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By the Tax Management Staff, Arlington, VA
President Obama, Nov. 2, signed into law the Bipartisan Budget Act of 2015, a two-year budget deal paid for in part by provisions that would make it easier for the Internal Revenue Service to audit large partnerships.
The Bipartisan Budget Act of 2015, in addition to funding the government to avoid a shutdown, would also alter a general rule about who should be recognized as a partner when acquiring partnership interests by gift. Below is a summary of the tax-related provisions contained in the Bill.
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The Bill would increase the single employer flat-rate premium by six to eight percent per year. The flat-rate premium increases to $69 for plan years commencing in 2017, $74 for plan years commencing in 2018, and $80 for plan years commencing in 2019 and later, as re-indexed for inflation. Variable-rate premiums would continue to be indexed for inflation and would be increased by an additional $3 for plan years commencing in 2017, an additional $4 for plan years commencing in 2018, and an additional $4 for plan years commencing in 2019. [ERISA §4006(a)]
To raise revenue, the Bill would accelerate the flat-rate and variable-rate premium due date for the 2025 plan year by one month. Therefore, the premium due date changes from the 15th day of the 10th full calendar month of the premium payment year to the 15th day of the ninth calendar month beginning on or after the first day of the premium payment year. [ERISA §4007(a)]
Under current law, the Secretary of the Treasury is required to issue a mortality table (based on the actual experience of pension plans and projected trends) in regulations to be used in determining present value or making any computation under the funding rules. Substitute mortality tables are permitted upon the request of a plan sponsor and the approval of the Secretary of the Treasury. In order for a requested substitute mortality table to be approved: (1) the table must reflect the actual experience of the pension plans maintained by the plan sponsor and projected trends in general mortality experience, and (2) there must be a sufficient number of plan participants, and the pension plans must have been maintained for a sufficient period of time, to have credible information necessary for that purpose.
Effective with respect to plan years beginning after December 31, 2015, the Bill would provide that a determination of whether plans have credible information will be made in accordance with established actuarial credibility theory that is materially different from current I.R.C. provisions and IRS guidance. A plan may use tables that reflect adjustments to the tables released by the IRS if the adjustments are based on the plan's actual experience. [ERISA §303(h), I.R.C. §430(h)]
After 2011, the interest rates that were used to calculate minimum funding contributions (i.e., pension fund liabilities) were adjusted to prevent large fluctuations. The Moving Ahead for Progress in the 21st Century Act (MAP-21), as amended by the Highway and Transportation Funding Act of 2014 (HATFA), provided that interest rates for minimum funding purposes are adjusted so that they fall within a range based on average interest rates over a 25-year period. For 2012 through 2017, the range variance is 10%. The range for 2018 through 2020 increases by 5 percent per annum until it finally stabilizes at a 30% variance for 2021 and later.
Generally effective for plan years beginning after December 31, 2015, the Bill would provide that the 10% range variance would be effective through 2020, with a 15% range variance in 2021, a 20% range variance in 2022 and a 25% range variance in 2023. For 2024 and later, the range stabilizes at a 30% variance. This provision raises revenue because minimum employer contributions are reduced and therefore less deductions for contributions will be taken, resulting in higher taxable income. [ERISA §303(h), I.R.C. §430(h)]
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Three different regimes currently exist for auditing partnerships. For partnerships with 10 or fewer partners, the IRS generally applies the audit procedures for individual taxpayers, auditing the partnership and each partner separately. For most large partnerships with more than 10 partners, under the so called “TEFRA” rules, the IRS conducts a single administrative proceeding to resolve audit issues regarding partnership items that are more appropriately determined at the partnership level than at the partner level. Under the TEFRA rules, once the audit is completed and the resulting adjustments are determined, the IRS must recalculate the tax liability of each partner in the partnership for the particular audit year.
Under yet a third regime, partnerships with 100 or more partners may elect to be treated as Electing Large Partnerships (ELPs) for reporting and audit purposes. A distinguishing feature of the ELP audit rules is that, unlike the TEFRA partnership audit rules, partnership adjustments generally flow through to the partners for the year in which the adjustment takes effect, rather than the year under audit. As a result, the current-year partners' share of current-year partnership items of income, gains, losses, deductions, or credits are adjusted to reflect partnership adjustments relating to a prior-year audit that take effect in the current year. The adjustments generally do not affect prior-year returns of any partners (except in the case of changes to any partner's distributive share).
Under the Bill, the current TEFRA and ELP rules under the Code would be repealed and instead new partnership audit rules would be streamlined into a single set of rules under Chapter 63, Subchapter C, for auditing partnerships and their partners at the partnership level. Similar to the current TEFRA rules excluding small partnerships, the Bill would allow partnerships with 100 or fewer qualifying partners to elect out of the new rules, in which case the partnership and partners would be audited under the general rules applicable to individual taxpayers.
To give taxpayers time to adjust, the new rules would be delayed for two years, i.e., they would apply to returns filed for partnership tax years beginning after 2017. Another election would allow the new rules to apply to any return of the partnership filed for partnership taxable years beginning after the date of enactment and before January 1, 2018.
