The Tax Technical Corrections Act of 2016 (available here) introduced recently makes technical corrections to the new partnership audit rules in the Bipartisan Budget Act of 2015 (“BBA”). The BBA repealed and replaced the 1982 Tax Equity and Fiscal Responsibility Act (“TEFRA”) and electing large partnership rules with a new regime for partnership audits and adjustments focused on partnership-level assessments and collections. The new partnership audit rules are effective for partnership tax years beginning after 2017 and are discussed in more detail here.
The technical corrections are extensive and more substantive than most technical corrections. Indeed, the technical corrections address some of the deficiencies and open issues in the BBA. The significant changes include:
- The modifications eliminate references to adjustments to partnership income, gain, deduction or credit and instead refer to partnership-related items, which is a broader provision. Thus, the scope of BBA is intended to address the same partnership items, affected items, and computational items as in the TEFRA context.
- The modifications clarify that the partnership audit rules do not apply to taxes imposed under chapters 2 and 2A of the Code (i.e., self employment taxes and net investment income taxes), and that any partnership adjustment determined for income tax purposes is taken into account for purposes of determining these other taxes to the extent that the partnership adjustment is relevant to such determination. Thus, for example, if a partnership adjustment results in a change of income of an individual partner, the change is reflected as required in calculating the individual’s net earnings from self employment or net investment income and such tax may be collected through a process outside of the partnership audit rules.
- For purposes of netting, limitations (on deductions) that would apply at the partner level are treated as applying unless the IRS determines otherwise. For example, if any adjustment would increase the amount of partnership loss allocable to partners, but the loss could be subject to the passive loss rules of Section 469, then the adjustment will not be taken into account in determining the partnership’s imputed underpayment, unless the IRS determines otherwise.
- Items of different character are not netted together in determining the amount of an imputed underpayment. Therefore, capital losses could no longer be netted against ordinary income.
- The new expressed intent of the modifications to the imputed underpayment is to determine the amount of tax due as closely as possible to the tax due if the partnership and partners had correctly reported and paid the tax. This is a change from the rough justice currently in the BBA to allow the IRS to efficiently collect tax due from partnership adjustments.
- Under the BBA, an imputed underpayment may be reduced by the filing of amended returns by partners, but the IRS must accept the amended returns. The technical corrections provide that the imputed underpayment shall be reduced by the portion of the adjustments taken into account by the partners filing amended returns, so long as certain requirements are satisfied, including the payment of any tax due with the amended returns. Thus, the IRS no longer must review and approve the amended returns. However, the partners filing the amended returns must make payments of any tax due with their amended returns and must file amended returns for the reviewed year as well as for any intervening year(s) with respect to which any tax attribute of the partner is affected by reason of the adjustment to the reviewed year. This strikes a fair balance between efficiency and collections.
- The technical corrections introduce a new “pull-in” procedure as an alternative to reviewed year partners filing amended returns. Under the pull-in procedure, reviewed year partners pay the tax that would be due with amended returns, make binding changes to their tax attributes for subsequent years, and provide the IRS with information to substantiate that the tax was correctly paid. While the procedure seems very similar to the amended return procedure, it expressly applies to tiered partnerships and indirect partners. In addition, partner payments and partner information may be collected centrally and remitted to the IRS by the partnership representative or a third party, including an accounting or law firm. Thus, this procedure is designed to assist the IRS in efficiently collecting the tax due from the partnership adjustments.
- The push-out election is allowed in tiered structures. Thus, if a pass-through partner receives a statement in a push-out election, the pass-through partner may either pay its imputed underpayment or push-out the adjustments to its partners or shareholders. To do so, the partnership must file with the IRS a new partnership adjustment tracking report.
- If a partnership fails to pay an imputed underpayment within 10 days of notice and demand, the applicable interest rate on the underpayment will increase by 2% and the IRS may assess and collect adjustment against adjustment-year partners for their proportionate shares. This makes the partners severally, but not jointly, liable for the imputed underpayment. This would allow the IRS to recover from the partners in circumstances in which the partnership has terminated (excluding a technical termination).
The Technical Corrections bill did not pass before Congress adjourned for the year, but we will continue to follow the bill in the new year. If you have any questions about the technical corrections or partnership audits, please contact one of us or any of the other Tax lawyers at Thompson & Knight.