December 9, 2020 IRS issues proposed rules on 'special enforcement matters' under centralized partnership audit regime The IRS has released proposed regulations (REG-123652-18) on certain partnership-related items involving "special enforcement matters" that are excepted from the centralized partnership audit regime enacted by the Bipartisan Budget Act of 2015 (BBA). The proposed regulations also include amendments to the existing final regulations under the BBA regime on eligibility to elect out of the regime, imputed underpayments, partnerships that cease to exist and other matters. Background The BBA overhauled the manner in which partnerships are audited and how any resulting tax liability is computed, assessed and collected. The BBA adopted a new regime that allows for assessment and collection of tax at the partnership level under centralized audit procedures, along with other changes to the partnership audit process. These rules are generally effective for most partnerships for tax years starting after December 31, 2017. Title II of the Consolidated Appropriations Act of 2018 (TTCA), enacted on March 23, 2018, amended the partnership audit rules established by the BBA. TTCA addressed several procedural and substantive rules under the BBA and added IRC Section 6241(11) on the treatment of special enforcement matters. The TTCA amendments are effective for tax years that are subject to the BBA (i.e., tax years that begin after December 31, 2017, or an earlier tax year for which the partnership has elected to apply the BBA rules). For partnership-related items involving special enforcement matters, IRC Section 6241(11), as added by the TTCA, authorizes the Secretary of the Treasury to prescribe regulations providing that the centralized partnership audit regime does not apply to such items and that such items are subject to special rules as the Secretary determines to be necessary for the effective and efficient enforcement of the Internal Revenue Code. For this purpose, "special enforcement matters" include:
In January 2019, the IRS issued final regulations (TD 9844) implementing the BBA centralized partnership audit regime and concurrently issued related guidance (Notice 2019-06) announcing plans to issue additional proposed regulations addressing special enforcement matters under IRC Section 6241(11). For additional information on the BBA regime generally, the TD 9844 final regulations and the Notice 2019-06 guidance on special enforcement matters, see Tax Alert 2019-0110. Proposed regulations The proposed regulations follow through on the IRS's announced plans in Notice 2019-06 to propose regulations addressing special enforcement matters under IRC Section 6241(11). The regulations also propose some amendments to the final rules issued in TD 9844. In addition, the regulations include proposed changes to the rules implementing IRC 6241(7) regarding the collection of amounts due under the centralized partnership audit regime when a partnership ceases to exist. Eligibility to elect out of the centralized partnership audit regime Under IRC Section 6221(b), certain partnerships may elect out of the centralized partnership audit regime. The related regulations set forth conditions for a partnership to be eligible to elect out of the regime, including a condition that each partner in a partnership is an eligible partner. These regulations specify that a partner is not an eligible partner if the partner is a "disregarded entity described in [Treas. Reg. Section] 301.7701-2(c)(2)(i)." The proposed regulations would change this language to state that a partner is not an eligible partner if the partner is "a wholly-owned entity disregarded as separate from its owner for Federal income tax purposes." The IRS states that this change is intended to make the regulation consistent with other regulations under the BBA regime. QSubs as ineligible partners The proposed regulations would also add language addressing partnerships with qualified subchapter S subsidiaries (QSubs) as partners to remove any ambiguity regarding whether a partnership with a QSub as a partner can elect out of the centralized partnership audit regime. Notice 2019-06 highlighted partnership structures with QSubs as partners as presenting special enforcement concerns, because allowing a partnership with a QSub partner to elect out of the centralized partnership audit regime would enable a partnership to elect out when there are over 100 ultimate taxpayers. Accordingly, Notice 2019-06 announced the IRS's intention to propose regulations providing that the ability to elect out of the centralized partnership audit regime under IRC Section 6221(b) generally does not apply to a partnership with a QSub as a partner. Notice 2019-06 stated that the proposed regulations would allow such partnerships to make an election under IRC Section 6221(b) if they meet certain requirements. In the proposed regulations, however, the IRS has reconsidered its position in Notice 2019-06 and narrowed the rule (eliminating the exception). The proposed regulations address the special enforcement concern by stating that a QSub is not an