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An upcoming IRS hearing on proposed regulations that implement a law overhauling partnership audits will give taxpayers and their advisers the chance to air their concerns and questions about the rules.
“Taxpayers are in a bind because these new rules are coming and they need to get ready for them, but there’s still a lot of uncertainty,” Michael P. Bresson, a partner at Baker Botts LLP in Houston, told Bloomberg BNA.
The Internal Revenue Service currently follows procedures set forth in the Tax Equity and Fiscal Responsibility Act to audit partnerships, but those procedures will be replaced by a new regime that was enacted by the Bipartisan Budget Act of 2015 starting Jan. 1, 2018.
The BBA provides for assessment and adjustments at the partnership entity level—rather than among individual partners—absent an election that would push out liability to the partners.
There are a number of questions that practitioners have about the proposed regulations (REG-136118-15) that they hope will be answered at the Sept. 18 hearing.
Groups including the American Institute of CPAs have been so concerned by what they view as significant gaps in the regulations that they have urged the Treasury Department and the IRS to work with lawmakers to delay the regime’s effective date.
Tax accountants and lawyers have been pushing for technical corrections to the BBA that would allow tax adjustments to be pushed out to the final partner in a tiered partnership.
A technical corrections bill that would address that issue and other industry concerns was introduced in the last session of Congress by top tax-writers but has yet to be reintroduced this year. Practitioners hoped the bill could be attached to a broader tax reform package, but it’s unclear whether legislation will be passed this year before the new audit regime goes into effect.
The IRS didn’t provide rules on tiered partnership push-outs in the proposed regulations, but reserved the ability to issue guidance on that issue in the future.
The tiered partnership push-out issue is the biggest question remaining, Bresson said.
To prepare for all possibilities, taxpayers and their advisers are adding flexibility to their partnership agreements, he said.
“So you might include provisions that say, ‘We’ll push out to the maximum extent permitted by law,’ or you might include provisions that include some standard” about who can decide when there’s a push-out, Bresson said.
The lack of clarity means that some partnerships will have no choice but to pay taxes at the entity level, “which is really a paradigm shift for the taxation of partnerships,” he said.
The proposed regulations don’t say when or if partnerships can appeal a decision made by the IRS during the auditing process, said Michael J. Greenwald, a partner at Friedman LLP in New York.
“Normally in an examination, the appeals process and where it fits in is pretty well laid out,” he told Bloomberg BNA. “In these rules it hasn’t been discussed at all, either in the preamble or the body of the regulations themselves.”
Greenwald said he would like to know what decisions, if any, can be appealed, including when the IRS finds that an election to opt out of the new auditing regime is invalid, denies a modification to the imputed underpayment, or determines that the partnership has ceased to exist.
Matthew J. Bonney, a tax partner and CPA with Citrin Cooperman & Co. in New York, said all of his remaining questions on the partnership audit rules revolve around the partnership representative.
Under the old auditing regime, a partnership would designate one of its partners as the “tax matters partner” to act for the entity in proceedings with the IRS. In the BBA regime, that person is called the “partnership representative” and has far greater authority than a TMP.
Bonney said he would like clarification from the IRS on the partnership representative’s role and whether that person has to report back to the other partners. “While IRS has addressed this I think it was done in vacuum and I would like to see some guidance,” he said in an email.
Greenwald said he would like to see the IRS give partnerships more flexibility to change their partnership representatives prior to examinations. “The partnership representative has a tremendous amount of power and so partnerships should have more flexibility with respect to making changes in that area.”
The proposed regulations provide that a partnership representative designation may not be changed—either by resignation or evocation—until the IRS issues a notice of administrative proceeding to the partnership, except when the partnership files a valid administrative adjustment request. The process of changing a representative also isn’t instantaneous.
The rules as they stand can be troublesome in scenarios where a representative has a falling out with the partnership, becomes ineligible, or severs business ties with the partnership, Greenwald said.
Both Bresson and Greenwald said they would like to see the IRS provide more guidance on how the new partnership audit rules will affect a partner’s outside basis or capital account.
Outside basis measures the adjusted basis of a partner’s interest in the partnership, and a capital account reflects the partner’s equity investment in the partnership.
The proposed regulations reserved the ability to draft rules on this issue at a later date.
“Capital account allocations can end up affecting who ultimately bears the burden of the tax” because capital accounts can determine a partner’s economic return from the partnership if liquidating distributions are made in accordance with those accounts, Bresson said. That’s why clarity is important, he said.
The confusion around potential adjustments to outside basis or capital accounts didn’t exist under TEFRA because there weren’t situations in which the partnership, as opposed to the individual partners, was writing the check to the IRS, Bresson said.
“It’s a new issue under these new rules so we don’t have any road maps for how to handle it,” he said.
Joel N. Crouch, a managing partner at Meadows, Collier, Reed, Cousins, Crouch & Ungerman LLP in Dallas, said in an email that if the IRS leaves any areas open to interpretation, they will likely end up being resolved through litigation.
(Corrected Sept. 15 to clarify when the proposed regulations permit a partnership representative to be changed)
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