpayment and which Partnership Adjustments are to be taken into account in a particular Imputed Underpayment based upon the nature of the Adjustment. o. Types of Imputed Underpayments: Prop. Reg. 301.6225-1(e)(2) describes two types of Imputed Underpayments a General Imputed Underpayment and a Specific Imputed Underpayment (both as defined) and each of those types of Imputed Underpayments are separately calculated. A Specific Imputed Underpayment is one in which the Adjustments to an item were allocated to one partner or group of partners having the same or similar characteristics. Any Adjustment that isn t thus defined is treated as a General Imputed Underpayment. The IRS has discretion to determine which Partnership Adjustments should be taken into account for a Specific Imputed Underpayment or a General Imputed Underpayment. p. Imputed Underpayment Not Deductible. Section 6241(4) states a payment (ie, Imputed Underpayment) made by a partnership under subtitle A is not deductible. Observation: The Imputed Underpayment Amount does not appear to take the AMT or Net Investment Income Tax under Section 1411 into account. In addition, affected items at the partner level appear to be ignored. 16
7. Modification of Imputed Underpayment Amount: Under Section 6225 and/or the Proposed Regulations, the following modifications to an Imputed Underpayment Amount are available if requested by a partnership (i.e., the PR) that has received a NOPPA: a. Amended Returns: The Imputed Underpayment Amount may be modified, with IRS approval, if one or more Reviewed Year partners file amended return taking into account all Partnership Adjustments allocable to the partner and any other tax attribute affected by the Adjustment and the tax is paid with the Amended Return. If the Adjustment is a reallocation of distributive share item, all partners affected by the Adjustment must file amended returns. i. IRS Approval: IRS approval conditioned on IRS receiving within the 270-day period affidavits from the partners signed under penalties of perjury that each amended return required to be filed has been filed (including the date on which the returns were filed) and that full payment of the tax, penalties, additions to tax, additional amounts, and interest have been paid (including the date on which the payments were made). The partners must file amended returns for each year affected by the modification. Prop. Reg. 301.6225-2(d)(2)(iii) - (iv). ii. iii. iv. Statute of Limitations: Amended return modification not allowed if the statute of limitations for assessment of the tax for the year for which the amended return is filed has expired. However, the IRS may approve the amended return modification if a refund of tax, provided all partnership adjustments allocated to the partners filing the amended returns are taken into account on the amended returns, the only items reported on the amended returns are items attributable to such partnership adjustments, and the partners file all required amended returns in which adjustments are required. Prop. Reg. 301.6225-2(d)(2)(v)(A) - (B). Pass-Through Partners. A pass-through partner (or indirect partner that is a pass-through partner) that has a valid Opt-Out Election in effect for a partnership taxable year may elect, solely for purposes of the modification procedures, to take into account its share of the partnership adjustments and determine and pay an amount calculated under the safe harbor provisions. Prop. Reg. 301.6225-2(d)(2)(vii). Additional Amended Returns Restricted. If an amended return is filed, the partner may not file a subsequent amended return without the permission of the IRS. Prop. Reg. 301.6225-2(d)(vii)(B). 17
v. Modification Denied. If the IRS denies a modification request, the Proposed Regulations do not address how or whether the partner who filed the amended return can obtain a refund of the tax paid and do not address whether and how the denial can be appealed in the IRS. vi. Refund. If the modification is an amended return, the amended return includes the Imputed Underpayment items and the net nonpositive adjustment items. If the result of including all adjustments is a refund for the Review Year, the normal 3 year statute of limitations for refund claims under Section 6511 is waived. Prop. Reg. 301.6225-2(b)(3)(v). b. Tax Exempt Partners: A modification may be requested for a partnership with a tax exempt partner who would not owe tax. Prop. Reg. 301.6225-2(d)(3). c. Lower Tax 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. For purposes of the capital gain or qualified dividends modification, an S corporation is treated as an individual. The lower rate cannot be less than the highest rate for the type of income or taxpayer (i.e., modified rate is not actual rate applicable to Reviewed Partner). Prop. Reg. 301.6225-2(d)(4). 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 value as of the close of the Reviewed Year. Blue Book at 67; Prop. Reg. 301.6225-2(b)(3)(iii). d. Passive Losses of Publicly Traded Partnerships: i. Adjustment to Imputed Underpayment Amount: The Imputed Underpayment Amount is determined without regard to the portion attributable to a net decrease in a specified passive activity loss which is allocable to a specified partner. Prop. Reg. 301.6225-2(d)(5)(i); Section 6225(c)(5). The net decrease is taken into account as an adjustment in the Adjustment Year with respect to the specified partners to who such decrease relates. Section 6225(c)(5). ii. Specified Passive Activity Loss: This term means, with respect to any specified partner, the lesser of (i) the passive activity loss of 18
