New Tax Audit Rules Are A Game-Changer For Partnerships
On January 1, 2018, new rules regarding tax audits for partnerships known as the “centralized partnership audit regime” (the “CPA Regime”) went into effect for all partnerships and entities taxed as partnerships, such as limited liability companies. The new partnership tax audit rules have widespread applicability, and in most situations, will require either an amendment to, or a complete restatement of, existing partnership agreements or limited liability company operating agreements. This client and advisor alert summarizes the CPA Regime and key issues based upon the new statute, final treasury regulations, and proposed treasury regulations. A future client and advisor alert will explore the mechanics of a partnership audit pursuant to the CPA Regime, the complex netting rules for partnership adjustments, and basis adjustments that must be made by the partners after audit.
The Bipartisan Budget Act of 2015 (the “BBA”) created the CPA Regime. Prior to the enactment of the BBA, partnership tax audits were governed by the rules set forth in the Tax Equity and Fiscal Responsibility Act of 1982 (“TEFRA”). TEFRA partnership audits required the IRS to adjust all partnership items on each individual partner’s return through deficiency proceedings for partnerships with 10 or fewer direct partners. For partnerships with 10 or more direct partners, TEFRA generally allowed the IRS to make adjustments for “partnership items” at the partnership level, which were then passed on and collected from the partners. The IRS found this to be a burdensome and labor-intensive process, as many partnerships are tiered and determining the ultimate partner was difficult. Compounding matters, the statute of limitations for assessing the tax at the partner level continued to run while the IRS was reviewing the partnership.
II. General Summary of the CPA Regime and Key Definitions Within the CPA Regime.
a. Key Definitions.
The CPA Regime creates a number of unique terms, the definitions of which are key to understanding the CPA Regime. The following is a list of key terms and their definitions:
1. Partnership Representative. The partnership representative is designated annually on the partnership’s income tax return and is the exclusive agent for representing any partnership during an audit with the Internal Revenue Service. The partnership representative has unilateral authority to bind the partnership and the partners (including former partners) to various outcomes in the partnership audit, including making the “push-out” election (explained later).
Partnership Adjustment. A partnership adjustment is any change at the conclusion of the audit in the: (a) amount of income, gain, loss, deduction or credit of a partnership; or (b) any partner’s distributive share of income, gain, loss, deduction, or credit of a partnership.
3. Imputed Underpayment. Any imputed underpayment is any underpayment of tax that results from a partnership adjustment to the partnership or a reallocation of a partner’s share of income, gain, loss, deduction or credit from one partner to another. An imputed underpayment can be general or specific. A general imputed underpayment applies to all the partners in a partnership. A specific imputed underpayment applies to one partner or a group of partners. There can only be one general imputed underpayment in any audit; however, there can be more than one specific imputed underpayment.
4. Adjustment Year. The adjustment year is the year in which the partnership audit adjustment becomes final by a Notice of Final Partnership Adjustment, court decision, or as a result of an administrative adjustment request.
5. Adjustment Year Partner. An adjustment year partner is any person or entity who owns a partnership interest during the adjustment year.
6. Reviewed Year. The reviewed year is the partnership tax year that is being audited.
7. Reviewed Year Partner. A reviewed year partner is any person or entity who owned a partnership interest during the reviewed year.
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