As reported in a prior Sutherland Legal Alert, the Bipartisan Budget Act of 2015 (the 2015 Budget Act) makes significant changes to the procedural rules governing federal income tax audits and judicial proceedings that apply to partnerships and other entities (such as limited liability companies or statutory trusts) classified as partnerships for federal income tax purposes. These changes, which repeal the existing Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) partnership procedures and the electing large partnership rules and create new partnership procedural rules (the Budget Act Procedures), are effective for partnership taxable years beginning after December 31, 2017. However, partnerships generally may elect, at such time and in such manner as determined by the Treasury Department, to apply the Budget Act Procedures early. On August 5, 2016, the Treasury issued temporary and proposed regulations (the Regulations) that address the time, form and manner for making such an election (an Early Opt-In Election).
Sutherland Observation. In general, under the Budget Act Procedures, liability for taxes, penalties and interest arising from adjustments to partnership tax items generally is imposed on the partnership in the year in which the adjustments become final, rather than the persons who were partners for the year under review. The approach of the Budget Act Procedures is a radical departure from the historic treatment of a partnership as a pass-through entity that is not subject to federal income tax and has the potential to significantly alter the economic arrangements of the partners relating to liabilities for historic tax positions.
Under the Regulations, an Early Opt-In Election is permitted to be made only for an “eligible taxable year,” which is defined as any partnership taxable year beginning after November 2, 2015, and before January 1, 2018. However, the Regulations include exceptions to the definition of eligible taxable year, which are intended to avoid duplicative proceedings under both the existing partnership procedures and the Budget Act Procedures in cases where the partnership has taken affirmative steps to apply the existing partnership procedures. More specifically, under the Regulations, an eligible taxable year does not include any taxable year for which the partnership has filed, or is deemed to have filed, an administrative adjustment request (AAR) under the TEFRA procedures (in the case of partnerships subject to TEFRA) or an amended return (in the case of non-TEFRA partnerships). (For partnerships subject to TEFRA, an AAR generally is the equivalent of an amended return or a claim for refund.) For this purpose, a partnership is deemed to have filed an AAR under the existing TEFRA procedures if the partnership files an AAR before January 1, 2018, except in cases where the partnership is already subject to the Budget Act Procedures as a result of an Early Opt-In Election under the general rule discussed below.
Eligible Taxable Years
Under the general rule set forth in the Regulations, an Early Opt-In Election must be made within 30 days of the date of notification to the partnership, in writing, that a return of the partnership for an eligible taxable year has been selected for examination.
The partnership makes the Early Opt-In Election by providing a written statement to the Internal Revenue Service (IRS) contact identified in the notice of selection for examination. The statement must include the words “Election under Section 1101(g)(4)” at the top, must be signed under penalties of perjury by the tax matters partner (for TEFRA partnerships) or an individual who has the authority to sign the partnership return for the taxable year under examination, and must include general contact information for the partnership and the following additional information:
- Language indicating that the partnership is electing to apply the Budget Act Procedures for the partnership return for the eligible taxable year identified in the notice of selection for examination;
- The information required to properly designate the partnership representative as defined in the Budget Act Procedures; and
- Representations that the partnership (i) is not insolvent and does not reasonably anticipate becoming insolvent, (ii) is not currently and does not reasonably anticipate becoming subject to a bankruptcy petition under title 11 of the United States Code, and (iii) has sufficient assets and reasonably anticipates having sufficient assets to pay any imputed underpayment for the partnership taxable year that may be determined under the Budget Act Procedures.
The Regulations provide that, upon receipt of the Early Opt-In Election, the IRS will promptly mail a notice of administrative proceeding to the partnership pursuant to the Budget Act Procedures, but such mailing will not be made before 30 days after the IRS’s receipt of the Early Opt-In Election.
Exception to the General Rule
The Regulations provide an exception to the general rule discussed above that allows a partnership to elect the Budget Act Procedures for an eligible taxable year in cases where the partnership has not received a notice of selection for examination from the IRS but wishes to file an AAR under the Budget Act Procedures for such year. An Early Opt-In Election cannot be made under the exception prior to January 1, 2018. Such an election must be made in the manner prescribed by the IRS for that purpose in accordance with applicable regulations, forms and instructions, and other guidance issued by the IRS. According to the preamble to the Regulations, prior to January 1, 2018, the Treasury and the IRS plan to issue additional guidance regarding AARs filed under the Budget Act Procedures.
Once a valid Early Opt-In Election is made under the Regulations, the election can only be revoked with consent from the IRS. Moreover, the Regulations provide that an Early Opt-In Election is not valid if it frustrates the purposes of the Budget Act Procedures.
Sutherland Observation. As a general matter, the Budget Act Procedures are intended to make it easier for the IRS to collect taxes, penalties and interest resulting from adjustment to partnership tax items by imposing liability for such items on the partnership rather than the partners. Based on the representations concerning the financial condition of the partnership that are required to be included in an Early Opt-In Election under the General Rule, and the apparent ability of the IRS to invalidate an Early Opt-In Election if it frustrates the purposes of the Budget Act Procedures, it is clear that the Treasury is concerned that some partnerships may seek to utilize an Early Opt-In Election for tax avoidance purposes.
Sutherland Observation. There are many aspects of the Budget Act Procedures that are uncertain, and numerous provisions in the Budget Act Procedures defer to Treasury regulations that have not yet been issued. Accordingly, in the absence of such needed clarification and guidance, a partnership and its partners should carefully consider the possible consequences of an Early Opt-In Election. Moreover, because the general approach of the Budget Act Procedures has the potential to alter the underlying economics of the partnership by imposing liability on the partnership rather than the partners, persons entering into partnership relationships, or purchasing or disposing of partnership interests, should be mindful of the possibility of an Early Opt-In Election and the economic consequences (both beneficial and detrimental) that could result from such an election.