To-Be-Issued Proposed Regulations will Address Centralized Partnership Audit Regime
In Notice 2019-06 (the “Notice”), the IRS previewed changes to its streamlined partnership audit regime that are planned to take effect later in 2019. The Notice provides that the to-be-issued proposed regulations under IRC § 6241(11)(B)(vi) (the “Regulations”) will address two matters that have been determined to present special enforcement considerations.
First, the Notice addresses certain situations where an adjustment during an examination of a person (other than the partnership) requires a change to a partnership-related item. Specifically, the Regulations will allow the IRS to “effectively and efficiently focus on a single partner or a small group of partners with respect to a limited set of partnership-related items without unduly burdening the partnership and avoiding procedural concerns about the appropriate level at which such items must be examined.” For instance, the Regulations will provide that the IRS may determine that the centralized partnership audit regime does not apply to adjustments to partnership-related items when the following conditions are met: (1) the examination being conducted is of a person other than the partnership; (2) a partnership-related item must be adjusted, or a determination regarding a partnership-related item must be made, as part of an adjustment to a non-partnership-related item of the person whose return is being examined; and (3) the treatment of the partnership-related item on the return of the partnership under IRC § 6031(b) or in the partnership’s books and records was based in whole or in part on information provided by, or under the control of, the person whose return is being examined.
Second, the Notice addresses issues that may arise when a qualified subchapter S subsidiary (“QSub”) is a partner in a partnership. The Regulations will provide that this situation presents special enforcement considerations because partnership structures with QSubs as partners could have hundreds of partners and still potentially elect out of the centralized partnership audit regime. The Notice provides that allowing such a large partnership to elect out of the centralized partnership audit regime would frustrate the efficiencies introduced by the centralized partnership audit regime. Thus, the Regulations will provide that a partnership with a QSub as a partner will generally be ineligible to elect out of the centralized partnership audit regime under IRC § 6221(b). However, the Regulations will also provide that if a partnership with a QSub as a partner meets certain requirements, the partnership may make an election under IRC § 6221(b). Specifically, the Regulations will apply a rule similar to the rules for S corporations under IRC § 6221(b)(2)(A), and will also provide that for purposes of determining whether a partnership has 100 or fewer partners for the tax year for purposes of the election under IRC § 6221(b), the partnership must include: (1) the statement the partnership is required to furnish to the QSub partner under IRC § 6031(b); and (2) each statement the S corporation that holds 100% of the stock of the QSub partner is required to furnish to the S corporation’s shareholders under IRC § 6037(b).
The Notice states that the intention is for the proposed and final regulations to be issued before 18 months after enactment of the Technical Corrections Act of 2018 (March 23, 2018), and for the regulations to apply to all partnership tax years beginning after December 31, 2017. If this 18-month deadline is not met, the intention is for the regulations to be applicable to partnership tax years beginning after December 31, 2017, and ending after December 20, 2018 (the date when the Notice was released).
Please see the Notice in full here.
IRS Releases Form for Election Out of Centralized Partnership Audit Regime
The IRS recently released Schedule B-2 (Form 1065) and its instructions, which reflect the election out of the centralized partnership audit regime. Effective for returns filed for a partnership taxable year beginning after 2017, a new centralized partnership audit regime was enacted as part of the Bipartisan Budget Act of 2015 (“BBA”). Under the new regime, any adjustment to items of income, gain, loss, deduction, or credit of a partnership for a partnership tax year (and any partner’s distributive share thereof) will generally be determined, and any tax attributable thereto will be assessed and collected, at the partnership level.
However, certain partnerships are eligible to annually elect out of the BBA. If a partnership elects out, any federal audit of the partnership must be conducted at the partner level, on a partner-by-partner basis, under the audit procedures applicable to each partner. With a valid election, the IRS would generally make any adjustment relating to the partnership’s return in an audit of a partner. The partnership would also generally not owe any taxes, interest, or penalties.
Who Is Eligible To Elect Out
IRC § 6221(b) states that a partnership is eligible to elect out of the BBA if: (1) the partnership has 100 or fewer partners during the year, and (2) all partners are eligible partners at all times during the tax year. The regulations provide that a partnership has 100 or fewer partners during the year if the partnership is required to furnish 100 or fewer Schedules K-1 during the tax year for which the partnership makes the election.
The regulations define an eligible partner as any person who is an individual, C corporation, foreign entity that would be treated as a C corporation were it a domestic entity, S corporation, or an estate of a deceased partner. An S corporation is an eligible partner even if it has a shareholder who would not be an eligible partner himself or herself.
An eligible partner does not include any partnership, trust, disregarded entity described in Treas. Reg. § 301.7701-2(c)(2)(i), person that holds an interest in the partnership on behalf of another person, foreign entity that would not be treated as a C corporation were it a domestic entity, and estate that is not the estate of a deceased partner. A disregard entity is an ineligible partner even if it is owned by persons or entities that would otherwise be eligible partners.
What Must Be Included In Election
The partnership must make the election by completing and attaching Schedule B-2 to a timely filed partnership return (including extensions) for every tax year to which the election relates. On the Schedule, the partnership must provide the following information: name, correct U.S. taxpayer identification number, and federal tax classification of each person or entity that was a partner (and each shareholder of an S-corporation partner) at any point during the taxable year. Thus, each partner, foreign or domestic, must have a valid U.S. taxpayer identification number.
If the Schedule is not completed correctly, the IRS may determine that the election is invalid.
Within 30 days of an election, the partnership must also notify each partner of the election in the form and manner elected by the partnership.
The new centralized partnership audit rules can cause other issues not discussed here that are important to understand. Accordingly, it is imperative for taxpayers to consider reviewing and updating existing partnership agreements and operating agreements, as well as modifying the tax audit provisions of future agreements to address the centralized partnership audit rules, especially when the partnership is not eligible to make an election under IRC § 6221(b).
For more information or for assistance in reviewing or drafting your documents, please contact us at (504) 569.2900.