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In-Depth: Bipartisan Budget Act Avoids Government Shutdown, Replaces TEFRA Partnership Audit Procedures.
(Parker Tax Publishing November 13, 2015)
On November 2, President Obama signed into law the Bipartisan Budget Act of 2015 (2015 BBA), which will fund the government through the 2017 fiscal year and avoids a repeat of the 2013 government shutdown. Unlike recent budget deals, this one had far less drama and was passed by Congress well ahead of the last-minute deadline other budgets had bumped against. The law repeals TEFRA partnership audit procedures and replaces them with a single centralized audit system, eliminates Obamacare's automatic enrollment requirement for employers with more than 200 employees, and makes several other tax changes. P.L. 114-74.
I. Changes to Partnership Audit Provisions
With respect to partnership audit rules, the 2015 BBA repeals the voluntary centralized audit procedures for electing large partnerships, as well as the TEFRA procedures (i.e., rules adopted as part of the Tax Equity and Fiscal Responsibility Act of 1982). Under the new system, the audit and adjustments of all partnership items are generally determined at the partnership level, although an opt-out provision to the new rules is available for certain partnerships.
OBSERVATION: Under the new rules, distinctions among partnership items, non-partnership items, and affected items no longer exist.
The changes to the audit rules are designed as revenue provisions related to tax compliance. According to the Joint Committee on Taxation, the repeal of the TEFRA partnership audit procedures is expected to increase revenues by over $9.3 billion in the next ten years.
Current Rules
Under current law, the manner in which an audit and redetermination of tax of partnership activities are determined depends upon the number of partners in a partnership and whether the partnership has elected to avail itself of certain special procedures. As a result, there are three different regimes for auditing partnerships.
First, for partnerships with 10 or fewer partners, the IRS generally applies the audit procedures for individual taxpayers. Thus, the IRS audits the partnership and each partner separately.
Second, for partnerships with more than 10 partners, the IRS conducts a single administrative proceeding under the TEFRA rules to resolve audit issues of partnership items that are more appropriately determined at the partnership level than at the partner level. Under TEFRA, once the audit is completed and the resulting adjustments are determined, the IRS recalculates the tax liability of each partner in the partnership for the particular audit year.
Third, partnerships with 100 or more partners can elect to be treated as electing large partnerships (ELPs) for reporting and audit purposes. A distinguishing feature of the ELP audit rules is that unlike the TEFRA audit rules, partnership adjustments generally flow through to the partners for the year in which the adjustment takes effect, rather than the year under audit. As a result, the current-year partners' share of current-year partnership items of income, gains, losses, deductions, or credits are adjusted to reflect partnership adjustments relating to a prior-year audit that take effect in the current year. The adjustments generally do not affect prior-year returns of any partners (except in the case of changes to any partner's distributive share).
New Law
The 2015 BBA repeals the TEFRA and ELP rules and streamlines the partnership audit rules into a single set of rules for auditing partnerships and their partners at the partnership level. Under the streamlined audit approach, the IRS will examine the partnership's items of income, gain, loss, deduction, credit and partners' distributive shares for a particular year of the partnership (i.e., the "reviewed year"). Any adjustments are taken into account by the partnership, and not the individual partners, in the year that the audit or any judicial review is completed (i.e., the "adjustment year"). Partners would not be subject to joint and several liability for any liability determined at the partnership level.
The new law gives partnerships the option of demonstrating that an adjustment would be lower if it were based on certain partner-level information from the reviewed year rather than imputed amounts determined solely on the partnership's information in such year. As an alternative to taking the adjustment into account at the partnership level, a partnership can issue adjusted information returns (i.e., adjusted Form K-1s) to the reviewed year partners, in which case those partners would take the adjustment into account on their individual returns in the adjustment year through a simplified amended-return process. The practical effect of this rule is that partnerships generally will no longer issue amended Form K-1s after the partnership return is filed, but instead will use the adjusted Form K-1 process for prior year adjustments.
According to Robert Kane, Sr. Tax Director, RSM US LLC, "if the partnership doesn't issue adjusted K-1s and instead pays the tax itself, any new partners who were not partners in the year to which the adjustment applies will bear the tax cost. This is because the additional tax is leveled in the adjustment year, and not the reviewed year. Alternatively, if the partnership issues adjusted K-1s to the partners in the reviewed year, those partners are responsible for the additional tax. The IRS will need to issue additional guidance addressing this issue."
Notes Kane, "[p]artnerships will need to review their operating agreements to ensure the agreements spell out the process for determining whether the partnership will pay any additional tax liability or will push the liability down to partners via the adjusted K-1 process."
Opt-Out Provision
Similar to the current rule excluding small partnerships from the TEFRA provisions, the new law allows partnerships with 100 or fewer qualifying partners to opt out of the new rules, in which case the partnership and partners will be audited under the general rules applicable to individual taxpayers. In order to qualify for this opt-out provision, the partners must be either individuals, C corporations, a foreign entity that would be treated as a C corporation if it were a domestic entity, an S corporation, or an estate of a deceased partner. The election must be made with a timely filed return for the tax year it is to be effective and include a disclosure of the name and taxpayer identification number of each partner in the partnership, and each partner must be notified of the election.
