More Partnerships Face Audits Under Budget Deal

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Oct. 27 — Businesses organized as partnerships would undergo more audits than they currently face under language included in the budget deal moving through Congress.

The provisions in the bill, released Oct. 27, are intended to make it easier for the IRS to audit large partnerships by making a determination of taxes at the partnership level, ensuring that a partner's return must be consistent with the partnership return, and the designation of a partnership representative.

The move is one that IRS Commissioner John Koskinen has been asking Congress to implement, saying that updating Tax Equity and Fiscal Responsibility Act of 1982 procedures to allow the IRS to audit partnerships, make a tax adjustment in the year in which the audit is done, and have the general partner have the income flow through to the partners.

Koskinen argued that life would be simpler for partnerships because they wouldn't have to generate a set of new Schedule K-1s and all the partners wouldn't have to file amended returns.

Lawmakers took the idea seriously and, needing an offset for a two-year budget bill, based the proposed language on an earlier bill (H.R. 2821) (128 DTR G-1, 7/6/15).

The proposed tax provisions in the bill would raise $11.2 billion over 10 years, with about $9 billion of that coming from the changes to partnership audit procedures, lawmakers said.

The revised audit language would eliminate a joint and several liability provision, which could have subjected partners to pay adjustments disproportionate to their stake in the firm, and allow more exemptions than first proposed, for example. Small partnerships can elect to opt out of the audit regime, while some previous versions only subjected entities with more than 100 partners to the audit rules.

A partnership's adjustment would be based on the character of the income, rather than at the highest rate as suggested in prior proposals. Partnerships of all sizes would have the option to push an adjustment through to each of the partners, rather than paying the tax at the entity level.

Concerns From Ways and Means Members

Those changes were generally viewed positively, but some of the revisions were regarded more dubiously.
Concern emerged that the revenue the language could generate for the budget deal prompted hasty usage, before the bill could be fully refined even though some initial changes were included.

“The bill has been pulled into this package, and the majority of changes are in there, but quite frankly I'm a little concerned that we have not finished the process,” said Rep. James B. Renacci (R-Ohio), the audit legislation's chief sponsor and a member of the House Ways and Means Committee. “I had a hearing scheduled, another meeting scheduled with stakeholders. So I'm still looking at everything.”

Other Republican members of the House Ways and Means Committee reacted coolly to the audit provision, saying the leadership scooped up Renacci's bill while the congressman was still trying to iron out problems.

“There's no question that some positive changes were made there,” Rep. Kevin Brady (R-Texas) told reporters, adding that he supported taking out the provision on joint and several liability. But the issue, which affects the oil and gas industry, needs further discussion and could benefit from congressional hearings, he said.

Rep. Charles Boustany, Jr. (R-La.) said the measure is a “big deal” for oil and gas, both upstream and in pipeline operations.

“I'm not happy with it,” Boustany told reporters, although he said he was still studying details of the changes offered. And while further tweaking might be possible after enactment, Boustany said, “I don't know about that. I hate to take that chance.”

Boustany said he was mostly troubled by the manner in which leaders took the bill for a budget offset, adding that he wasn't sure he would support the budget measure. “I think the process is horrible, the way this came about.”

Gift Changes

Changes to the language for partnership interests created by gifts appears to be aimed at cutting off aggressive reporting and litigating positions taken by some taxpayers who claim that the tax code prohibits the IRS and the courts to employ traditional doctrines to distinguish debt from equity.

“The provision would clarify that Congress did not intend for the family partnership rules to provide an alternative test for whether a person is a partner in a partnership,” according to a summary of the legislation.

Renacci said he might withhold support because of how the budget process played out. And his concerns rippled beyond Capitol Hill.

Some changes were made at the behest of lobbyists for business interests, including allowing real estate investment trusts to opt out of the new audit rules if they have fewer than 100 partners.

In Renacci's bill, REITs weren't eligible for the opt-out provision, and industry lobbyists said all partnerships should be treated equally. The deal worked out by House leaders also drops joint and several liability provisions from Renacci's bill that could have held individual partners responsible for the entire partnership's tax debts.

In the new version, the presence of a REIT or an S corporation among partners wouldn't automatically trigger the new audit regime, as it would have in Renacci's bill.

The issue has attracted the attention of groups tied to businesses that often are organized as partnerships, including shopping centers, multifamily housing developments, manufacturers and fuel and petrochemical companies. About half of the 3.3 million partnerships in the U.S. are related to real estate, said the Real Estate Roundtable, an industry group that lobbied for changes to Renacci's bill.

Representatives for some of those industries told Bloomberg BNA the changes largely—but not entirely— addressed their concerns.

“I think it's still problematic,” said a lobbyist for one organization tied to small businesses, which is holding out for further revisions.

Chilling M&A

The audit measure, which is more closely aligned with how C Corporations are taxed, could slow mergers and acquisitions by influencing would-be buyers to more closely evaluate investments, said Noel Brock, an assistant professor at West Virginia University.

Purchasers will want to see past returns and financial records to evaluate if the partnership has taken aggressive positions the Internal Revenue Service could challenge in an audit, he said.

“Existing partnerships will want to make sure they have their tax books and records order so that purchasers won't be scared away or ask for larger escrows to protect themselves,” Brock told Bloomberg BNA. “There's only two years and two months until these transactions start being impacted.”

In addition to the Real Estate Roundtable, organizations lobbying for revisions to Renacci's bill included the National Association of Real Estate Investment Trusts Inc., the National Multifamily Housing Council, the National Apartment Association and the National Association of Manufacturers, among others.

Developers of apartment buildings, for instance, expressed concern that the liability provision could discourage investment toward such projects because a partnership's tax liability at that point probably would be hard to predict.
Instead, the partner's tax liability should be tied to the entity's pro-rata share of ownership in the partnership, the National Multifamily Housing Council said in a July 8 letter to Renacci and his main co-sponsor on the bill, Rep. Ron Kind (D-Wis.).

The multifamily housing industry is dominated by passthrough businesses, they said.

“We spent months working in a constructive way with Congressional tax professionals to explain the potential real world problems,” said a statement from Real Estate Roundtable President and Chief Executive Officer Jeffrey D. DeBoer. “The result is not perfect. But the recommendations we made helped move the provision in the right policy direction. Hopefully there will be future opportunities to continue to iron out remaining aspects that are not needed to accomplish the policy goal of greater tax compliance.”

A news release from the group said it would work with Congress and the Treasury Department to ensure that “any necessary technical changes” are adopted, without elaborating.

With assistance from Marc Heller and Laura Davison in Washington.

To contact the reporter on this story: Aaron E. Lorenzo in Washington at aaron@bna.com
To contact the editor responsible for this story: Brett Ferguson at bferguson@bna.com