January 3, 2018 IRS issues final regulations on electing out of centralized partnership audit regime IRS issues final regulations on electing out of centralized partnership audit regime The IRS has released final regulations (TD 9829) on electing out of the centralized partnership audit regime introduced by the Bipartisan Budget Act of 2015 (BBA). This election is authorized by Section 6221(b). The final regulations generally adopt the approach taken in the proposed regulations, with some minor revisions and clarifications in response to comments received. Background The BBA legislation 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 the partners who would have owed such tax had the partnership properly reported its items on its original return. 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 that start after December 31, 2017. Certain partnerships are eligible to elect out of the BBA rules under Section 6221(b). This election is made on an annual basis; if a partnership makes a valid election out, any adjustment relating to the partnership's return would generally be made in an audit of a partner, not an audit of the partnership. In addition, the partnership would generally not owe any taxes, interest or penalties. It is important to distinguish this election out under Section 6221(b) from the Section 6226 push-out election. The Section 6226 push-out election applies to a partnership that is subject to the BBA rules, but enables the partnership to avoid paying tax at the partnership level. A Section 6226 push-out election may distort the amount of tax that a partner must pay. These final regulations only address the election out of the BBA rules under Section 6221(b) for eligible partnerships. The Treasury and the IRS have previously released three sets of proposed regulations relating to the BBA. On June 13, 2017, Treasury and the IRS released the "June Proposed Regulations," which provide 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 electing 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. On November 30, 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. On December 19, 2017, the IRS published the third set of proposed regulations. Those proposed regulations address Section 6226 push-out elections in tiered partnership structures. Those proposed regulations also address other procedural issues, including tax assessment and collection, penalties and interest, periods of limitations, and judicial review of partnership adjustments. See Tax Alert 2017-2184. Final regulations on electing out As indicated, the final regulations address the election out of the BBA rules that is provided by Section 6221(b) and not any of the other BBA rules. These final regulations generally adopt the rules that were proposed in the June Proposed Regulations, with some minor revisions and clarifications in response to comments received. Section 6221(b) provides that a partnership is eligible to elect out of the BBA regime if: (1) it has 100 or fewer partners during the year; and (2) all partners are "eligible partners" at all times during the tax year. Under the final regulations, a partnership has 100 or fewer partners during the year if it is required to furnish 100 or fewer statements under Section 6031(b) during the tax year for which the partnership makes the election. A special rule applies when a partner is an S corporation: any statements required to be filed by the S corporation partner for the relevant tax year under Section 6037(b) are added to the number required to be filed by the partnership. The final regulations generally declined to adopt recommendations that statements furnished to certain types of partners (for example, statements furnished to pass-through entities and disregarded entities, as well as to spouses) should not be taken into account for purposes of determining whether the partnership is required to furnish 100 or fewer statements. The final regulations define "eligible partner" as any person who is an individual, C corporation, "eligible foreign entity," S corporation or an estate of a deceased partner. An "eligible foreign entity" is a foreign entity that is a per se corporation under Treas. Reg. Section 301.7701-2 or an association taxable as a corporation (either by default or due to an election under Treas. Reg. Section 301.7701-3). An S corporation is an eligible partner even if it has a shareholder that would not be an eligible partner had it held the partnership interest directly. Although the IRS received numerous comments requesting that the IRS exercise its discretionary authority to expand the definition of eligible partner, the IRS decided not to expand the definition beyond those already in the statute. Thus, the term "eligible partner" does not include partnerships, trusts, foreign entities that are not eligible foreign entities, disregarded entities, persons that hold an interest on behalf of another person, and estates that are not estates of a deceased partner. The preamble to the final regulations does indicate, however, that the definition of eligible partner may be revisited after the IRS gains experience with the centralized partnership audit regime. Making the election The final regulations set forth the time, form and manner for an election out of the partnership audit regime to be valid for a particular tax year. The election must be made on a timely-filed partnership return (including extensions) for the tax year to which the election relates. In addition, the partnership must provide the name, correct US taxpayer identification number (TIN) and federal tax classification of each partner and each shareholder of a partner that is an S corporation. Therefore, each partner (foreign or domestic) must have a US TIN. In addition, a partnership electing out of the regime must notify each of its partners of the election with 30 days; the final regulations clarify that the manner of such notification is left to the partnership to determine. Additional guidance is expected when the IRS issues forms and instructions relating to the filing of an election out of the BBA rules under Section 6221(b). Implications The key takeaway from the final regulations is that a partnership will not be eligible to elect out if it has a partner that is itself a partnership or a disregarded entity, such as a disregarded single-member LLC or grantor trust. In addition, all eligible foreign partners, even those with no US filing requirements, must apply for and obtain a US TIN in order for the partnership to file a valid election out of the BBA rules under Section 6221(b). The IRS and Treasury are continuing to review this requirement for eligible foreign partners and may issue additional guidance regarding this requirement. If a partnership is interested in electing out of the BBA rules and is eligible to make this election, it may want to consider restricting the number and type of partners, as well as the ability of partners to change tax status. It should also ensure that it will be able to substantiate the tax status of its partners (and shareholders of partners that are S corporations). If a partnership elects out of the BBA rules, the partnership will generally not be audited in a centralized procedure. Instead, the IRS would audit any or all of the partners in separate partner-level proceedings. Therefore, if a partnership makes the election out, its partners should ensure that they will have sufficient access to the partnership's books and records in the event that they need to substantiate the amounts allocated by the partnership in an IRS audit. More significantly, if a valid election out is made by the partnership, the applicable statute of limitations for assessment of tax will be determined at the partner level, determined separately for each partner. Finally, a partnership that plans to elect out of the BBA rules should still consider appointing a partnership representative, which can later be designated to the IRS as the person with the authority to bind the partnership and its partners, in its partnership agreement in the event that the IRS contests the validity of an election out of the BBA rules. It is important to note that these regulations finalize only some of the guidance provided in the June Proposed Regulations, and there will likely be a number of other regulations issued over the coming months, including regulations addressing adjustments to outside basis, capital accounts, and the tax and book bases of partnership property. Now that we are past the January 1, 2018 effective date for the BBA regime, partnerships should continue to consider the effect of the BBA regime, 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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