IRS to Limit Certain Partnerships from Opting Out of Centralized Partnership Audit Regime

(Parker Tax Publishing January 2019)

The IRS announced its intention to issue proposed regulations addressing certain special enforcement matters under Code Sec. 6241(11) relating to the centralized partnership audit regime rules. According to the IRS, the proposed regulations would (1) would provide that Code Sec. 6221(b), relating to the election to opt out of the centralized partnership audit regime rules, generally does not apply to a partnership with a QSub as a partner, and (2) would also allow the IRS to determine that the centralized partnership audit regime does not apply to adjustments to partnership-related items when certain conditions are met. Notice 2019-6.

Background

The Technical Corrections Act of 2018 (TTCA) enacted Code Sec. 6241(11), which deals with the treatment of special enforcement matters in the case of partnership-related items. Under Code Sec. 6241(11), in the case of partnership-related items involving special enforcement matters, the IRS may issue regulations providing that the centralized partnership audit regime (or any portion thereof) does not apply to such items and that such items are subject to special rules as is determined to be necessary for the effective and efficient enforcement of the Code.

For purposes of Code Sec. 6241(11), the term "special enforcement matters" means:

(1) failure to comply with the requirements of Code Sec. 6226(b)(4)(A)(ii) (regarding the requirement for a partnership-partner or S corporation partner to furnish statements or compute and pay an imputed underpayment);

(2) assessments under Code Sec. 6851 (relating to termination assessments of income tax) or Code Sec. 6861 (relating to jeopardy assessments of income, estate, gift, and certain excise taxes);

(3) criminal investigations;

(4) indirect methods of proof of income;

(5) foreign partners or partnerships; and

(6) other matters that the IRS determines by regulation present special enforcement considerations.

Code Sec. 6221(a) requires that any adjustment to a partnership-related item is determined at the partnership level under the centralized partnership audit regime, except to the extent otherwise provided. A partnership-related item is defined in Code Sec. 6241(2) as any item or amount with respect to the partnership which is relevant in determining the income tax liability of any person, including any distributive share of such an item or amount.

Opting Out of Centralized Partnership Audit Regime

Certain partnerships may elect out of the centralized partnership audit regime under Code Sec. 6221(b). A partnership is eligible to make an election out if it has 100 or fewer partners for the taxable year, each partner in the partnership is an eligible partner, the election is timely made in the prescribed manner, and the partnership notifies its partners of the election. The number of partners is determined by counting the number of statements required to be furnished by the partnership under Code Sec. 6031(b) and the number of statements required to be furnished by any S corporation partners of the partnership. Eligible partners include C corporations.

A qualified subchapter S subsidiary (QSub) is defined as a domestic corporation that has 100 percent of its stock held by an S corporation and for which an election has been made to treat it as a QSub. Except as provided by regulation, a QSub is not treated as a corporation separate from its S corporation shareholder and its assets, liabilities, and items of income, deduction and credit are treated as the assets, liabilities, and items of its S corporation shareholder for the taxable year. A C corporation is defined as a corporation which is not an S corporation. Because a QSub is not an S corporation, it is a C corporation. Because a QSub is a C corporation, it is an eligible partner under Code Sec. 6221(b).

Proposed Regulations

The IRS said it intends to propose regulations under Code Sec. 6241(11)(B)(vi) regarding two matters that the IRS has determined present special enforcement considerations. The first matter involves situations in which an adjustment during an examination of a person other than the partnership requires a change to a partnership-related item. According to the IRS, the regulations will allow it 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. Consequently, 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 Code Sec. 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.

The second matter concerns situations where a QSub is a partner in a partnership. According to the IRS, this situation presents special enforcement considerations because partnership structures with QSubs as partners could have far more than 100 ultimate partners. Allowing such a large partnership to elect out of the centralized partnership audit regime, the IRS said, would give rise to significant enforcement concerns and frustrate the efficiencies introduced by the centralized partnership regime. As a result, the future regulations will provide that Code Sec. 6221(b) generally does not apply to a partnership with a QSub as a partner. The regulations will also provide, however, that if a partnership meets certain requirements as set forth in the regulations, the partnership may make an election under Code Sec. 6221(b). Specifically, the regulations will apply a rule similar to the rules for S corporations under Code Sec. 6221(b)(2)(A). The regulations 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 Code Sec. 6221(b), the partnership must include (1) the statement the partnership is required to furnish to the QSub partner under Code Sec. 6031(b) and (2) each statement the S corporation that holds 100 percent of the stock of the QSub partner is required to furnish to its shareholders under Code Sec. 6037(b).

Regs Will Apply to Tax Years Beginning after 2017

Citing Code Sec. 7805(b)(2), the IRS said it intends to issue the above-described proposed and final regulations before 18 months after enactment of TTCA so that the regulations will be applicable to all partnership tax years beginning after December 31, 2017. If final regulations are not issued before 18 months after enactment of the TTCA, the IRS intends the regulations to be applicable to partnership tax years beginning after December 31, 2017, and ending after December 20, 2018 (i.e., the date Notice 2019-6 was issued).

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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