On March 23, 2018, the President signed into law the Consolidated Appropriations Act, 2018. The act includes several technical corrections (the "Technical Corrections") to the centralized regime for partnership audits enacted originally as part of the Bipartisan Budget Act of 2015 (the "Partnership Audit Rules"). The Partnership Audit Rules are generally effective for partnership taxable years beginning on or after January 1, 2018 (you can read more about the Partnership Audit Rules in this earlier Tax Update).
The Technical Corrections clarify the scope of the Partnership Audit Rules. Previously, the scope of the Partnership Audit Rules was literally narrower than the rules in the Tax Equity and Fiscal Responsibility Act of 1982 ("TEFRA") that the Partnership Audit Rules replaced, though proposed regulations under the Partnership Audit Rules had nevertheless adopted an expansive interpretation of their scope. The Technical Corrections expand the scope by eliminating references to adjustments to partnership income, gain, loss, deduction, or credit, and instead refer to "partnership-related items," which is generally defined as any partnership item or amount that is relevant in determining the income tax liability of any person, without regard to whether the item or amount appears on the partnership's return. This definition also specifically includes imputed underpayments and items or amounts relating to partnership transactions, basis, or liability.
The Technical Corrections clarify the netting rules for determining the amount of an imputed underpayment. The Technical Corrections make clear that items of different character, either capital or ordinary, may not be netted together for determining an imputed underpayment. This was previously unclear, though proposed regulations had interpreted the prior statutory language to have a similar result.
When adjustments are made to a partnership-related item that result in an imputed underpayment, the partnership pays an amount equal to the imputed underpayment, but adjustments that do not result in an imputed underpayment are passed through to the adjustment year partners. By not allowing the netting of capital and ordinary tax items, the Technical Corrections clarify that an imputed underpayment of a partnership is determined by applying the highest rate of tax in effect for the reviewed year for ordinary and/or capital income items, without any reductions to the imputed underpayment when, for example, there is a positive ordinary income adjustment and a negative capital gain adjustment. This netting rule will likely result in higher imputed underpayments, which in turn will likely encourage partnerships to push out adjustments to their partners rather than pay at the partnership level.
Modifications to Imputed Underpayments
The Technical Corrections clarify the imputed underpayment modification rules to better carry out their function - to determine the amount of tax due as closely as possible to the tax that would have been due if the partnership and partners had correctly reported and paid tax, while also allowing the efficient and prompt assessment and collection of taxes due.
To this end, the Technical Corrections add provisions which (1) clarify the rules allowing reviewed-year partners to take adjustments into account in amended returns so that the partnership's imputed underpayment can be determined without regard to that portion of the adjustments; and (2) under the new "pull-in" procedure, allow the reviewed-year partners, in lieu of actually filing amended returns, to pay tax that would be due with amended returns, make changes to tax attributes for later years, and provide the IRS with information to check that the tax was correctly computed. The pull-in procedure is available to direct and indirect reviewed-year partners (i.e., through tiered partnerships). The pull-in procedure was designed to ensure that there would be no corollary effects on the partners' returns (beyond the effects on tax attributes) in other taxable years of the adjustments to partnership-related items.
Push Outs through Tiered Partnerships
The Technical Corrections provide rules allowing for tax liabilities to be pushed out through tiers of partnerships, settling lingering questions over this controversial issue. The IRS initially took the position that push outs through tiered partnerships might not be allowed, but later reversed its position and published proposed regulations providing for tiered partnership push outs. However, some practitioners were concerned that, without statutory direction, the IRS might reverse its position on the issue again.
Special Enforcement Matters
The Technical Corrections contain provisions granting regulatory authority for partnership items involving special enforcement matters. These rules are similar to rules that existed under TEFRA, but were not previously included in the Partnership Audit Rules. Under the new provisions, the IRS may turn off the partnership audit rules in circumstances involving specifically defined special enforcement matters, applying special rules including those related to assessment and collection needed for "effective and efficient enforcement.".