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New Law Clarifies Partnership Audit Rules

May 21, 2018

Amber A. Monaghan, CPA, MSAT
Tax Director

The Consolidated Appropriations Act (CAA), 2018 (P.L. 115-141), which was signed by President Trump on March 23, contains numerous technical corrections, modifications and clarifications related to the centralized partnership audit regime rules that were enacted in the Bipartisan Budget Act (BBA), 2015 (P.L. 114-74). Included in these changes is a revision to the definition of a partnership adjustment and a new term, "partnership-related item." A new "pull-in" procedure is also introduced as an alternative procedure to filing amended returns related to an imputed underpayment of tax.

The new audit regime is intended to make it easier for the Internal Revenue Services (IRS) to examine partnerships, which have been notoriously complicated for the agency to audit. The new audit process shifts the collection of underpaid tax to the entity level, rather than to the partners. The new process applies generally to partnership tax years beginning after 2017.

Scope

The CAA clarifies the scope of the partnership audit rules. The new rules are not narrower than the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) partnership audit rules; they are intended to have a scope sufficient to address partnership-related items. The CAA eliminated references to adjustments to partnership income, gain, loss, deduction, or credit, and replaced them with partnership-related items. "Partnership-related items" are any item or amount that is relevant to determining the income tax liability of any partner, according to the Joint Committee on Taxation (JCT). Among other things, partnership-related items include an imputed underpayment, or an item or amount relating to any transaction with, basis in, or liability of the partnership.

According to the JCT, the partnership audit rules do not apply to withholding taxes except as specifically provided. However, any partnership income tax adjustment will be considered when determining and assessing withholding taxes when the partnership adjustment is relevant to that determination.

Netting in the Determination of Imputed Underpayments

Further, the technical corrections clarify that an imputed partnership underpayment is determined by appropriately netting partnership adjustments for that year, and then applying the highest rate of tax for the reviewed year. It also clarifies that items of different character (capital or ordinary), for example, are not netted together in determining the amount of an imputed underpayment. Rather, an imputed underpayment of a partnership with respect to a reviewed year is determined by the IRS by appropriately netting partnership adjustments for that year and by applying the highest rate of individual or corporate tax in effect for the reviewed year.

Pull-In; Push-Out

Also included in the CAA is a "pull-in" procedure, which allows for modifying an imputed underpayment without requiring individual partners to file an amended tax return. The "pull-in" procedure, if elected, would replace the "push-out" election. A push-out shifts liability to individual partners.

The "pull-in" procedure contemplates that partner payments and information could be collected centrally by the IRS. However, the procedure permits the partnership representative or a third-party accounting or law firm to collect the data and remit it to the IRS.

Penalties

The partnership adjustment tracking report required in a push-out is a return for purposes of failure to file, frivolous submission, and return preparer penalties. Also, the failure to furnish statements in a push-out is subject to the failure to file or pay tax penalties. However, neither an administrative adjustment request nor a partnership adjustment tracking report are returns for purposes of the partner amended return modification procedures.

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