IRS Partnership Audit Regime Risks Multiple State Responses

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By Jennifer McLoughlin

May 9 — States may exacerbate the complexities accompanying the new IRS partnership audit rules should they adopt varying approaches to the overhauled federal regime, leading practitioners say.

“What we don't want is 50 different state responses,” Bruce P. Ely, with Bradley Arant Boult Cummings LLP, said May 6 during a panel at an American Bar Association Section of Taxation meeting. “And we don't want all the snowflakes to be different.”

Enacted as part of the Bipartisan Budget Act of 2015, and effective for taxable years after Dec. 31, 2017, the rules provide that Internal Revenue Service partnership audits will be assessed and collected at the partnership level (225 DTR H-1, 11/23/15).

Federal financial projections estimate that the new administrative procedures will generate $9.3 billion over 10 years (83 DTR G-3, 4/29/16).

With potentially 50 nuanced reactions to the federal procedures, Steve Wlodychak of EY LLP’s Indirect (State and Local Tax) Practice noted that the collective movement in the “laboratories of democracy” may stir a greater change.

“This whole area here has probably opened up a whole ability to re-think how do we want to tax partnerships,” he said.

Addressing Complications

Ely expects a technical corrections bill from Congress within the next year to clarify components of the original legislation.

At the state level, there is discussion of a working group between the American Institute of CPAs, the American Bar Association SALT committee, the Multistate Tax Commission and potentially the Council On State Taxation to assist states in navigating and responding to the regime.

Alongside the MTC, which has initiated a uniformity effort on the partnership rules, MTC Counsel Bruce Fort also identified working groups in California and New York that are evaluating their state-specific responses.

The many complications, which include concerns related to apportionment and nexus, raise three primary questions highlighted by the panel:

  •  the authority of states to audit under the provisions—for example, some states, such as Alabama and Arizona, don't define partnerships as taxpayers;
  •  the states' plans to change composite return rules—tiered partnerships could fall within composite returns, although there are questions of the mechanics in broadening the scope of such returns; and
  •  a broader discussion of states' general approach to partnerships.

Assess Agreements Now

Wlodychak observed that as the IRS steps up partnership audits, there will be a significant increase in states' receipt of information through sharing arrangements with the IRS.

However, the question remains whether the states are equipped to handle the information. Wlodychak noted that only California maintains a state audit manual.

But as practitioners gauge the impact of the federal rules, and consider state responses, the panelists echoed the call for partnerships to start reviewing their operating agreements to determine where revisions might be necessary (08 DTR S-12, 1/13/16).

To contact the reporter on this story: Jennifer McLoughlin in Washington at

To contact the editor responsible for this story: Ryan Tuck at

For More Information

The panel's PowerPoint presentation is at

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