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States seeking administrative guidance on the new federal partnership audit regime will have to wait a little longer.
White House Chief of Staff Reince Priebus released a Jan. 20 memorandum to the heads of executive departments and agencies instructing them, among many directives, to withdraw those regulations submitted to the Office of the Federal Register but not yet published in the Federal Register. For those regulations that have been published but have not taken effect, and absent an exception, officials should postpone their effective date for 60 days.
Included in this body of regulations are the Internal Revenue Service’s proposed regulations (REG-136118-15) implementing the new law introduced in the Bipartisan Budget Act of 2015 ( Pub. L. No. 114-74). Released Jan. 18, the proposed rules detailed the agency’s plans to administer the regime that generally provides for assessment and adjustments at the partnership entity level.
President Donald Trump’s regulatory moratorium delays direction on how the federal law will operate in practice—which many states have been awaiting as they mull how to address the new regime.
Notwithstanding the actions of the new administration, Multistate Tax Commission (MTC) General Counsel Helen Hecht explained that “this whole exercise has taught us a lot.”
“First, auditing complex partnerships is virtually impossible unless those audits are done at the partnership level,” she told Bloomberg BNA in an e-mail. “Second, that reality has clearly affected taxpayer compliance. And third, auditing and assessing at the partnership level is entirely doable.”
Motivating the new federal law was lost collection opportunities for underpaid taxes from partnerships, which have been subject to record-low rates of federal audits that are resource-intensive and time-consuming. During the MTC’s annual meeting in July 2016, a Treasury Department representative presented research from the Office of Tax Analysis demonstrating the growth of the passthrough sector and difficulties in tracking partnership ownership and income flowing through complex constructs.
In early December, technical changes were introduced in the Tax Technical Corrections Act (H.R. 6439, S. 3506) to clean up what many consider a complex regime. While the measure didn’t pass, many federal lawmakers expect it will push through this year—potentially incorporated within another legislative package.
The 277 pages of proposed regulations released last week detail several administrative procedures, including filing requirements, processes for determining the amount owed to the IRS, and steps for electing out of the regime. The IRS reportedly has targeted Jan. 1, 2018, for final regulations—coinciding with the statute’s effective date.
Unlike the Section 385 debt-equity rules, “most of us don’t expect the partnership regs to be permanently suspended nor do we see any groundswell of support in Congress for repealing the statute,” Bruce P. Ely, a partner at Bradley Arant Boult Cummings LLP, told Bloomberg BNA in an e-mail.
Having reviewed the proposed regulations, Ely doubts “that Treasury will make any material changes to them before they’re reissued—especially before the comment period has even begun. So it’s more about when they’ll be reissued.”
Jonathan Horn, senior technical manager of tax policy and advocacy with the American Institute of CPAs, expects the same. He told Bloomberg BNA that the proposed regulations offer insight into the IRS’s thinking and that the reissued regulations likely won’t reflect significant changes, “assuming that the technical corrections bill isn’t passed before then.”
Noting that the regulations’ preamble refers to a technical corrections bill, Horn said that the IRS recognized that the law will impact its proposed regulations.
Trump’s freeze of federal rule-making isn’t without precedent—Presidents Barack Obama and George W. Bush took similar actions when they assumed office—although questions remain regarding the full scope and effect of the order.
As they await clarity from the feds, states continue to examine the impact from the new federal approach to partnership audits.
In particular, the MTC’s partnership work group has regularly met since last September to discuss the federal shift and state-related issues. And while states are looking for congressional and administrative guidance to assist with their response to the partnership audit regime, Hecht explained that states aren’t directly impacted by Trump’s order pulling back the IRS regulations.
“It doesn’t matter,” she said. “The audit and adjustment process is a procedural issue. If the federal government assesses tax for an audit adjustment, states should pick up the state tax due as well. But they are not bound by the way the federal government makes those adjustments.”
In response to the withdrawal order, Arizona Department of Revenue spokesman Sean Laux told Bloomberg BNA that “we’re still looking at it, but from first glance it does not appear to affect us negatively.”
“Our statute related to that is based on what happens federally in the event that a partnership is issued an assessment by the IRS,” he said. “If the IRS does not audit partnerships and issue assessments to the partnerships, then the statute is not triggered, and it would be treated just like it is today.”
During the Jan. 17 teleconference of the MTC’s partnership work group, Tracee Abel, an income tax specialist with Montana’s Department of Revenue, explained the reasons behind the introduction of the legislative proposal this session. The bill fits in with the department’s ongoing efforts to improve procedures for passthrough entities. And the Legislature, which meets biannually, is in session now—introducing legislation in 2019 would leave the DOR with little time to work through proposed regulations by 2020.
With the halt on the IRS regulations, some practitioners found one key takeaway: States shouldn’t force through legislative measures in response to the federal law.
“The only silver lining here is that states such as Montana, that were considering conformity legislation this year, really should take a wait-and-see approach in light of the withdrawal of these proposed regulations and the likely passage of a new Tax Technical Corrections Bill sometime this year,” Ely said.
Ely has regularly echoed the “wait-and-see” advice as co-chair of a task force of the American Bar Association tax section’s State and Local Tax Committee that is addressing the state implications from the federal law. The ABA task force has partnered with an AICPA work group on the project.
“Everyone needs to take a deep breath,” Horn said. “Because there’s still a lot of uncertainty, and there’s still a lot that needs to be clarified in terms of how this whole thing is going to work.”
Horn explained that the federal regime presents multiple moving parts, and clarity is needed on what the end result will look like at the federal level.
Some of the questions include: “What are the feds going to produce? What are the adjustments going to look like under the different options that are available? What’s going to be the end product for when a partnership pays it directly? What’s going to be the end product when a partnership decides to push it out?”
Without that information, Horn said it will be difficult “for the states to set up a regime that’s going to allow them to then overlay that into their system and figure out what their share of the adjustment is going to be.”
With assistance from William H. Carlile in Phoenix.
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