New Federal Partnership Audit Rules Not a Certainty

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By Jennifer McLoughlin

Dec. 8 — The Nov. 8 election results may dictate the future of the new federal partnership audit regime, according to a leading state tax practitioner.

The new federal regime, signed into law under the Bipartisan Budget Act of 2015 ( Pub. L. No. 114-74), modified rules governing federal audits of partnership entities. The default regime provides for assessment and adjustments at the entity level—rather than among individual partners—absent an election that would transfer liability to the partners.

However, the rules may not have effect if there is a federal tax overhaul.

“I think now we have a 100 percent chance of tax reform,” Steve Wlodychak, a Washington-based principal with Ernst & Young LLP’s Indirect (State and Local Tax) Practice, said during a Dec. 8 panel during the New York University 35th Institute on State and Local Taxation.

And it is therefore unclear whether the new partnership audit regime will be law next year.

Don’t Waste a Crisis

Nonetheless, both Wlodychak and Bruce P. Ely, a partner at Bradley Arant Boult Cummings LLP, emphasized the importance of revising every partnership agreement to reflect the new rules—particularly the rights, responsibilities and restrictions for the partnership representative.

In addition, Ely encouraged states to collaborate on a common approach—although Ely and several practitioners have advised that states should move slowly on taking action pending administrative guidance and legislative corrections from the federal level. A technical corrections bill is pending, but it is unlikely to pass this year.

“Never let a good crisis go to waste,” Ely said—invoking a line from Chicago Mayor Rahm Emanuel (D)—meaning that states should work toward uniform language and a model revenue agent report (RAR) statute in response to the federal regime.

Ely is co-chair of a task force of the American Bar Association Section of Taxation’s State and Local Tax Committee, which has partnered with an American Institute of CPAs work group on a project addressing state implications from the federal law. The Multistate Tax Commission’s partnership work group has heard from both the ABA task force and AICPA work group during several meetings.

Focus on Partnership Nexus

During a prior panel, RSM principal Brian Kirkell said that flow-through nexus issues will be a key partnership-related issue over the next five to 10 years. The new federal partnership audit regime will potentially make it easier for states to audit partnerships and partners, Kirkell said, noting that “you’ve got to know your unitary theory to be able to deal with it.”

In a May ruling, the Ohio Supreme Court ruled a statute unconstitutional as applied to a taxpayer, where it imposed income tax on a capital gain realized by the remote investor’s sale of ownership interest in a passthrough entity. The statute, Ohio Rev. Code Ann. Section 5747.212, mandated that for nonresidents holding 20 percent or more interest in a passthrough entity, the capital gain from a sale of that interest must be apportioned to Ohio based upon the apportionment factors of the entity.

The Ohio high court ruled that the statute was a due process violation, holding that the state couldn’t tax the proceeds of a nonresident’s sale of intangible personal property on the basis that the entity being sold conducted some of its business in the state ( Corrigan v. Testa, 2016 BL 141664, Ohio, No. 2016-2805, 5/4/16 ).

The Ohio ruling will generate “a much higher level of suspicion” over comparable rules in other states, Kirkell said.

To contact the reporter on this story: Jennifer McLoughlin in New York at jmcloughlin@bna.com

To contact the editor responsible for this story: Ryan C. Tuck at rtuck@bna.com

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