IRS Finalizes Centralized Partnership Audit Regime Regulations

(Parker Tax Publishing January 2019)

The IRS issued final regulations implementing the centralized partnership audit regime. These final regulations affect partnerships for tax years beginning after December 31, 2017, and ending after August 12, 2018, as well as partnerships that make the election to apply the centralized partnership audit regime to partnership tax years beginning on or after November 2, 2015, and before January 1, 2018. T.D. 9844.

Background

The Bipartisan Budget Act of 2015 (BBA) removed former subchapter C of chapter 63 of the Code effective for partnership tax years beginning after December 31, 2017. That portion of the Code contained the unified partnership audit and litigation rules enacted by the Tax Equity and Fiscal Responsibility Act of 1982 that were commonly referred to as the TEFRA partnership procedures or simply TEFRA. The BBA also removed subchapter D of chapter 63 of the Code and part IV of subchapter K of chapter 1 of the Code, rules applicable to electing large partnerships, effective for partnership tax years beginning after December 31, 2017. The BBA also replaced the TEFRA partnership procedures and the rules applicable to electing large partnerships with a centralized partnership audit regime that determines adjustments and, in general, determines, assesses, and collects tax at the partnership level.

The BBA set forth the effective dates for these amendments, which are effective generally for returns filed for partnership tax years beginning after December 31, 2017.

On June 14, 2017, the IRS issued proposed regulations under Code 6221 regarding the scope and election out of the centralized partnership audit regime, Code Sec. 6222 regarding consistent treatment by partners, Code Sec. 6223 regarding the partnership representative, Code Sec. 6225 regarding partnership adjustments made by the IRS and determination of the amount of the partnership's liability (i.e., the imputed underpayment), Code Sec. 6226 regarding the alternative to payment of the imputed underpayment by the partnership, Code Sec. 6227 regarding administrative adjustment requests (AARs), and Code Sec. 6241 regarding definitions and special rules.

On November 30, 2017, the IRS issued proposed rules regarding international provisions under the centralized partnership audit regime, including rules relating to the withholding of tax on foreign persons, the withholding of tax to enforce reporting on certain foreign accounts, and the treatment of creditable foreign tax expenditures of a partnership.

On December 19, 2017, the IRS issued proposed regulations relating to the administrative and procedural rules under the centralized partnership audit regime, including rules addressing assessment and collection, penalties and interest, periods of limitations on making partnership adjustments, and judicial review of partnership adjustments. The proposed regulations also provided rules addressing how pass-through partners take into account adjustments under the alternative to payment of the imputed underpayment described in Code Sec. 6226 and under rules similar to Code Sec. 6226 when a partnership files an AAR under Code Sec. 6227.

On January 2, 2018, the IRS issued final regulations under Code Sec. 6221(b) providing rules for electing out of the centralized partnership audit regime.

On February 2, 2018, the IRS issued proposed regulations for adjusting tax attributes under the centralized partnership audit regime.

On March 23, 2018, Congress enacted the Tax Technical Corrections Act (TTCA), which made a number of technical corrections to the rules under the centralized partnership audit regime. The amendments under the TTCA are effective as if included in the BBA.

On August 9, 2018, the IRS issued final regulations under Code Sec. 6223 providing rules relating to partnership representatives and final regulations under Sec. 301.9100-22 providing rules for electing into the centralized partnership audit regime for taxable years beginning on or after November 2, 2015, and before January 1, 2018. Corresponding temporary regulations under Reg. Sec. 301.9100-22T were also withdrawn.

On August 17, 2018, the IRS issued proposed regulations which partially withdrew the regulations proposed in June 2017, November 2017, December 2017, and in February 2018, and proposed regulations reflecting the technical corrections enacted in the TTCA as well as other changes.

The IRS has now issued final regulations in T.D. 9844. The final regulations partially adopt comments made in connection with the June 2017, the November 2017, and the December 2017 regulations (i.e., former proposed regulations). replace the regulations proposed in June 2017, November 2017, and December 2017. The proposed regulations issued on August 17, 2018, are still in proposed form.

The IRS noted that it had received several comments concerning the rules regarding basis and tax attributes under the proposed regulations and that these comments would be addressed in future guidance.

Final Regulations

Numerous changes and clarifications were made in the final centralized partnership audit regime regulations. The following is a summary of some of the more important changes.

