As discussed in a previous post, in late 2015 Congress enacted the Bipartisan Budget Act of 2015 (the “BBA”) which completely revamped the way partnerships (including LLCs taxed as partnerships) will be audited beginning in 2018. Since the introduction of the BBA, tax professionals have discovered a vast number of problems with the new audit regime and the administrative strain it will place on partnerships.
In response, on December 6, 2016, Congress introduced the Technical Corrections Act of 2016 (H.R. 6439) (the “TCA”) to address a number of these concerns. The bill is currently under review by congressional committee, but the contents of the bill as it currently stands gives a reliable look into the likely changes to the BBA. Below provides partnerships and advisors with a summary of the changes proposed by Congress in the TCA.
Expansion of the BBA’s Application
As currently enacted, the BBA’s new partnership audit rules apply to adjustments of partnership income, gain, loss, deduction, or credit. The TCA expands the new partnership audit rules the adjustment of any “partnership-related item.” A partnership-related item includes any item with respect to the partnership which is relevant in determining the tax liability of the partnership or any partner’s distributive share of any such item. This change brings within the scope of the new rules items such as basis and liability allocation.
New Alternative for Partners to Cover Any Imputed Underpayment
The BBA provides that, in the event the partnership is assessed an imputed underpayment of tax, the partners may file amended returns for the reviewed year taking into account all adjustments and paying any tax due. This approach eliminates the partnership’s liability for the imputed underpayment. The TCA introduces a new alternative for the partners to pay additional tax due as a result of an imputed underpayment.
This new alternative will allow partners to demonstrate to the IRS the amount of tax for which each partner would be responsible, and then pay such tax and make any corresponding adjustments to the partner’s partnership items. This alternative intends to provide each partner with a means to pay its share of additional tax without filing an amended return. The specifics of this option will require substantial interpreting regulations.
Guidance on the Treatment of the Push-Through Election for Tiered Partnerships
In the event that the partnership is assessed a tax adjustment, the BBA allows a partnership to elect to “push-through” such adjustment to the partners in the partnership, rather than take the adjustment at the partnership level. A major concern for tax practitioners was whether this push-through election would be required to be pushed-through up the equity chain of any partners that were themselves taxed as a partnership. The TCA provides that these partners would have the option, but not be required, to either continue to push-through the adjustment up the equity chain, or to pay the tax at the entity level. The payment of tax by the partner, or the flow-through of the tax, must be made by the due date of the partnership’s return for the year.
Change in Method of Determining the Amount of Any Imputed Underpayment
The BBA states that the amount of imputed underpayment of a partnership for the year under review is calculated by netting the increases and decreases of partnership income. If this process results in a net increase in the partnership’s income, that amount is multiplied by the highest tax rate in effect at that time. The TCA changes this process, by requiring that all adjustments be separately determined within each category of item (i.e. by each line item on Schedule K-1), and then netted against each other. The TCA also disallows adjustments reducing liability if the amount would be subject to certain loss limitations (e.g. passive loss limitations).
While the TCA changes remain subject to review and revision, most expect that the TCA will remain substantially intact, meaning partners and practitioners can reasonably rely on the text of the TCA in planning for 2018.
The major decisions arising from the TCA, in addition to those created by the BBA, include whether the partners will elect to pay any additional tax due with or without filing amended returns, and also whether those partners who are themselves taxed as partnerships will choose to further “push-through” any adjustment items up the equity chain.
The TCA represents merely the first step in addressing the many issues with the BBA, and further corrections, clarifications, and regulations will be needed to fully implement the new audit regime.