IRS Releases Proposed Partnership Audit Rules After Delay

Daily Tax Report: State provides authoritative coverage of state and local tax developments across the 50 U.S. states and the District of Columbia, tracking legislative and regulatory updates,...

By Laura Davison and Jennifer McLoughlin

The IRS proposed rules to implement the new partnership audit regime after a regulatory freeze delayed release of the guidance for five months.

The regulations ( REG-136118-15, RIN:1545-BN77) released June 13 by the Internal Revenue Service are similar to a proposal from January that was withdrawn after President Donald Trump halted federal rulemaking. The 277-page document describes the centralized audit process for partnerships, a provision of the 2015 Bipartisan Budget Act.

The BBA audit regime, intended to make it easier for the IRS to examine complex partnership structures, allows the agency to collect unpaid tax at the entity level. The law goes into effect in 2018. The proposed regulations give tax lawyers and accountants insight into how the IRS will implement the new process, which will replace the former rules under the Tax Equity and Fiscal Responsibility Act (TEFRA).

The American Institute of CPAs, in a June 13 letter, urged IRS and Treasury Department officials to delay the rules’ effective date, saying the proposed regulations contain significant gaps and that Congress could introduce legislation making technical changes to the law. Partnerships will need to update their agreements to designate an audit representative and implement procedures in the event of an audit. Most entities have been waiting for more definitive guidance before doing so.

It’s “unlikely that all the procedures and guidance necessary for taxpayers to make informed decisions” will be available by the end of the year, the AICPA said in its letter.

“Treasury will have just a few months to review all the comments, take into consideration changes and write a preamble that will stand up to scrutiny,” Jonathan Horn, AICPA senior manager for tax policy and advocacy, told Bloomberg BNA. “Is it possible to have temporary regs? Yes. Do we think it is wise? No, this is a substantial sea change in the way partnerships are audited and assessments are collected.”

The IRS will also need to create new forms, which can take 18 months to complete, Horn said. Other laws with large-scale tax changes, such as the Affordable Care Act and the Foreign Account Tax Compliance Act, had a longer implementation period, he said.

Noting Changes

The newly issued proposed rules include a few minor changes from the January draft version. The agency deleted an example dealing with the netting of ordinary income and depreciation. It also expanded a section asking for comments about allowing tiered partnerships to pass through adjustments to the ultimate partners.

The agency is seeking comments on how the IRS can track information related to indirect and direct partners and monitor whether the adjustments flow through the tiers properly. The IRS is also looking for comments on how to reduce noncompliance risk in tiered structures while limiting administrative costs, the rules said.

Whether or not tiered partnerships can push out adjustments beyond the first tier has been a matter of debate since the law was passed. The Joint Committee on Taxation’s description of the law says the adjustments can only be pushed out once.

Leading members of the congressional tax-writing committees introduced technical corrections legislation in 2016 that clarified that adjustments can be pushed out to the ultimate investors. The legislation has yet to be reintroduced this year and it isn’t certain when Congress will move a tax bill to which the technical corrections can be attached as a rider.

The statute gives the IRS authority to write rules that allow partnerships to push out to the ultimate partner, said Don Susswein, a principal at RSM US LLP in Washington. Since Congress has indicated that is the direction they would like to go, they can write temporary rules to tide taxpayers over until the technical corrections legislation is resolved, he said.

The IRS should “err on the side of not disrupting the economy. The IRS can solve this problem if they want to be cooperative,” he told Bloomberg BNA. “It’s not 100 percent clear that it’s allowed, but it’s certainly not disallowed.”

States in Waiting

States are closely watching the rulemaking process so they can alter their systems in response to federal changes. During the Multistate Tax Commission’s Partnership Work Group’s June 8 teleconference, several “interested parties” unveiled draft model legislation as a potential starting point for uniform state statutes addressing the federal partnership audit procedures. The draft statute proposes a new regime for reporting both adjustments to federal taxable income and federal partnership audit adjustments.

“The model legislation was designed to complement, but not depend on the ultimate IRS regulations, so that process can and should continue to move forward,” Horn told Bloomberg BNA by email. The AICPA collaborated with several parties on the model statute, including the Council On State Taxation (COST), Tax Executives Institute, Institute for Professionals in Taxation, and a task force of the American Bar Association tax section’s State and Local Taxes Committee.

Bruce P. Ely, a partner with Bradley Arant Boult Cummings LLP and co-chair of the ABA tax section task force, told Bloomberg BNA by email that “hopefully, the reissuance of these proposed regulations will spur” several parties to promptly consider the draft model legislation, including states and the Multistate Tax Commission.

The MTC Partnership Work Group has been analyzing ramifications of the new federal audit approach and is tasked with drafting model language for states.

“It’s good to have the proposal from the interested parties as well, since we will be able to think about issues which that proposal raises and whether the implementation of the new regime at the federal level will support it,” Helen Hecht, MTC general counsel, told Bloomberg BNA by email.

Hecht said that MTC staff are preparing draft comments on the proposed IRS regulations, “mainly addressing the questions that the rules create for the states,” and will seek input from member states.

Likewise, Ely said that the ABA Section of Taxation is preparing comments on the proposed regulations, with three committees focusing on specific aspects of the rules. He said the State and Local Taxes Committee’s comments may be “focused more on items or issues that need to be added to the proposed regulations rather than needed changes to the proposed regulations.”

The proposed partnership audit rules are scheduled to appear in the Federal Register on June 14. The IRS will hold a hearing on the rules Sept. 18. Comments are due by Aug. 14.

To contact the reporters on this story: Laura Davison in Washington at lDavison@bna.com and Jennifer McLoughlin in Washington at jmcloughlin@bna.com

To contact the editor responsible for this story: Meg Shreve at mshreve@bna.com

For More Information

Text of REG-136118-15 is at http://src.bna.com/pNm.

Copyright © 2017 Tax Management Inc. All Rights Reserved.

Request Daily Tax Report: State