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Laura Davison Washington Reporter Meg Shreve Washington
Long-awaited technical corrections to the new partnership audit law give IRS officials writing rules to implement the new regime what they haven’t had since the law passed in 2015—certainty about congressional intent.
The corrections, introduced in late 2016 and included in the omnibus spending bill approved by Congress this week and signed by President Donald Trump on March 23, revise many of the vagaries in the audit regime added to the 2015 Bipartisan Budget Act at the last minute without a thorough vetting. The legislation gives the IRS authority to make some changes to the partnership audit process that taxpayers had requested.
The new audit regime is intended to make it easier for the IRS to examine partnerships, a business structure that has been notoriously complicated for the agency to audit. The audit process shifts the collection of underpaid tax to the entity level, rather than to individual partners.
“Most of the technical corrections reflect sound policy conclusions that the Treasury or IRS had already reached, but in some cases were able to go farther with actual corrective legislation than could be done in regulations,” Don Susswein, a principal at RSM US LLP in Washington, told Bloomberg Tax.
The provisions allow taxpayer-favorable changes occurring in an intervening year between the audit and when the adjustment is pushed out to the taxpayer to be taken into account.
For example, a partner who sold their interest in an intervening year can now adjust the gain on the sale, said Michael Greenwald, a partner at Friedman LLP in New York. Additionally, if changes are made to depreciation—such as capitalizing an item that was expensed—there may be a smaller deduction in the reviewed year but the partner can now take additional depreciation deductions in the intervening years, he told Bloomberg Tax.
The changes could also mean that it will take the Internal Revenue Service longer to issue regulations as it takes the statutory changes into account, Greenwald said. The new audit regime took effect at the start of 2018, but it will be a year before the IRS begins auditing partnerships with the new centralized procedure.
The legislation also allows a partner’s adjustments to capital losses and ordinary losses to be calculated separately and then netted thereafter only if appropriate. It also allows for a “pull-in” procedure, which is a simplified means for modifying the imputed underpayment that doesn’t require partners to file amended returns.
The legislation expands the scope of the audit rules, clarifying that it applies to any item on a partner’s return affecting their tax liability. The initial legislation said the audit rules applied only to adjustments to partnership “income, gain, loss, deduction or credit.”
However, this could help taxpayers because it specifies that the audit regime doesn’t apply to items on the return not affecting a partner’s tax bill, said Glenn Dance, a former IRS official who is now a managing director at Grant Thornton LLP in Washington. The IRS had been taking the position that the scope of the audit could apply to anything on the return, he said, adding that if there’s a mistake that doesn’t affect the ultimate tax due, it’s not in the scope of the audit.
“This puts more burden on the IRS examiner to examine the partner’s individual tax return to see, ‘did this mistake cost the government any money,’” Dance told Bloomberg Tax.
The law change also codifies a position that the IRS has taken in proposed regulations (REG-120232-17, REG-120233-17), allowing partners to push out unpaid tax liabilities to the ultimate investor in a tiered partnership structure. That issue had been a primary concern for taxpayers after a Joint Committee on Taxation description indicated that the adjustments could only be pushed out one tier.
“The issue is now one of settled law,” said Ryan McCormick, senior vice president and counsel at the Real Estate Roundtable in Washington. “It reflects bipartisan agreement across branches of government.”
The IRS had looked to the technical corrections as a sense of what lawmakers were intending when they wrote the law, but the agency couldn’t go beyond what the statute said, Dance said.
The passage of these technical corrections comes as lawmakers are debating technical fixes to the 2017 tax act. Those could prove to be more politically difficult to pass because Democrats oppose the tax overhaul legislation—unlike the 2015 Bipartisan Budget Act, which had support from both parties. The partnership audit technical corrections had the backing of the chairmen and ranking members of both the House Ways and Means Committee and the Senate Finance Committee.
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