Consistency Requirement in the Treatment of Partnership Items

Code Sec. 6222(a) and Reg. Sec. 301.6222-1(a) require consistent treatment of partnership-related items on partners' returns and the partnership return filed with the IRS, except in cases where a partner notifies the IRS of an inconsistency. The requirement to be consistent with the partnership return extends to each return filed by the partner that reflects, or is required to reflect, partnership-related items. This includes both original and amended returns. Any other application of this requirement, the IRS noted, would render the requirement of consistency meaningless. For example, a partner could file a return on April 15 taking a consistent position, only to turn around on April 16 and file an amended return taking an inconsistent position.

To clarify that the consistency requirement applies to each return of the partner, the final regulations provide that the term "partner's return" for purposes of Reg. Sec. 301.6222-1 includes any return, statement, schedule, or list, and any amendment or supplement thereto, filed by the partner with respect to any tax imposed by the Internal Revenue Code. Accordingly, pursuant to Reg. Sec. 301.6222-1(a), a partner on either an original or an amended return must treat partnership-related items consistently with how those items were treated on the partnership return filed with the IRS.

The clarification of the term "partner's return" also addresses a practitioner's suggestion that the regulations permit inconsistent treatment on an amended return provided the IRS is notified of that inconsistent treatment. Under Reg. Sec. 301.6222-1(c)(1), the requirement that a partner treat a partnership-related item consistently with the partnership's treatment of that item, and the effect of inconsistent treatment, do not apply to partnership-related items identified as inconsistent (or that may be inconsistent) in a statement attached to the partner's return on which the partnership-related item is treated inconsistently. As clarified in the final regulations, the term "partner's return" for purposes of Reg. Sec. 301.6222-1 includes any amendment to the partner's original return. Accordingly, so long as a partner notifies the IRS of an inconsistent treatment by attaching a statement (in the form prescribed by the IRS) to the partner's return - including an amended return - on which the partnership-related item is treated inconsistently, the consistency requirement under Reg. Sec. 301.6222-1(a), and the effect of inconsistent treatment under Reg. Sec. 301.6222-1(b), do not apply to that partnership-related item.

The final regulations provide that, when a partner on an amended return treats a partnership-related item inconsistently with how the item was treated on the partnership return, the partner is making a request for an administrative adjustment of that partnership-related item. Accordingly, the IRS revised the rule under proposed regulations, which that provided a partner could not request an administrative adjustment of a partnership-related item, to account for situations in which, on an amended return, a partner treats a partnership-related item inconsistently with the partnership return pursuant to Reg. Sec. 301.6222-1(c)(1).

Regulations Relating to the Filing of AARs

Code Sec. 6227(c) provides that in no event may a partnership file an AAR after a notice of an administrative proceeding with respect to the tax year is mailed under Code Sec. 6231. Consistent with Code Sec. 6227(c), the proposed regulations provided that no AAR may be filed after a Notice of Administrative Proceeding (NAP) has been mailed by the IRS, except as provided in the rules relating to the withdrawal of a NAP. To give effect to this rule in the context of inconsistent treatment, the final regulations under Reg. Sec. 301.6222-1(c)(5) provide that a partner may not notify the IRS that the partner is treating an item inconsistently with the partnership return for a tax year after a NAP with respect to such partnership tax year has been mailed by the IRS under Code Sec. 6231. This rule clarifies that once the IRS initiates an administrative proceeding with respect to a partnership tax year, any adjustment to a partnership-related item for that year must be determined exclusively within that partnership-level proceeding in accordance with Code Sec. 6221(a). Neither the partnership, through filing an AAR, nor a partner, by taking an inconsistent position, may adjust a partnership-related item outside of that proceeding. Any actions taken by the partnership and any final decision in the proceeding are binding on the partnership and all its partners.

Under the proposed regulations, the provisions of Reg. Sec. 301.6222-1(c) did not apply with respect to the partner's treatment of a partnership-related item reflected on an AAR. This meant that a partner could not treat an item inconsistently with how such item was treated on an AAR. One practitioner recommended that the regulations under Reg. Sec. 301.6222-1(c)(2) be revised to permit a partner to notify the IRS of an inconsistent position taken with respect to an item reported on an AAR and the IRS adopted this recommendation.

