Treasury: Persuade Us on Partnership Audit Opt-Out Eligibility

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April 21 — Government officials are ready to be persuaded to expand the kinds of entities eligible to opt out of the new audit rules for partnerships with 100 or fewer partners.

The new partnership audit law, which simplifies the process for the Internal Revenue Service, includes a carve-out for single-tier partnerships with no more than 100 members, as long as all the partners are individuals, C corporations, S corporations or estates of deceased partners.

“Commenters should consider providing more about: Are these the only entities? Should regulations allow these entities? What are the reasons that they should? It's still a very open question,” Rochelle Hodes, associate tax legislative counsel in Treasury's Office of Tax Policy, said April 21 on a webcast hosted by Bloomberg BNA
The law gives the IRS the ability to expand that definition to treat other entities, such as partnerships and trusts, as long as the total partners of the entity and underlying partners don't exceed 100. This expansion would increase the number of partnerships eligible to opt out of the new regime.

Regulatory Health Risk

This limit is giving some people “heartburn,” Charles Ruchelman, a member at Caplin & Drysdale Chartered, said. He notes that the Joint Committee on Taxation's budget estimates, known as the Bluebook, include examples that would allow partnerships with disregarded entities to opt out of the rules (50 DTR G-2, 3/15/16).

It raises the question if “there is any room there to disregard the disregarded entity in terms of counting the number of partners for the 100 or fewer partner,” Ruchelman said.

The Bluebook “says, ‘hey IRS, you may—not must—create rules to have other entities not specifically permitted come in and be treated in a manner similar to S corps,' ” Hodes said.

The IRS is beginning to write regulations for the new audit regime that make it easier for the IRS to audit partnerships by collecting tax adjustments at the entity level, rather than from individual partners, as required by the Tax Equity and Fiscal Responsibility Act (TEFRA).

The deadline for submitting comments was April 15, but Hodes said the government is still accepting comments and is seeking detailed input addressing industry-specific concerns.

Leniency Likelihood

Clifford Warren, IRS special counsel in the Office of Chief Counsel (Passthroughs and Special Industries) said in March that he does not see the agency as being very lenient in who can elect out, because the partnerships will then be audited under rules that haven't been used in decades (48 DTR G-5, 3/11/16).

In addition to the counting issue, the IRS also has to address another critical piece: how to collect names and taxpayer identification numbers from all the partners of partnerships that choose to opt out, said Gregory Armstrong, a senior technical reviewer in the IRS's Office of Associate Chief Counsel (Procedure & Administration).

Ruchelman asked if partnerships that elect out will still be eligible to file an administrative adjustment request.

Government officials will really need to think about “whether the statutory regime will be treated similar to TEFRA, in which case, you're either in TEFRA or you're not in TEFRA,” Hodes said. “Or is there some aspect of the new regime that provides for a new way for auditing partnerships generally?”

Not Monoliths

The government is also considering the wide array of industries using partnerships as it writes new rules for auditing these business structures, Hodes said.

“Partnerships are not a monolith,” she said. “As we think about the rules and the policy calls, we need to be cognizant of the fact that partnerships come in many shapes and sizes, have a variety of purposes and don't all look or act like each other.”

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