On November 2, President Obama signed the Bipartisan Budget Act of 2015 (BBA), which essentially repeals the partnership audit provisions that existed under the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) for tax years beginning after 2017. The new law leaves many issues unanswered, which will need to be addressed through IRS guidance, an amendment, or by technical correction provisions made by Congress.
Given current IRS budget constraints, guidance may be a long time coming, because the IRS will likely shift its resources to other enforcement priorities. Consequently, taxpayers have limited guidance on navigating future IRS examinations of partnerships. Let’s review that guidance and some of the related issues partnerships will need to address.
Partnership-Level Tax and Imputed Underpayments
In general, the BBA imposes any tax burden resulting from an audit adjustment on the partnership instead of flowing it through to partners, as was the case under the TEFRA audit procedures. The audit adjustment tax burden is referred to as the “imputed underpayment,” and it’s computed based on the highest individual or corporate tax rate for the tax year in question. The BBA provides the Treasury with regulatory authority to develop differing methods to compute the appropriate partnership-level tax. Under the BBA procedures, none of the respective partners’ tax attributes, such as lower applicable tax rates, credits, or other deductions, apply to the imputed underpayment. This generally results in a higher applicable tax rate.
The BBA refers to the year under examination as the “reviewed year” and the year any tax adjustments become final as the “adjustment year.” Thus, current partners may be liable in the adjustment year for incorrect tax benefits allocated to former partners in a reviewed year. The downside is that current partners may have a higher tax liability that cannot be recovered from former partners.
Shifting the Tax Burden to Affected Partners
To provide relief from the tax-year liability mismatch, the BBA provides two methods to shift the standard partnership-level imputed underpayment to the prior-year tax partners:
- The first method requires the partnership to issue adjusted Schedule K-1s to all affected partners and to assure that all partners amend their returns. Partners must make any required tax payments within 270 days after the partnership receives notice of the proposed partnership adjustment.
- The second method requires the partnership to issue—to each prior-year partner and the IRS—a statement of each partner’s share of the adjustment within 45 days of the partnership receiving a notice of final partnership adjustment. Significantly, this second method shifts the burden of compliance from the partnership to the partners, and it will most likely be a partnership’s preferred method of addressing audit adjustments.
Both the first and second method allow partner-level tax attributes to be applied to the tax computation, potentially resulting in an overall lower tax burden from the audit adjustment.
Contesting Audit Adjustments
The dates for utilizing either of the two methods for shifting partnership-level imputed underpayments to partners are firm. If the partnership chooses to challenge the proposed or final partnership adjustment, either administratively or judicially, the proceedings will need to be completed within 270 or 45 days, respectively. If not completed, the partnership loses its ability to shift the additional tax liability to the affected partners and instead will be assessed the imputed underpayment at the partnership level.
Electing Out of the New Audit Procedures
The BBA applies standardized audit procedures to all partnerships regardless of size. An opt-out election is available for partnerships with less than 100 partners consisting of individuals, C and S corporations, estates of deceased partners, and foreign entities that would be treated as C corporations if they were domestic. You can make the opt-out election on an on-time tax return on an annual basis under two conditions:
- Each partner must be notified that the partnership made the election.
- The partnership must supply the IRS with a list of partners and taxpayer identification numbers, including S corporation shareholders that are indirect partners.
A significant limiting factor to opting out may be obtaining the required information from indirect partners that are S corporation shareholders. Electing to opt out means any audit adjustments will generally flow through to the respective partners, shifting any amended filing and tax payment responsibility to them.
Statutes of Limitation and Administrative Adjustment Requests
Prior statutes of limitation in TEFRA audit proceedings were many times based on an individual partner’s statute of limitation, which confused the process and was frequently contested. The BBA provides that an audit adjustment can’t be made three years after the latter of:
- The date the partnership return was filed
- The due date of the partnership return
- The date the partnership filed an administrative adjustment request
This simplifies the determination of when the statute of limitation expires for filed partnership tax returns. Changes were also made to when administrative adjustment requests can be filed. This results in significant limitations on a partnership’s ability to file administrative adjustment requests during audit proceedings.
Similar to the existing tax matters partner rules, any partnership that doesn’t choose to elect out of the new partnership audit procedures can designate a partner or other person with substantial presence in the United States to be the partnership representative. This person has the right to bind the partners and the partnership to any decisions in the proceedings brought about under the new partnership audit procedures. If a partnership fails to designate a representative or replace a partner who was previously chosen, the IRS has authority to designate a person to perform this function. Given the significant implications of decisions made in audit proceedings, a partnership and its partners are well advised to choose their partnership representative carefully.
We're Here to Help
Moss Adams can help your partnership identify whether it’s eligible to elect out of the new audit standards as well as assist in any audit proceedings, the goal being to support adherence to the appropriate methods and proper application of your rights and benefits. To learn more about how you can successfully navigate complex partnership tax issues, visit our Web page on services for pass-through entities or contact:
Jim Dubeck, Director
Gary Stirbis, Director
Dawn Rhea, Director