When taking into account AAR adjustments under Reg. Sec. 301.6227-3, partners must adhere to the consistency requirements under Code Sec. 6222(a). According to the IRS, nothing in Code Secs. 6222, 6223(b), or 6227, however, precludes a partner from notifying the IRS that the partner is taking an adjustment into account inconsistently with how the adjusted item was treated in an AAR. While Code Sec. 6227 imposes certain requirements with respect to AARs, none of those requirements contradict Code Sec. 6222(c)'s exception to the consistency requirement. Accordingly, the final regulations under Reg. Sec. 301.6222-1(c)(2) remove the language stating that the provisions of Reg. Sec. 301.6222-1(c)(1) do not apply with respect to a partner's treatment of a partnership-related item reflected on an AAR. In addition, the final regulations under Reg. Sec. 301.6227-1 removed the rule under the proposed regulations regarding the binding nature of an AAR. As a result of these changes, a partner may notify the IRS that it is treating an AAR-adjusted item inconsistently in accordance with the provisions of Reg. Sec. 301.6222-1(c).

Under Code Sec. 6223(b), all partners, including partners that have filed a notice of inconsistent treatment, are bound by the actions of the partnership and any final decision in a proceeding with respect to the partnership under the centralized partnership audit regime. To clarify the application of this rule in the case of a partnership-level proceeding to adjust an identified, inconsistently reported item, the proposed regulations were revised to provide that where the IRS conducts a proceeding with respect to the partnership, and there is no proceeding with respect to the partner regarding an identified, inconsistently reported partnership-related item, the partner is bound to actions by the partnership and any final decision in the partnership proceeding.

Effect of Inconsistent Treatment When Partner Is a Partnership

The proposed regulations had provided that the rules of Reg. Sec. 301.6222-1 apply to a partnership-partner regardless of whether the partnership-partner has made an election under Code Sec. 6221(b) to elect out of the provisions of the centralized partnership audit regime. The final regulations clarify that the rules of Reg. Sec. 301.6222-1 apply to all partners including partnership-partners that have elected out of the centralized partnership audit regime and revised the language referring to such partners to better conform to similar references in other regulations.

Imputed Underpayments

According to the IRS, 20 comments were received concerning Code Sec. 6225 and the rules regarding imputed underpayments. Code Sec. 6225(b)(1)(B) provides that the determination of any imputed underpayment is made by "applying the highest rate of tax in effect for the reviewed year under section 1 or 11." Consistent with Code Sec. 6225(b)(1)(B), the proposed regulations provided that an imputed underpayment is determined by multiplying the total netted partnership adjustment by the highest rate of federal income tax in effect for the reviewed year under Code Sec. 1 or Code Sec. 11 and increasing or decreasing that product by certain adjustments to credits and creditable expenditures. The IRS noted that, because application of the highest rate is established by statute, the regulations also apply the highest rate of tax to determine an imputed underpayment under Code Sec. 6225(b).

The IRS noted that the structure of Code Sec. 6225(b) is premised on the concept that an imputed underpayment is determined with respect to a reviewed year and that adjustments with respect to the reviewed year result in such imputed underpayment or are adjustments that do not result in an imputed underpayment. Code Sec. 6225(b)(1)(A) expressly provides that "any imputed underpayment with respect to any reviewed year must be determined by the Secretary by appropriately netting all adjustments with respect to such reviewed year . . . ." The IRS noted that the statute does not reference adjustments with respect to any year other than the reviewed year. Accordingly, the IRS rejected practitioner requests to allow for the netting of adjustment across tax years, saying that such a rule is not consistent with the statutory language of Code Sec. 6225(b)(1)(A).

The IRS also noted that a rule that allows for automatic netting of adjustments across tax years ignores the limitation in Code Sec. 6225(b)(4) and would create significant administrative burdens for the IRS. Code Sec. 6225(b)(4) provides that if any adjustment would result in a decrease in the amount of the imputed underpayment and could be subject to any additional limitation under the Code if taken into account by any person, such adjustment should not be taken into account in the netting process described in Code Sec. 6225(b)(1)(A). This provision codifies the presumption that, except as otherwise provided, taxpayer favorable adjustments subject to any possible limitation under the Code if taken into account by any person are disregarded when determining an imputed underpayment. The statute does not require the IRS to determine whether taxpayer favorable adjustments are in fact subject to such limitations. A rule allowing for netting across tax years would, however, require the IRS to make such determinations. This would have the effect, the IRS said, of inappropriately expanding the number of tax years and partnership adjustments potentially at issue in the partnership-level proceeding. Not only would that result undermine the limitation under Code Sec. 6225(b)(4), it would also unnecessarily complicate the partnership examination, creating potential burdens for both the IRS and the partnership.

For a discussion of the centralized partnership audit regime rules, see Parker Tax ¶28,700.

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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