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Proposed regs on new partnership uniform audit rules: “Push out” election

Thomson Reuters Tax & Accounting  

Thomson Reuters Tax & Accounting  

IRS has issued 277 pages of proposed regs on the new partnership audit regime that was enacted as part of the Bipartisan Budget Act of 2015 (the BBA, P.L. 114-74, 11/2/2015). This article, part of a multi-part series, discusses the provisions in the proposed regs dealing with the so-called “push out” election under which a partnership can elect to have its partners take into account the adjustments made by IRS instead of paying the imputed underpayment itself.

For an overview of the proposed regs and a more detailed background, see ¶ 15.

For a more detailed discussion of the provisions dealing with the scope of the new regime and electing out of these rules, see ¶ 29.

For the consistency requirement under the proposed regs, see ¶ 16.

For a more detailed discussion of the provisions dealing with imputed underpayments under the proposed regs, see ¶ 3.
RIA observation: The addition of “:zz” to the various Code citations below is to ensure that Code sections appropriately link to the new BBA version (and not the TEFRA version) of the partnership provisions. The “:zz” is not part of the official Code cite and should be otherwise ignored.

Statutory background. Code Sec. 6226:zz provides an alternative to the general rule under Code Sec. 6225(a)(1) that the partnership must pay the imputed underpayment (see ¶ 3 for more details). Under Code Sec. 6226:zz, the partnership may elect to have its reviewed year partners take into account the adjustments made by IRS and pay any tax due as a result of those adjustments. In this case, the reviewed year partners must pay any tax resulting from taking into account the adjustments and the partnership is not required to pay the imputed underpayment.

Making the election. To make the Code Sec. 6226:zz election, a partnership must take two steps with respect to an imputed underpayment: (i) make an election in the manner provided by IRS no later than 45 days after the date the final partnership adjustment (FPA) is mailed by IRS under Code Sec. 6231:zz; (Code Sec. 6226(a)(1):zz) and (ii) furnish, at the time and in the manner provided by IRS, a statement of each partner’s share of any adjustment as determined in the FPA to its reviewed year partners. (Code Sec. 6226(a)(2):zz) If these steps are taken, Code Sec. 6225:zz does not apply with respect to the imputed underpayment, and each partner must take its share of the adjustments into account as provided in Code Sec. 6226(b):zz. (Code Sec. 6226(a):zz) The election is revocable only with IRS’s consent.

Accounting for adjustments. The reviewed year partners take the adjustments subject to the Code Sec. 6226:zz election into account by increasing each partner’s income tax, for the tax year that includes the date the statement was furnished, by the aggregate of:

1. for the partner’s tax year that includes the end of the reviewed year, the amount by which the partner’s income tax would increase if the partner’s share of the adjustments were taken into account for the tax year (Code Sec. 6226(b)(2)(A):zz), plus
2. for any of the partner’s tax years after the tax year that includes the end of the reviewed year and before the tax year that includes the date the statement was furnished, the amount by which the partner’s income tax would increase by reason of the adjustment to tax attributes. (Code Sec. 6226(b)(2)(B):zz) These adjustments to tax attributes will be made by adjusting the relevant attributes for any tax years after the tax year that includes the end of the reviewed year and before the tax year that includes the date the statement was furnished, and then appropriately adjusting the attributes for later tax years. (Code Sec. 6226(b)(3):zz)

Penalty, etc. determination. When an election is made under Code Sec. 6226:zz, any penalties, additions to tax, or additional amounts are determined under Code Sec. 6221:zz at the partnership level, and the reviewed year partners of the partnership are liable for any such penalty, addition to tax, or additional amount. (Code Sec. 6226(c)(1):zz)

Interest determination. Interest is determined at the partner level. (Code Sec. 6226(c)(2)(A):zz) Interest is calculated from the due date of the partner’s return for the tax year to which the increase in tax is attributable taking into account any increases attributable to a change in tax attributes for an intervening year as determined under Code Sec. 6226(b)(2):zz. The interest is computed at the underpayment rate under Code Sec. 6621(a)(2):zz, substituting five percentage points for three percentage points for purposes of Code Sec. 6621(a)(2)(B):zz (the sum of the federal short-term rate plus five percentage points instead of three percentage points).

New proposed regs. Prop Reg § 301.6226-1(a) would allow partnership to be able to elect under Code Sec. 6226 to “push out” adjustments to its reviewed year partners rather than paying the imputed underpayment determined under Code Sec. 6225:zz . If a partnership makes a valid election, the partnership would no longer liable be for the imputed underpayment. The election would be able to be made respect to one or more imputed underpayments identified in an FPA.