Audit and Adjustment at Partnership Level. Under the streamlined audit approach, the IRS would examine the partnership's items of income, gain, loss, deduction, credit and partners' distributive shares for a particular year of the partnership (the “reviewed year”). Any adjustments would be taken into account by the partnership (not the individual partners) in the year that the audit or any judicial review is completed (the “adjustment year”). Partners would not be subject to joint and several liability for any liability determined at the partnership level.
Under the Bill, any adjustment would result in the partnership having to pay an imputed underpayment with respect to such adjustment in the adjustment year. Any adjustment that did not result in an imputed underpayment generally would be taken into account by the partnership in the adjustment year as a reduction in non-separately stated income or an increase in non-separately stated loss, or in the case of a credit, as a separately stated item.
Partnerships would have the option of demonstrating that the adjustment would be lower if it were based on certain partner-level information from the reviewed year rather than imputed amounts determined solely on the partnership's information in such year. This information could include amended returns of partners opting to file, the tax rates applicable to specific types of partners (e.g., individuals, corporations, tax-exempt organizations), and the type of income subject to the adjustment (e.g., ordinary income, dividends, capital gains). As an alternative to taking the adjustment into account at the partnership level, a partnership would be allowed to issue adjusted information returns (i.e., adjusted Form K-1s) to the reviewed year partners, in which case those partners would take the adjustment into account on their individual returns in the adjustment year through a simplified amended-return process. As a result, partnerships generally would no longer issue amended Form K-1s after the partnership return is filed, but instead would use the adjusted Form K-1 process.
A partnership would also have the option of initiating an adjustment for a reviewed year, such as when it believes additional payment is due or an overpayment was made, with the adjustment taken into account in the adjustment year. The partnership generally would be permitted to take the adjustment into account at the partnership level or issue adjusted information returns to each reviewed-year partner.
A partnership generally would have 270 days to submit information to the IRS when seeking to modify the imputed underpayment amount following receipt of a notice of proposed partnership adjustment unless the IRS consents to an extension.
Assessment and Collection at Partner Level. Under the Bill, any additional tax due as a result of the partnership adjustments would flow through to the direct partners in the year in which the adjustment relates and any additional tax due would be collected from the direct partners (and not the partnership). Pass-through partners, however, would have to pay the tax on behalf of their indirect partners. Pass-through partners would have 180 days to challenge the assessment based on the tax attributes of their partners (direct and indirect) for the year to which the adjustments relate.
Notice to Authorized Persons and Partners. Under the Bill, only the partnership would participate in the audit through an “authorized person,” i.e., partners would not participate. An authorized person would be the individual who is designated by the partnership to act on its tax return but would not necessarily need to be a partner. The IRS still would have authority to designate a person authorized to act if the partnership failed to do so.
The Bill would eliminate the present TEFRA requirement that the IRS provide notice to partners of the beginning of an administrative proceeding or adjustment.
Consistent Reporting by Partner Required. The Bill would require partners to report their partnership items consistently with the partnership's reporting unless the IRS is notified of inconsistent treatment. If a partner fails to so notify the IRS, the IRS may assess a computational adjustment as a math error. However, if the partner notifies the IRS of the inconsistent position, the IRS would have to audit the partnership in order for it to audit the partner.
A determination as to an inconsistent position in a proceeding to which the partnership is not a party would not be binding on the partnership.
Refund Requests at Partnership Level. Only the partnership could request a refund under the Bill, and once received by the partnership, would be allocated to a partner and treated as a distribution to be reflected on the partner's Schedule K-1. [I.R.C. §6221 (new) - I.R.C. §6241 (new)]
The Bill would remove the rule concerning gifted partnership interests from §704(e) (“Family Partnerships”), and added to the general definition of “Partner” in §761(b). This procedural move would clarify Congress's intent that the family partnership rules, now relabeled “Partnership Interests Created by Gift” were not intended to create an alternate test for determining whether a person is a partner in a partnership. The original addition of §704(e)(1) was designed to effectively reverse early case law that required a partner to contribute capital or services in order to be treated as a partner, which particularly impacted family partnership entities. The new location appears to be aimed at cutting off aggressive reporting and litigating positions taken by some taxpayers who claim that §704(e)(1), by referring to interests acquired by purchase as well as gift, had eliminated the ability of the IRS and the courts to employ traditional doctrines, such as substance over form, economic substance, and debt/equity principles, to determine whether a person was a genuine partner possessing an equity interest in the partnership. Thus, a person with a capital interest will be recognized as a partner in a partnership for purposes of Subchapter K, even if the interest is received by gift, where capital is a material income-producing factor, regardless of whether the partnership is a family partnership, but only to the extent that the partnership and the partnership interest are valid under existing doctrines. The “new” definitions would apply to partnership taxable years beginning on or after January 1, 2016. [I.R.C. §704(e), I.R.C. §761(b)]
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