eligible partner for purposes of making an election out of the centralized partnership audit regime under IRC Section 6221(b). Imputed underpayments and chapter 1 taxes, penalties, additions to tax and additional amounts The proposed regulations would change some rules relating to imputed underpayments resulting from an IRS adjustment to a partnership's chapter 1 taxes, penalties, additions to tax or similar amounts. The proposed regulations would modify the rules under Treas. Reg. Section 301.6225-1 on calculating the imputed underpayment. The proposed rules would provide a mechanism for including the partnership's chapter 1 taxes, penalties, additions to tax or additional amounts (as well as any adjustment to a previously determined imputed underpayment (chapter 1 liabilities)) in the calculation of the imputed underpayment. The proposed rules would specify the treatment of adjustments to the partnership's chapter 1 liabilities and include two special rules for the treatment of a net negative adjustment to chapter 1 liabilities. In addition, the proposed regulations would specify that a partnership that makes a push-out election under IRC Section 6226 must pay any chapter 1 taxes, penalties, additions to tax and additional amounts or the amount of any adjustment to an imputed underpayment at the time statements are furnished to its partners in accordance with Treas. Reg. Section 301.6226-2. Adjustments to items that are not items of income, gain, loss, deduction or credit The IRS notes that the final regulations under IRC Section 6225 do not expressly address how adjustments to items that are not items of income, gain, loss, deduction or credit (non-income items) are taken into account (1) in the calculation of the imputed underpayment, (2) as adjustments that do not result in an imputed underpayment or (3) if the partnership elects to push out the adjustments to its reviewed-year partners. However, the final regulations permit the IRS to treat an adjustment to a non-income item as zero solely for purposes of calculating the imputed underpayment if the effect of the adjustment is already reflected in an adjustment to an item of income, gain, loss, deduction or credit. The proposed regulations would go a step further and generally treat an adjustment to a non-income item that is related to, or results from, an adjustment to an item of income, gain, loss, deduction or credit as zero as part of the calculation of an imputed underpayment unless the IRS determines that the adjustment should be included in the imputed underpayment. In addition, the proposed regulations would clarify the rules for taking into account adjustments to non-income items if they are adjustments that do not result in an imputed underpayment. Under the proposed rules, a partnership would generally take into account adjustments to non-income items in the adjustment year by adjusting the item on its adjustment year return to be consistent with the adjustment. Partnerships that cease to exist Under IRC Section 6241(7), if a partnership ceases to exist before the partnership adjustments taking effect, the adjustments are taken into account by the former partners of the partnership. IRC Section 6232(f) authorizes the IRS to assess a former partner for that partner's proportionate share of any amounts owed by the partnership under the centralized partnership audit regime. The proposed regulations would make changes to reflect that the rules under IRC Section 6241(7) would apply before the adjustments taking effect and the rules under IRC Section 6232(f) would apply once the adjustments have taken effect. When partnership adjustments take effect The proposed regulations would amend the rules under Treas. Reg. Section 301.6241-3(b) concerning when a partnership has ceased to exist to specify that a partnership adjustment takes effect (1) when the adjustments become finally determined as described in Treas. Reg. Section 301.6226-2(b)(1), (2) when the partnership and IRS enter into a settlement agreement regarding the adjustment or (3) for adjustments reflected in an administrative adjustment request (AAR), when the AAR is filed. In addition, the proposed regulations would specify that a partnership ceases to exist if the IRS determines that the partnership does not have the ability to pay in full any amount for which the partnership may become liable under the centralized partnership audit regime. The proposed regulations would also remove Treas. Reg. Section 301.6241-3(b)(2), regarding situations when the IRS will not determine that a partnership ceases to exist. Additionally, the proposed regulations would modify the rules to require statements under Treas. Reg. Section 301.6241-3 to be furnished to the former partners and filed with the IRS no later than 60 days (rather than 30 days) after the later of the date the IRS notifies the partnership that it has ceased to exist or the date the adjustments take effect. Former partners The proposed regulations would modify the definition of "former partners" to be partners of the partnership during the last tax year for which a partnership return or AAR was filed