In December 2017, we described the importance of addressing the new partnership audit rules, effective January 1, 2018, by tax-exempt investors in entities that are treated as partnerships for federal income tax purposes (e.g. limited partnerships and limited liability companies). Subsequent to our prior update, the IRS issued additional proposed regulations that set forth additional guidance how the new partnership audit rules are to be applied. Specifically, these recently issued proposed regulations provide relevant guidance on certain issues relevant to tax-exempt investors.

Application of “Push-out” Election to Tiered Partnerships or other Pass-Through Entities


The originally proposed regulations were re-released on June 13, 2017 (REG-136118-15). These proposed regulations were in substantially similar form as the version that was unofficially released in January 2017. The June 2017 proposed regulations provided guidance on how a partnership may utilize a “push-out election” under Code Section 6226 to pass through adjustments (“6226 adjustments”) to partners. Under the June 2017 proposed regulations, if the push-out election were made, the audited partnership would issue a statement (which would be similar to a Schedule K-1) to partners who were partners during the year that was the subject to the audit (the “Reviewed Year”). Such partners would then reflect the required adjustments on their own tax returns.


The recently issued proposed regulations, which were published shortly after our update on December 19, 2017, provide additional guidance on the push-out 6226 adjustments for partnerships that hold interests in lower-tier partnerships (such as lower-tier funds or operating companies treated as partnerships for federal income tax purposes). The December 2017 proposed regulations clarify that each pass-through partner in a chain of ownership has the choice to either (a) push the adjustments out to its own partners, or (b) pay tax with respect to the adjustments as contemplated under Code Section 6225. Further, to ensure compliance by each pass-through partner in the chain of ownership, the December 2017 regulations provide a mechanism to collect tax due from a non-compliant pass-through partner.

The issue of pass-through partnerships is relevant to investors, including tax-exempt investors, when investing in a fund that itselfinvests in lower-tier partnerships. If there is an audit at the level of a lower-tier partnership, which itself makes an election under Code Section 6226 to pass through adjustments to its partners, including the fund, it would be beneficial to tax-exempt investors in the fund for the fund (the upper-tier partnership) to elect to make its own push-out election to pass through the adjustment to its partners, including the tax-exempt investor.

In the absence of each lower-tier partnership making the push out election, no push-out election may be made by the fund with respect to the audit adjustment made at the lower-tier partnership level. The importance of the push out election being made at the lower-tier partnership level for tax-exempt investors is that, in the absence of such a push-out election, a tax-exempt investor could be allocated a part of the partnership-level costs related to the audit adjustments made at the lower-tier partnership level, even though such costs could have been avoided if the push out election were made.

The December 2017 proposed regulations make it clear that in order for the fund to make the push-out election with respect to audit adjustments made to a lower-tier partnership, the lower- tier partnership must provide the fund with certain information in a timely manner. If the lower-tier partnership does not forward this information (either because it fails to do so, or is not otherwise required to do so under its own governance documents), the fund could be precluded from taking the appropriate action to “push out” these audit adjustments to the its investors, so that a tax-exempt investor can reflect these adjustments directly on its own return (and apply its own tax attributes to the adjustments). 

Procedure for Asserting Defenses

The December 2017 proposed regulations also provide guidance on when a tax-exempt investor can assert a defense with respect to the partnership level audit adjustments. Under the June 2017 proposed regulations, it appeared that all defenses would have to be raised by the partnership or else they would be deemed waived. In contrast, the December 2017 proposed regulations appear to reverse this position in some instances. Nonetheless, tax-exempt investors should continue to track this defenses issue if and when final regulations are issued, so that tax-exempt investors can avoid an inadvertent waiver of defenses.