Effect of election. Prop Reg § 301.6226-1(b)(1) would provide that if a partnership makes a valid election, the reviewed year partners of the partnership would be liable for tax, penalties, additions to tax, and additional amounts, as well interest on such amounts, after taking into account their share of the partnership adjustments determined in the FPA. Any modifications approved by IRS under Prop Reg § 301.6225-2 (see ¶ 3) would also be reported to the reviewed year partners.

The election wouldn’t be valid unless the partnership complies with all applicable requirements, and it would be revocable only with IRS’s consent. If IRS determines that an election is invalid, it would notify the partnership and partnership representative within 30 days of its determination and give its reason. A final determination that an election is invalid would mean that the partnership is liable for any imputed underpayment to which the election related, as well as any penalties and interest with respect to the imputed underpayment determined under Code Sec. 6233.

Making the election. The election would have to be made within 45 days of the date the FPA was mailed by IRS, be signed by the partnership representative, include all required information, and be properly filed with IRS. A copy of the FPA to which the election relates would also have to be attached. (Prop Reg § 301.6226-1(c)(4)) The partnership would have to furnish statements to the reviewed year partners with respect to the partner’s share of the adjustments, within 60 days after the date the adjustments become finally determined, and file such statements with IRS. (Prop Reg § 301.6226-2(a)) All reviewed year partners would be bound by the election and would be required to take the adjustments on the statement into account and pay any additional tax as a result. The proposed regs describe information required to be included on the statements (Prop Reg § 301.6226-2(e)), as well as procedures for correcting any errors in statements filed with IRS. (Prop Reg § 301.6226-2(d))

Partner’s share of adjustments. A reviewed year partner’s share of the adjustments that the partner would have to take into account would have to be reported to that partner in the same manner as originally reported on the return filed by the partnership for the reviewed year. If the adjusted item was not reflected in the partnership’s reviewed year return, the adjustment would have to be reported in accordance with the rules that apply with respect to partnership allocations, including under the partnership agreement. However, if the adjustments, as finally determined, are allocated to a specific partner or in a specific manner, the partner’s share of the adjustment would have to follow how the adjustment is allocated in that final determination. (Prop Reg § 301.6226-2(f))

Any penalties, additions to tax, or additional amounts would be reported to the reviewed year partners in the same proportion as each partner’s share of the adjustments to which the penalties relate, unless the penalty, addition to tax, or additional amount is specifically allocated to a specific partner(s) or in a specific manner by a final court decision or in the FPA, if no petition is filed. (Prop Reg § 301.6226-2(f)(2)) If a penalty, addition to tax, or additional amount does not relate to a specific adjustment, each reviewed year partner’s share thereof would be determined in accordance with how such items would have been allocated under rules that apply with respect to partnership allocations, including under the partnership agreement, unless it is allocated to a specific partner in a specific manner in a final determination of the adjustments, in which case it is allocated in accordance with the final determination. (Preamble to Prop Reg01/19/2017)

Computation of tax. A reviewed year partner that is furnished a statement under Prop Reg § 301.6226-2 would be required to pay any additional income tax for the partner’s tax year which includes the date the statement was furnished to the partner that results from taking into account the adjustments reflected in the statement. (Prop Reg § 301.6226-3) This additional tax would be either the aggregate of the adjustment amounts, as determined in Prop Reg § 301.6226-3(b) (see below), or, if an election is made under Prop Reg § 301.6226-3(c), a safe harbor amount.

The reviewed year partner would also have to pay, for the reporting year, the partner’s share of any penalties, additions to tax, or additional amounts reflected in the statement, and any interest on such amounts. Interest would be determined in accordance with Prop Reg § 301.6226-3(d).

Aggregate adjustment amounts. The aggregate of the adjustment amounts would be the aggregate of the relevant “correction amounts” determined under Prop Reg § 301.6226-3(d)—one correction amount for the partner’s tax year which includes the reviewed year of the partnership, and a second for the partner’s tax years after the first affected year and before the reporting year. These correction amounts cannot be less than zero, and any amount below zero after applying the rules in Prop Reg § 301.6226-3(b) would not reduce any correction amount, any tax in the reporting year, or any other amount.