In the case of an S corporation partner, the partnership will only be treated as meeting the requirement for opting out if the partnership discloses the name and taxpayer identification number of each person with respect to whom the S corporation is required to furnish a statement for the tax year of the S corporation ending with or within the partnership tax year for which the election out of the new law is elected.
Notes Kane, "[p]artnerships that have other partnerships as partners, in other words tiered arrangements, are not eligible for the opt-out process. So that eliminates a lot of partnerships from this provision. However, the new law allows room for the IRS to identify by regulations or other guidance additional partners to which the opt-out provision may apply."
Effective Date and Early Election of Changes
The changes relating to the partnership audit provisions generally apply to returns filed for partnership tax years beginning after December 31, 2017. This should give the IRS time to issue the additional guidance necessary to address all the issues that will emerge as a result of the new law.
However, except for the election relating to the opt-out provision, a partnership may elect to apply the new partnership audit rules to any return of the partnership filed for partnership tax years beginning after November 2, 2015, and before January 1, 2018.
Practice Tip: Should partnerships make the early election? Says Kane, "TEFRA is a tough audit process. For example, for partnerships that have 100 or fewer partners, the IRS is required to notify each partner at the beginning and at the end of the partnership audit and recalculate each partner's liability. Additionally, the IRS has run into significant statutes of limitation issues as a result of failing to properly identify a TEFRA partnership. As a result, you have less partnership audits. Congress sees getting rid of TEFRA as a revenue raiser because there will be more partnership audits and more money flowing into the Treasury. By making an early election into the non-TEFRA rules, a partnership may be increasing its chances of being audited." However, Kane added, "[l]arge partnerships typically take conservative positions so they don't end up sending amended K-1s to 100 partners and the IRS may find there is not a lot of money to be made by more partnership audits."
II. Changes to "Family Partnership" Rules in Code Sec. 704(e)
Current Rules
Currently, Code Sec. 704(e) is titled "Family partnerships." Under Code Sec. 704(e)(1), a person is recognized as a partner in a partnership if the person owns a capital interest in a partnership in which capital is a material income-producing factor, whether or not such interest was obtained by purchase or by gift.
The predecessor of this provision was enacted in 1951 to prevent the IRS from denying partner status to a taxpayer who shared actual ownership of the partnership's income-producing capital on the basis that the interest was acquired from a family member. According to the legislative history, Code Sec. 704(e)(1) was intended to make clear that, however the owner of a partnership interest may have acquired such interest, the income is taxed to the owner, if he is the real owner. If the ownership is real, it does not matter what motivated the transfer or whether the business benefitted from the entrance of the new partner.
OBSERVATION: The problem with Code Sec. 704(e)(1) was that its scope was not entirely clear. Some read it as doing nothing more than stating the general principle that income derived from capital is taxed to the owner of the capital. Others read it as providing an alternative test as to what constitutes a "partner" by treating the holder of a capital interest as a partner without regard to how the term is defined in Code Sec. 761. The argument was that if a partner holds a capital interest in a partnership, the partnership must be respected regardless of whether the parties demonstrated that they joined together to conduct an active trade or business.
New Law
The new law revises Code Sec. 704(e)(1) and clarifies that, by adding a new sentence to Code Sec. 761(b), Congress did not intend for the family partnership rules to provide an alternative test for determining whether a person is a partner in a partnership. Congress intended the rule in Code Sec. 704(e) to merely explain that a family member who received, via gift, a capital interest in a partnership, where capital is a material income-producing factor (as opposed to services), should be respected as a partner in the partnership and should be taxed on the income from that partnership. Thus, the determination of whether the owner of a capital interest is a partner is made under the generally applicable rules defining a partnership and a partner.
Effective Date
The changes to Code Sec. 704(e) and Code Sec. 761(b) relating to family partnerships and partnership interests created by gift apply to partnership taxable years beginning after December 31, 2015.
III. Repeal of ACA Automatic Enrollment Requirements
Under the Affordable Care Act (ACA), employers with more than 200 employees were required to automatically enroll new full-time equivalents into a qualifying health plan if offered by that employer, and to automatically continue enrollment of current employees. Employers were also required to provide adequate notice and the opportunity for an employee to opt out of any coverage in which he or she was automatically enrolled.
The Departments of Labor, Health and Human Services, and the Treasury stated in a 2010 FAQ that employers were not required to comply with automatic enrollment until regulations were issued. As of the enactment of the 2015 BBA, such regulations had not been issued.
The 2015 BBA repeals the automatic enrollment provisions added by the ACA, effective November 2, 2015.
IV. Other Changes
Other changes in the law made by the 2015 BBA include:
(1) A modification of the fixed premium that single-employer pension plans pay annually to the Pension Benefit Guarantee Corporation;
(2) A change to the criteria for determining whether a defined benefit pension plan has credible information to use mortality tables separate from those prescribed by regulations;
(3) An extension on current funding stabilization percentages for valuing defined benefit pension plan liabilities; and
(4) Authorization to use automated telephone equipment to call cell phones for the purpose of collecting debts owed to the U.S. government.
(Staff Editor Parker Tax Publishing)
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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