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States and taxpayers aren’t waiting for a fix to the new federal partnership audit regime as they wade further into it to assess how the law will shape state tax systems.
The Bipartisan Budget Act of 2015 (Pub. L. No. 114-74), signed into law in November 2015, ushered in a new centralized system for federal audits of partnership entities. The default regime provides for assessments and adjustments at the entity level—rather than among individual partners—absent an election to “push out” liability to the partners.
However, the BBA provoked criticism from federal tax professionals, both inside and outside the Internal Revenue Service, who have panned the overhauled system as complex and largely unworkable. On the state side, officials and practitioners have bemoaned what they see as Congress’ disregard for the myriad of state-specific issues arising out of the regime.
Efforts at clarification have stalled at the federal level. And many question how federal officials will find time to tackle changes to the regime before it takes effect in 2018, with a congressional calendar dominated by health care legislation, government funding resolutions and possibly federal tax reform.
In the meantime, a lineup of state tax groups continue to suss out and address the stateside impact from the federal regime.
Below, Bloomberg BNA discusses developments at the federal and state levels.
In early December, House Ways and Means Committee Chairman Kevin Brady (R-Texas) introduced the Tax Technical Corrections Act (H.R. 6439, S. 3506) to tweak the federal law. While the bill stalled, many federal lawmakers have expected it will push through this year—potentially attached to another legislative package.
However, there are questions about whether Congress will bypass a bill, possibly favoring federal repairs through administrative regulations.
Proposed regulations (REG-136118-15) implementing the new regime were released by the IRS in mid-January, but were withdrawn Jan. 20 when the White House announced a regulatory freeze shortly after President Donald Trump’s inauguration. Impeded by Trump’s regulatory restrictions and vacancies in the Treasury Department’s Office of Tax Policy, there is no indication that Treasury will soon rerelease the regulations.
Government officials have indicated there won’t be a delay of the 2018 effective date.
Soon after the BBA became law, the Multistate Tax Commission launched a Partnership Informational Project, intended to address questions and analyze ramifications of the new audit approach. The Uniformity Committee tasked the work group in July 2016 with drafting model language for states seeking to respond to the federal regime.
MTC staff have maintained a working issues list that sorts through the federal changes and summarizes state-related issues. In an April 5 report, the staff provided a comparison of its issues list with a checklist developed by a task force of the American Bar Association tax section’s State and Local Tax Committee and an American Institute of CPAs work group. The checklist likewise presents questions for states mulling legislation responding to the federal legislation.
Helen Hecht, MTC general counsel, told Bloomberg BNA that most states will require a statutory adjustment to address the new federal regime. However, the process of crafting model legislation will present challenges because the changes concern procedural law.
“A procedural statute is typically harder to write because there are already procedures in place,” Hecht said. “There are statutes of limitations, penalties and interest, filing requirements, and other procedural requirements that are already in place. And every state is going to have to modify any model so that it fits in with their existing procedures.”
Regulatory revisions might appeal to states seeking flexibility for taxing agencies, which likely will have to adapt to future federal revisions.
“This is an area in flux,” Hecht said. “We’ll see if the IRS can actually make this work. If it does, it probably is going to have some hiccups along the way. It would be nice if we didn’t have to run to the legislature every time we had a hiccup to change the law. I don’t think anybody wants that.”
Responding to direction from the Uniformity Committee and the partnership work group, the MTC staff’s April 5 report incorporated recommendations to start establishing policy objectives prior to drafting model legislation. The report notes that it “was prepared by MTC staff for review and discussion only.”
One objective underlying the report was to ascertain whether there was sufficient agreement to start drafting—as opposed to pushing the work group in one direction, Hecht said.
“We have a giant issues list, a lot of which requires us to get into the weeds. In that case, someone has to take the 10,000-foot approach and identify one direction to start the process,” Hecht said.
“Until you lay out issues and recommendations, you can’t have a discussion,” she added. “But you don’t want it to seem like it’s more set in concrete than it is. And I wanted to make that clear up front.”
Arizona is the only state that has enacted legislation addressing the federal regime. Proposals surfaced in other statehouses in 2017—Georgia, Minnesota and Montana—but none became law.
Simultaneously, several “interested parties” are collaborating on model legislation addressing both procedures for reporting federal income tax changes and procedures for reporting changes under the new regime. The parties are the Council On State Taxation (COST), Tax Executives institute (TEI), the Institute for Professionals in Taxation (IPT), the American Institute of CPAs and the ABA State and Local Tax Committee.
In a March presentation before the MTC Uniformity Committee, COST and TEI representatives presented a concept paper for the proposed model legislation. The proposal broadened the groups’ original request for the MTC to update its 2003 Model Uniform Statute for Reporting Federal Tax Adjustments (RAR statute). The MTC spent approximately 10 years drafting and adopting the RAR statute, which no state adopted.
“As we started looking at the changes on the federal partnership audit side, and as states are going to do something to incorporate or somehow conform to the new procedures, we realized this would be a good opportunity to provide some greater uniformity for all reporting of federal changes,” Nikki E. Dobay, senior tax counsel for COST, told Bloomberg BNA.