The correction amount for the first affected year would be the amount by which the reviewed year partner’s income tax would increase for the first affected year by taking into account the adjustments reflected in the statement provided to the reviewed year partner under Prop Reg § 301.6226-2. The aggregate correction amount for all intervening years would be the sum of the correction amounts for each intervening year. (Prop Reg § 301.6226-3(b)(3))

Election to pay safe harbor amount. Any reviewed year partner that is furnished a statement described in Prop Reg § 301.6226-2, including partnership-partners and S corporation partners, would be able to elect, on the partners’ return for the reporting year, to pay the safe harbor amount (or the interest safe harbor amount, in the case of certain individuals) shown on the statement in lieu of the additional reporting year tax. (Prop Reg § 301.6226-3(c)) The safe harbor amount for each reviewed year would be calculated in the same manner as the imputed underpayment under the safe harbor amount for each reviewed year is calculated in the same manner as the imputed underpayment under Prop Reg § 301.6225-1, except that the adjustments allocated to the partner on the statement (including any amounts attributable to adjustments to partnership tax attributes) would be used instead of the adjustments that are taken into account for purposes of determining the imputed underpayment. With one exception (for when a reviewed partner filed an amended return or entered into a closing agreement during the modification phase), any approved modifications of the imputed underpayment, including a rate modification under Code Sec. 6225(c)(4):zz, would have no effect on the determination of the safe harbor amount for any partner.

A partnership would also have to calculate an interest safe harbor amount for partners who are individuals and who have a calendar year tax year, at the rate set forth in Prop Reg § 301.6226-3(d)(4) from the due date (without extension) of the individual reviewed year partner’s return for the first affected year until the due date (without extension) of the individual reviewed year partner’s return for the reporting year. A separate safe harbor amount (and interest safe harbor amount, if applicable) would be calculated for each separate statement furnished to the partner under Prop Reg § 301.6226-2.

Reviewed year partners would also be liable for interest on any correction amount for the first affected year and any intervening years under Prop Reg § 301.6226-3(d)(1). If the partner elects to pay the safe harbor amount, a reviewed year partner that is an individual could also elect to pay the interest safe harbor amount. For all other partners and individuals that do not elect the safe harbor amount, interest would apply under Prop Reg § 301.6226-3(d)(2).

RICs, and REITs. The proposed regs would coordinate the rules under the centralized partnership audit regime with the deficiency dividend procedures under Code Sec. 860 for partners that are regulated investment companies (RICs) and real estate investment trusts (REITs). Under Prop Reg § 1.6226-2(h), if a statement described in Prop Reg § 1.6226-2 is furnished to a reviewed year partner that is a RIC or REIT, the RIC or REIT would be able to take into account the adjustments reflected in the statement that also are “adjustments” within the meaning of Code Sec. 860(d) by using the deficiency dividend procedures set forth in Code Sec. 860, subject to certain limitations. Prop Reg § 301.6226-3(b)(4) would also coordinate the deficiency dividend rules with the rules for determining the additional reporting year tax under Prop Reg § 301.6226-3(b) with respect to any adjustments shown on a statement furnished to a RIC or REIT under Prop Reg § 301.6226-2.

Petition for readjustment. Under Code Sec. 6234(a):zz, a partnership may petition for readjustment within 90 days of the date the FPA is mailed. The proposed regs coordinate the rules under Code Sec. 6234:zz so that an election can be made during the time frame provided under Code Sec. 6226:zz (i.e., within 45 days of the date the FPA is mailed) without cutting off the partnership’s right to challenge the adjustments in court within the time frame provided for in Code Sec. 6234:zz. The proposed regs do this by providing that, while the election under Code Sec. 6226:zz must be filed within 45 days of the date the FPA is mailed, the filing and furnishing of the statements is not required until 60 days after the adjustments are finally determined. (Prop Reg § 301.6226-2(b)) The partnership adjustments would become finally determined upon the later of the expiration of the time to file a petition under Code Sec. 6234:zz or, if a petition is filed, the date when the court’s decision becomes final. (Prop Reg § 301.6226-2(b))

Reserved issues. IRS requested comments in a number of areas, and the proposed regs reserved on these issues. They include how IRS should administer the Code Sec. 6226:zz requirements in tiered structures (e.g., whether a pass-through partner should be able to flow adjustments through to its owners); how to treat under Code Sec. 6226:zz a direct partner in the partnership that is an estate or trust, or a foreign entity, such as a trust or corporation that may not be liable for U.S. federal income tax with respect to one or more adjustments, but an owner of the direct partner is (or could be) liable for tax with respect to such amount; and whether and how to adjust the outside bases and capital accounts of adjustment year partners if the reviewed year partner whose basis and capital account should have been adjusted is no longer a partner as a result of a liquidating distribution and thus no other partner has succeeded to the liquidating partner’s capital account. (Preamble to Prop Reg 01/19/2017)

References: For the post-2017 partnership audit rules, see FTC 2d/FIN ¶ T-2400 et seq.; United States Tax Reporter ¶ 62,214.12. et seq.

Preamble to Prop Reg 01/19/2017, Prop Reg § 301.6226-1, Prop Reg § 301.6226-2, Prop Reg § 301.6226-3

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