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The IRS has issued temporary (TD 9780) and proposed (REG-105005-16) regulations setting forth the time and manner for electing to apply the new partnership audit regime enacted by the 2015 Bipartisan Budget Act (BBA), for partnership tax years beginning after November 2, 2015 (the BBA enactment date) and before January 1, 2018.

Background

The BBA, enacted November 2, 2015, repealed the existing TEFRA (Tax Equity and Fiscal Responsibility Act of 1982) procedures for partnership audits and implements a new audit regime for most partnerships, effective for tax years beginning after December 31, 2017. The new audit regime is mandatory for all partnerships with 100 or more partners and certain other partnerships with flow-through partners.

Under the new audit regime, partnerships are generally responsible for paying any imputed underpayment that results from an IRS examination of the partnership return year (the reviewed year), which is generally paid in the year the audit or judicial review is complete. Partnerships may also elect into an alternative payment process, where the partners in the reviewed year take into account the adjustments made by the IRS and pay any tax due as a result of those adjustments, rather than have the partnership pay an imputed underpayment. In addition, under the new audit regime, the "partnership representative" will have sole authority before the IRS to bind the partnership and partners on partnership adjustments. Partnerships with 100 or fewer qualifying partners may elect out of the new audit system and instead be audited under the traditional rules applicable currently to small partnerships. For a more detailed discussion of the new audit regime, see Tax Alert 2015-2085.

While the provisions of the new audit regime generally apply to returns filed for partnership tax years beginning after December 31, 2017, BBA Section 1101(g)(4) allows partnerships to elect to apply the new audit regime (other than the small partnership opt-out election) to any of their partnership returns filed for partnership years beginning after November 2, 2015 (the BBA enactment date) and before January 1, 2018.

Electing into new audit regime for eligible tax years

The temporary regulations set forth the time, form and manner for electing to apply the new partnership audit regime to tax years beginning after November 2, 2015, and before January 1, 2018 (eligible tax years). The text of the temporary regulations also serves as the text of the proposed regulations (together, "the regulations"). Only elections made in accordance with the regulations will be considered valid. Elections will also be invalid if they conflict with the purposes of the BBA (e.g., collecting imputed underpayments due by partnerships). Valid elections may only be revoked with IRS consent. A partnership may not request an extension of time under §301.9100-3 to make this election.

Under the regulations, the new audit regime will not apply in certain circumstances, including when: (1) the partnership has taken the affirmative step to apply the TEFRA procedures to a partnership return for a tax year through the filing of an administrative adjustment request (AAR) under TEFRA for that partnership tax year, and (2) a partnership not subject to TEFRA has filed an amended return for the partnership tax year.

Timing of election

The regulations state that the election must be made within 30 days of the date that the IRS first notifies the partnership in writing that a partnership return for an eligible tax year has been selected for examination (a notice of selection for examination). Partnerships may not request an extension of time to make the election. The regulations stipulate that the IRS will not issue a notice of an administrative proceeding — thereby cutting off a partnership's time for filing an AAR — for at least 30 days after it receives a valid election. Accordingly, a partnership will have at least 30 days after making its election to file an AAR.

In an exception to the general rule that a partnership may only elect into the new audit regime after receiving notice of selection for examination, the regulations allow a partnership that has not received such notice to elect to have the new audit regime apply to an eligible tax year if the partnership wishes to file an AAR under Section 6227, as amended by the BBA. No such elections may be made before January 1, 2018. Accordingly, an AAR under Section 6227, as amended by the BBA, may not be filed before January 1, 2018 (except by partnerships that have been issued an applicable notice of selection for examination). In general, an AAR filed before January 1, 2018, will be treated as an AAR under Section 6227 of the TEFRA partnership procedures, or as an amended return for partnerships not subject to TEFRA. The IRS intends to issue guidance regarding AARs under Section 6227 as amended by the BBA before January 1, 2018.

Manner and form of election

The regulations specify that the election must be in writing and must include the following:

1. A statement at the top declaring "Election under Section 1101(g)(4)"

2. A statement that the partnership is electing to have the partnership audit regime enacted by the BBA apply to the partnership return identified in the IRS notice of selection for examination

3. The partnership's name, taxpayer identification number (TIN) and partnership tax year to which the statement applies

4. Representations that the partnership: (a) is not insolvent and does not reasonably anticipate becoming insolvent, (b) is not currently and does not reasonably anticipate becoming subject to a bankruptcy petition under title 11 of the United States Code, and (c) has sufficient assets, and reasonably anticipates having sufficient assets, to pay the potential imputed underpayment that may be determined during the partnership examination

5. A signature with date by the tax matters partner or other individual with applicable authority to sign for the partnership for the tax year

6. The name, TIN, address and phone number of the individual who signs the statement

7. A representation, signed under penalties of perjury, that the individual signing the statement is duly authorized to make the election under Treas. Reg. Section 301.9100-22T(b) and that, to the best of the individual's knowledge and belief, the statement is true, correct and complete

The statement must be provided to the individual identified in the notice of selection for examination as the IRS contact for the examination.

Partnerships electing into the new audit regime must also designate the partnership representative, and provide the representative's name, TIN, address and daytime phone number — as well as any additional information required by future guidance.

Implications

This is the first in a series of regulations to be issued under the new audit regime. While the regulations do not address the substantive provisions, this is a key first step in the IRS and Treasury's release of guidance implementing the new audit regime before January 1, 2018. More guidance, however, is necessary to fully understand whether an election into the new audit regime would be beneficial for the eligible tax years, and partnerships and partners will need to carefully analyze their specific facts and circumstances in determining whether to make the election (after receipt of a notice of selection for examination for a tax year beginning after November 2, 2015).

Until further guidance on the consequences of the new partnership audit regime is issued, it is likely that many partnerships will not elect into the rules early. Partnership agreements should also be reviewed and analyzed for purposes of deciding whether a partnership can make the election and who has the authority to decide to do so. In addition, the regulations are a useful reminder that taxpayers that have entered into collaboration agreements that, based on a weighting of applicable factors under existing guidance, are more properly characterized (for Federal tax purposes) as a deemed or constructive partnership need to be aware of the potential applicability of the new audit regime.

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