The model legislation is designed to be “all-encompassing,” Fred Nicely, senior tax counsel for COST, told Bloomberg BNA.
“It will give the states the chance to improve the overall reporting for C corporations, for individuals, for partnerships, and will also address the specific issues that states may have dealing with the new federal audit procedures for partnerships,” he said.
Tracee Abel, chair of the MTC partnership work group, said the plan is for the work group to burrow into the issues list and discuss which elements may be addressed through statute or regulation.
“The thing that we really want to focus on is making something that taxpayers will understand, a process they will be able to understand,” said Abel, an income tax specialist with the Montana Department of Revenue. “As well as a process that employees of each state tax department can understand. And we don’t want this process to take years. We want it to be accomplished relatively timely.”
Abel acknowledged during the work group’s April 6 meeting that she didn’t agree with all recommendations in the MTC’s April 5 report, but saw it as a “good conversation starter” toward model legislation, rather than the “be all, end all.”
“I understood that this is the starting point—taking the position that we’ll just start with conformity and work from there, completely understanding that conformity is not going to work in all situations, if any,” Abel said. “But at least start with the idea of trying to conform and build upon that.”
Although it wouldn’t be in final form, Hecht said that MTC staff could have draft model language for the work group by the end of 2017. In the meantime, MTC staff and the partnership work group are awaiting draft model legislation from the interested parties, and remain willing to review and propose revisions.
The interested parties are targeting mid-June for the public release of draft model legislation. And several interested parties are expected to have approved the draft legislation at that time—some administrative processes may require additional time.
Plans are to present the draft model legislation to the National Conference of State Legislatures and the Federation of Tax Administrators during their summer meetings.
The parties also intend to seek the MTC’s input, and possible endorsement, before lobbying state legislatures.
“One would hope that the MTC would take it, and if not adopt it in whole, may be use it as a starting point,” Jonathan Horn, senior technical manager of tax policy and advocacy with the AICPA, told Bloomberg BNA. He noted that the draft, which “piggybacks” but doesn’t completely tie to the federal partnership audit system, isn’t intended as the “be all, end all.”
However, Horn said that it’s important for states to adapt their RAR provisions in conjunction with statutory changes addressing the partnership audit regime—in part to avoid conflicting requirements and deadlines when RAR statutes for individuals, corporation and S corporations are triggered.
Until the MTC receives the interested parties’ proposed legislation, Hecht said it isn’t clear what direction the groups are taking. With both the MTC and the groups working on individual legislative prototypes, comparing and combining the two approaches could foster a “better ultimate outcome.”
“There are two sides to the equation,” Hecht said. In the meantime, “rather than just sit and wait, the states need to be thinking about these issues at least. To get them actively thinking about it is useful.”
Many practitioners expect that states increasingly will push to address the federal regime as part of their 2018 legislative agendas. Hecht explained that legislative bills generally don’t become law following their first introduction—typically they require reintroduction in future sessions.
“A year really is the minimum lead time to put legislation in place,” Hecht said, adding that a proposed measure often takes months to move through a state legislature and likely wouldn’t take effect until the following year.
“States are being patient right now,” she added. However, more so than recovering revenue, a state priority is having sufficient time to enact implementing regulations following a statutory change.
Hecht and Abel both noted that once the IRS starts auditing under the new rules, the focus will be on approximately 1 percent of the largest partnerships. States like California and New York, where a majority of ownership interests are located, will feel the greatest impact.
During the April 6 meeting, several interested parties voiced concerns with some of the MTC staff’s recommendations. With the recommendations memorialized in writing, some wondered if states will interpret them as final policy decisions without further discussion—particularly because the report didn’t discuss alternative recommendations, Horn said.
Bruce P. Ely, a tax partner at Bradley Arant Boult Cummings LLP and co-chair of the ABA task force, told Bloomberg BNA that he hopes MTC staff will defer further recommendations or policy decisions until there has been opportunity to review the interested parties’ legislative framework.
Ely said the risk of “dueling model acts” will jeopardize the prospects of uniform legislation among states, if the MTC declines to endorse the groups’ proposed legislation.
He said the ideal goal is for the business groups and the MTC to unite behind one uniform bill by this fall—he noted that the MTC can incorporate options into the interested parties’ model legislation to accommodate state differences. If there is shared support for the model bill, a grassroots system will spring into action, with lawyers and accounting firms in each state assisting the business organizations in identifying state-specific issues and lobbying state lawmakers to enact legislation.
“It’s a rare moment to have all the business and professional groups together on the same page,” Ely said, explaining that a coordinated effort with the MTC would improve the prospects of states adopting a uniform approach.
“We won’t see perfectly uniform legislation in every state, hopefully 90 percent correlation,” Ely said. However, absent broad agreement on one model bill, “I fear that we’ll be fighting for opposing bills in the legislatures of many states, and in D.C. and New York City next year.”
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Information on the MTC's partnership work group and submissions by the interested parties is at http://www.mtc.gov/Uniformity/Project-Teams/Partnership-Informational-Project.
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