or the most recent persons determined to be the partners of the partnership in a final determination. Special enforcement matters Proposed Reg. Section 301.6241-7 describes partnership-related items that involve special enforcement matters. Partnership-related item components of non-partnership-related items The IRS explained that special enforcement considerations apply when requiring the IRS to adjust certain partnership-related items at the partnership level in a centralized proceeding would interfere with the efficient enforcement of the Internal Revenue Code. The IRS has determined that such special enforcement considerations are present when the partnership's treatment of a partnership-related item on its return or in its books and records is based, in whole or in part, on information provided by a person other than the partnership. The IRS states that it would be more efficient in these circumstances for the IRS and the partner if the IRS makes an adjustment to a partnership-related item during an examination of the partner, rather than opening a separate examination of the partnership. The IRS notes this is particularly true when the adjustments are likely to only affect a single partner or small number of partners. The IRS explained that this special rule would alleviate the need to open an examination of the partnership under the centralized partnership audit procedures solely to adjust the partnership-related items based on information provided by the partner who is already independently under examination. Accordingly, a special rule applies under Prop. Reg. Section 301.6241-7(b) if the treatment of the partnership-related item on the return of the partnership (or in its books and records) is based in whole or in part on information provided by the person under examination. In such circumstances, the IRS may determine that subchapter C of chapter 63 (the centralized partnership audit regime) does not apply to an adjustment or determination of a partnership-related item if an adjustment or determination of that partnership-related item is part of, or underlies, an adjustment to a non-partnership-related item during an examination of a person other than the partnership. Termination and jeopardy assessments Special enforcement matters under IRC Section 6241(11)(B)(ii) include assessments under IRC Section 6851 on termination assessments of income tax or under IRC Section 6861 on jeopardy assessments of income, estate, gift and certain excise taxes. In these termination and jeopardy assessment situations, the IRS explained, the IRS needs to be able to make an immediate assessment against a taxpayer to collect tax when there is a risk of being unable to collect tax in the future. Accordingly, under Prop. Reg. Section 301.6241-7(c), for any tax year of a partner or indirect partner for which an assessment of income tax under IRC Section 6851 or IRC Section 6861 is made, the IRS may adjust any partnership-related item for that partner or indirect partner as part of making that assessment without regard to the centralized partnership audit procedures. Criminal investigations Criminal investigations present another special enforcement matter. To address these circumstances, Prop. Reg. Section 301.6241-7(d) authorizes the IRS to adjust any partnership-related item for any partner or indirect partner for any tax year of a partner or indirect partner for which the partner or indirect partner is under criminal investigation without regard to the centralized partnership audit procedures. Indirect methods of proof of income The IRS explained that, when using an indirect method of proving a person's income, it may not be able to determine whether the income is derived from partnership-related items of a partnership subject to the centralized partnership audit regime. Accordingly, Prop. Reg Section 301.6241-7(e)(1) allows the IRS to adjust any partnership-related item as part of a determination of any deficiency (or portion thereof) of the partner or indirect partner that is based on an indirect method of proof, without regard to the centralized partnership audit procedures. Controlled partnerships and the partner's period of limitations The IRS stated that it has determined that special enforcement considerations are present when (1) the period of limitations on making adjustments to the partnership has expired for a tax year but a controlling partner's period of limitations on assessment of chapter 1 tax has not expired; or (2) the partner has voluntarily agreed to extend the period of limitation. Accordingly, Prop. Reg. Section 301.6241-7(f) would enable the IRS to make adjustments or determinations as to partnership-related items without regard to the centralized partnership audit procedures if the partner has control of the partnership or if the partner has voluntarily agreed to extend his or her period of limitations on making assessments under IRC Section 6501. For this purpose, the extension agreement must expressly state that the partner is extending the time to adjust and assess any tax attributable to partnership-related items for the tax year. Penalties and taxes