such partner under Section 469(k) with respect to such partner s taxable year in which or with which the Reviewed Year of such partnership ends or (ii) such passive activity loss so determined with respect to such partner s taxable year in which or with which the Adjustment Year of such partnership ends. Section 6225(c)(5)(B); Prop. Reg. 301.6225(d)(5)(ii). iii. Specified Partner: This term means any person: (i) who is a partner of the publicly traded partnership; (ii) is an individual, estate, trust, closely held C corporation or personal service corporation; and (iii) has a specified passive activity with respect to such publicly traded partnership, with respect to each taxable year of such person which is during the period beginning with the taxable year of such person in which or with which the Reviewed Year of such publicly traded partnership ends and ending with the taxable year of such person in which or with which the Adjustment Year of such publicly traded partnership ends. Section 6225(c)(5)(C); Prop. Reg. 301.6225(d)(5)(iii). iv. Partner Notification: The IRS must approve of the modification and the partnership must report to each specified partner the amount of that partner s reduction of suspended passive loss carryovers at the end of the Adjustment Year to take into account the amount of any passive losses applied in connection with the modification request. The reduction in suspended passive loss carryovers is a determination of the partnership and is binding on the specified partners. Prop. Reg. 301.6225-2(d)(5)(iv). e. Qualified Investment Entities. A partnership may request modification of the Imputed Underpayment Amount based on the partnership adjustments allocated to a Reviewed Year partner (or indirect partner) where the modification is based on deficiency dividends distributed as described in Section 860(f), by a partner that is a qualified investment entity under Section 860(b), which includes both a regulated investment company (RIC) and a real estate investment trust (REIT). Prop. Reg. 301.6225-2(c)(7). f. Number and Composition of Imputed Underpayment: The Partnership may request that Partnership Adjustments be included in one or more particular Groups or Subgroups and that the IRS determine one or more specific Imputed Underpayments based on those modified groupings. g. Closing Agreements. A partnership may request modification based on a closing agreement entered into by the IRS and any partner (or indirect partner). Prop. Reg. 301.62256-2(c)(8). 19
h. Other Modifications. A partnership may request additional modifications not described above. The IRS will determine whether the requested modification is accurate and appropriate under the circumstances. Prop. Reg. 301.6226-2(c)(9). 8. Deadline for Submitting Documentation for Requested Modification: All documentation, including amended returns, must be submitted to the IRS not later than the close of the 270-day period beginning on the date on which the notice of proposed partnership adjustment ( NOPPA ) is mailed unless the partnership requests an extension of time and the IRS grants such an extension. Prop. Reg. 301.6225-2(c)(3)(i). a. Expiration of 270-day Period by Consent. The IRS and the PR may agree, in writing, to waive the 270-day period after the mailing of the NOPPA and before the issuance of the FPA. Prop. Reg. 301.6225-2(c)(3)(iii). 9. Required Documentation: The partnership must provide a detailed description of the structure, allocations, ownership, ownership changes, partners, and, if relevant, any indirect partners for each taxable year relevant to the request for modification and any other information the IRS determines is necessary. In addition, the partnership must provide documentation which may include tax returns and the partnership agreement. Prop. Reg. 301.6225-2(c)(2)(ii). 10. IRS Approval: The IRS will notify the PR in writing of the approval or denial, in whole or in part, of the requested modification but notification of approval will be provided only after receipt of all relevant information and necessary payments. Prop. Reg. 301.6225-2(c)(4). 11. Modification Does Not Result in Separate IRS Examination. The modification process is part of the partnership administrative proceeding and does not constitute a separate examination, inspection, or other administrative proceeding with respect to any other person. Prop. Reg. 301.6225-2(c)(1). B. Non-Imputed Underpayment Adjustments 1. General. Partnership Adjustments that did not result in an Imputed Underpayment are taken into account by the partnership in the Adjustment Year. Prop. Reg. 301.6225-3(a). 2. Reallocation Adjustments. If the Partnership Adjustment is a reallocation of a distributive share, the applicable Adjustment is allocated to the Adjustment Year partners who are also Reviewed Year partners to whom the amount was reallocated. If a Reviewed Year partner is not also an Adjustment Year partner, the amount otherwise allocable to the Reviewed Year partners is allocated to the Adjustment Year partners who are the successor or successors to the Reviewed Year partner. If a successor cannot be identified or does not exist, the Adjustment 20
is allocated among Adjustment partners according to their respective distributive shares. Prop. Reg. 301.6225(b)(4). 3. Adjustments Effected by Modification Process. If the modification process applies and a Reviewed Year partner takes into account an Adjustment that does not otherwise result in an Imputed Underpayment, and the modification is approved by the IRS, the partnership does not take the Adjustment into account in the Adjustment Year. Prop. Reg. 301.6225-3(b)(5). 4. Effect of Push Out Election. If a valid Push Out Election has been made regarding an Imputed Underpayment, the Partnership Adjustment that does not result in an Imputed Underpayment (i.e., the Adjustment is a distributive share allocation, is disregarded or the Adjustment is a non-positive adjustment) is taken into account by the Reviewed Year partner under Section 6226. Prop. Reg. 301.6225-3(b)(6). 5. Net Non-Positive Adjustment. A net non-positive adjustment (ie, decrease in income or gain or increase in deduction or loss) is treated as a reduction in nonseparately 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). C. Alternative to Payment of Imputed Underpayment Amount by Partnership ( Push Out Election ) (Section 6226) Section 6226 provides for an election ( Push Out Election ) whereby the Reviewed Year partners, and not the partnership, pay the Imputed Underpayment Amount. 1. Criteria. A partnership does not pay the Imputed Underpayment Amount if the partnership meets the following two criteria: (i) not later than 45 days after the date of the FPA, the partnership elects Section 6226 and (ii) at such time and in such manner as the Secretary provides, the partnership furnishes to each Reviewed Year partner and to the Secretary a statement of the partner s share of any adjustment to income, gain, loss, deduction, or credit (as determined in the notice of final partnership adjustment). In such case, Section 6225 does not apply and each Reviewed Year partner takes such adjustment into account as provided below. 2. Multiple Imputed Underpayments: A partnership may make a Push Out Election with respect to one or more Imputed Underpayments identified in the FPA. Prop. Reg. 301.6226-1(a). 3. Election: To be valid, a Push Out Election must include the following information: 21