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The IRS has released new proposed regulations (REG-120232-17; REG-120233-17) under the centralized partnership audit regime introduced by the Bipartisan Budget Act of 2015 (BBA) with guidance on Section 6226 push-out elections involving tiered partnership structures. The proposed regulations also address various other procedural issues under the BBA audit regime, including tax assessment and collection, penalties and interest, periods of limitations, and judicial review of partnership adjustments. The proposed regulations would allow an upper-tier partnership to make the Section 6226 push-out election for an adjustment attributed to it from a lower-tier partnership.

Background

BBA partnership audit regime and subsequent regulations

As part of the BBA, legislation was enacted that overhauls the manner in which partnerships are audited and how any resulting tax liability is computed, assessed and collected. Before the BBA, a partnership audit generally was conducted in accordance with the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), which did not provide any statutory mechanism for collecting tax at the entity level. Rather, the IRS generally had to seek payment of underpaid tax directly from those who were partners in the partnership during the year of audit. The BBA brought in a new regime to allow for assessment and collection of tax at the partnership level under centralized audit procedures, along with a number of other changes to the partnership audit process. These new rules are generally effective for most partnerships for tax years starting after December 31, 2017.

On June 13, 2017, Treasury and the IRS released the "June Proposed Regulations," which provide additional guidance on the applicable procedures, the determination of the amount of taxes, interest and penalties owed, and other consequences of an adjustment to a partnership tax return. Among other provisions, the June Proposed Regulations include procedures for opting out of the new regime, designating a partnership representative, filing administrative adjustment requests, and determining amounts owed by a partnership or its partners from adjustments following partnership exam. For a detailed discussion, see Tax Alerts 2017-0168 and 2017-1002.

In November 2017, the IRS issued proposed regulations providing guidance on the application of certain international tax rules under the BBA centralized partnership audit regime. For a detailed discussion, see Tax Alert 2017-2056.

Section 6226 push-out elections: alternative to payment of imputed underpayments

Under Section 6226 and the June Proposed Regulations, a partnership may elect to "push out" adjustments to its reviewed year partners rather than paying the imputed underpayment at the partnership level. To be valid, this election must comply with all the regulatory requirements for such an election and the partnership must provide notice to the partners and IRS. The June Proposed Regulations make it clear that the partnership is no longer liable for any imputed underpayment once a valid push-out election is made.

The June Proposed Regulations reserved on the issue of how the adjustments are taken into account for tiered partnership structures by partners that are pass-through partners (i.e., partnerships, S corporations, certain trusts and decedent's estates), and whether such partners can, in turn, push the adjustment out beyond their tier (i.e., to their partners).

New proposed regulations

Pass-through partners and the Section 6226 push out election

The new proposed regulations address the Section 6226 push-out adjustments in tiered structures. Under the proposed regulations, at each tier, a pass-through partner may choose either to pay tax with respect to an adjustment or to push it out to its partners, shareholders or beneficiaries. The preamble to the new proposed regulations states that, to ensure this approach does not hinder the IRS's ability to collect tax, the IRS will collect tax due from any pass-through partners that fail to comply with the requirement to either push the adjustments out to their owners or pay the tax resulting from the adjustments.

For pass-through partners choosing to further push an adjustment out to the next tier, the new proposed regulations include rules regarding the furnishing of statements to the next-tier partners and the information to be included therein. The regulations also specify how to compute the amount a pass-through partner must pay if it does not elect to push the adjustment out to the next tier. The deadline for paying or for pushing the adjustment to the next tier is the extended due date for the return for the adjustment year of the lower-tier partnership that made the Section 6226 election.

In addition, the new proposed regulations address the treatment of modifications approved by the IRS, the coordination of the rules therein with Chapters 3 and 4 of the Code, and other clarifying guidance.

Pass-through partners and administrative adjustment requests

The new proposed regulations also include rules on how a pass-through partner in a partnership that files an administrative adjustment request (AAR) takes the adjustment into account under "rules similar to the rules of [Section] 6226." In this respect, the new proposed regulations provide rules similar to the regulations under Section 6226, with some minor changes to reflect the fact that an AAR permits taxpayers to receive refunds of any tax overpaid and to reflect that an AAR occurs outside of an examination.

Penalties in the case of a Section 6226 push-out election

The new proposed regulations include rules for the calculation of penalties, additions to tax and additional amounts by the partner when a partnership has made an election under Section 6226. Under the new proposed regulations, when each partner takes the adjustments into account under Section 6226, the partner must compute any penalties by applying any applicable rules or thresholds based on the particular facts and circumstances of that partner as if each correction amount were an underpayment or understatement for the first affected year (or intervening year, if applicable).