imposed on the partnership under chapter 1 The IRS has also determined that that special enforcement considerations are present when a tax, penalty, addition to tax or additional amount is imposed on, and is the liability of, a partnership under chapter 1. Accordingly, under Prop. Reg. Section 301.6241-7(g), the IRS may determine that the centralized partnership audit regime does not apply to any taxes, penalties, additions to tax or additional amounts imposed on a partnership under chapter 1 and to any determination made to determine whether the partnership meets the requirements for the tax or penalty, addition to tax or additional amount. Determining that the centralized partnership audit procedures does not apply If the IRS determines that all or some of the rules under the centralized partnership audit regime do not apply to a partnership-related item (or portion thereof) under the prior rules, Prop. Reg. Section 301.6241-7(h)(1) specifies that the IRS will notify in writing the taxpayer to whom the adjustments are being made. Prop. Reg. Section 301.6241-7(h)(2) clarifies that any final decision on any partnership-related item adjusted outside of the centralized partnership audit regime is not binding on the partnership, any partner or any indirect partner that is not a party to the proceeding. Coordination with adjustments made at the partnership level Prop. Reg. Section 301.6241-7(i) sets forth a rule that would prevent taxing the same partnership-related item twice when the IRS makes adjustments to partnership-related items in an examination of a person other than the partnership and adjustments are made to the same partnership-related items in an examination of the partnership. Under this rule, if the IRS calculates a deficiency or proposes an adjustment, and the person can establish that specific amounts were previously taxed to the partner in one of two sets of circumstances, the amounts will not be included in the deficiency or adjustment. Applicability dates The proposed revisions to the existing final regulations, if finalized, would apply from November 20, 2020. The proposed rules on special enforcement matters would generally apply to partnership tax years ending after November 20, 2020, or any examination or investigation beginning after the date the final regulations are filed fo. public inspection at the Office of the Federal Register. The rules in Proposed Reg. Section 301.6241-7(b) (i.e., partnership-related items that underlie nonpartnership-related items), however, would apply to partnership tax years beginning after December 20, 2018, or to any examinations or investigations beginning after the date the final regulations are filed for public inspection. Implications The proposed regulations set forth the areas deemed special enforcement circumstances when the centralized partnership audit regime will not apply to partnership-related items. When one of the special enforcement circumstances is present, the IRS may choose to notify the partner(s) involved that the centralized partnership audit regime will not apply to any partnership-related items of that partner. The proposed regulations are not surprising and will generally have a limited application in the context of an IRS audit under the BBA regime, with the exception of two of the special enforcement provisions, which may apply in limited circumstances. These circumstances include when the partnership's treatment of a partnership-related item on its return or in its books and records is based in whole, or in part, on information provided by a person other than the partnership. Under this provision, the IRS may open an audit at the partner level and propose adjustment to those items without the need to open an audit of the partnership itself under the BBA rules. The proposed regulations may also apply when a partnership structure comes within the "controlled partner" provision. In this situation, the IRS may determine that there is an open statute of limitations to audit a partnership related item by reference to a "controlling partner's" open period of limitations on assessment of chapter 1 tax when the period of limitations on making adjustments to the partnership has expired. In addition, the proposed regulations would reverse the position set forth in Notice 2019-06 and provide that a partnership with a qualified subchapter S subsidiary (Q-sub) as a partner is not eligible to elect out of the BBA regime. The proposed regulations would also clarify when a partnership adjustment "takes effect" for purposes of applying the rules under IRC Sections 6241(7) and 6232(f), which involve situations in which the IRS has determined that a partnership ceased to exist, such that former partners become liable for any additional tax resulting from adjustments to partnership-related items. Finally, the proposed regulations would clarify the treatment of adjustments to non-income items, such as partnership assets, liabilities and capital accounts, and propose rules around the treatment of negative adjustments to imputed underpayments. ———————————————
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