The new proposed regulations also permit a partner to assert a defense against a penalty based on a defense that is personal to the partner (partner-level defense), such as reasonable cause or good faith, by first paying the tax and penalty due and then filing a claim for refund that asserts the partner's specific penalty defense.

The new proposed regulations would amend the June Proposed Regulations to make them consistent with the new rules.

Section 6226 push out election and the safe harbor amount

The June Proposed Regulations included a safe harbor amount that partners could pay in lieu of computing the tax and interest the partner owes as a result of taking the adjustments into account in the year under audit and determining the effect of this computation on tax attributes in subsequent years. The safe harbor amount was intended to reduce the burden of complex calculations. The new proposed regulations, however, would remove the safe harbor amount provisions in light of the new rules allowing for pushing the adjustments out through multiple tiers of pass-through partners. This revision would affect all partnerships that make a push-out election, including partnerships that are not in tiered structures. As a result, when a partnership makes a push-out election, its partners will generally be required to recompute the amount of taxes they owed for the reviewed year (and intervening years), even when the adjustment is small.

Administrative and procedural provisions under BBA partnership audit regime

Notices of proceedings and adjustments

The new proposed regulations set forth rules on the notice of administrative proceeding (NAP) described in Section 6231(a)(1), the notice of any proposed partnership adjustment (NOPPA) described in Section 6231(a)(2), and the final partnership adjustment (FPA) described in Section 6231(a)(3).

The new proposed regulations would permit a partnership to waive the restriction against the IRS mailing an FPA more than 270 days after the date on which the NOPPA was mailed. They also include rules for withdrawal of a NAP or a NOPPA and rescission of an FPA.

Assessment, collection and payment of imputed underpayments

The new proposed regulations also set forth rules for the assessment and collection of imputed underpayments under the BBA partnership audit regime. They describe certain exceptions to restrictions on assessment, give partnerships 60 days to request abatement of an assessment attributable to mathematical or clerical error, and address situations in which a partnership-partner that elected out of the BBA partnership audit regime under Section 6221(b) for the reviewed year has failed to comply with Section 6222.

Interest and penalties related to imputed underpayments

The new proposed regulations include rules applicable to interest and penalties related to imputed underpayments. The rules address the computation of interest, determination of the portion of imputed underpayments subject to penalties, and reasonable cause and good faith exceptions to penalties.

Judicial review of partnership adjustments

The new proposed regulations also address judicial review of partnership adjustments. The rules describe the jurisdictional deposit requirement for partnerships that wish to bring an action in a US district court or the Court of Federal Claims and explain how the jurisdictional deposit is treated for purposes of the Code.

Period of limitations on making adjustments

The new proposed regulations stipulate the period within which the IRS must mail an FPA to make a partnership adjustment for a partnership tax year. The new proposed regulations also provide that, once a NOPPA is mailed, the IRS will have at least 330 days from the date of the NOPPA to make a partnership adjustment, regardless of whether the partnership requests modification of the imputed underpayment.

Implications

It is welcome news that Treasury and the IRS have decided to allow the pushing out of the Section 6226 adjustment through tiers of partners to the ultimate taxpaying owner. This will enable a lower-tier partnership as well as pass-through partners to avoid paying tax in many instances. This does not mean, however, that the Section 6226 election will always be advantageous. There are many situations in which another alternative might be preferable, so it is generally advisable to keep options open to the extent possible. In addition, the Section 6226 election is available only when there is an imputed underpayment, and the proposed regulations do not change this result.

If a partnership and its pass-through partners would like to be able to make the push-out election through tiers of entities, they should take steps to ensure that they will be able to provide the requisite statements to the affected partners by the extended due date of the lower-tier partnership under IRS examination.

Outside of the new proposed regulations, the IRS is still also actively working on finalizing the general BBA guidance provided in the June Proposed Regulations, as well as regulations addressing adjustments to bases and capital accounts and the tax and book basis of partnership property. With the January 1, 2018 effective date for the BBA regime rapidly approaching, partnerships should continue to consider the effect of the BBA regime, whether and how to respond to the government's requests for comments on specific issues in the proposed guidance, and how to address certain issues with their partners (e.g., modifications to legal documents and terms surrounding a future potential assessment of tax).

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