Wait for Federal Partnership Audit Rules, California Advised

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By Laura Mahoney

California tax officials weighing whether to conform to new federal rules for partnership audits should wait until the rules are more certain, a representative of the Council On State Taxation told them.

California will need legislation if it wants to audit and impose tax at the partnership level, and Franchise Tax Board officials said they don’t want to be caught without that authority when the new federal rules take effect, because the state could lose a significant amount of revenue.

At the same time, it will be at least 2019 before partnerships begin filing returns and facing audits under the new rules, Nikki Dobay, senior tax counsel with COST, told a panel of staff members from the Legislature and the Franchise Tax Board on Feb. 3.

“I’m asking that you do nothing,” Dobay said. “There will be a time to act, but just not now.”

Uncertain Federal Rules

COST and other advocacy groups are urging California and other states to wait before acting, but Arizona has already enacted a bill to conform to the new federal rules. Montana lawmakers introduced a bill this session, though they agreed late Feb. 3 to table it in the face of pushback. Minnesota officials are drafting a possible measure, though no bill has been introduced.

The groups are cautioning state legislators against pursuing bills when so many questions remain about the federal partnership audit legislation approved as part of the Bipartisan Budget Act of 2015. It is expected that Congress will, perhaps in the first half of 2017, pass a technical corrections bill (H.R. 6439, S. 3506) addressing the unanswered questions about new federal partnership audit procedures.

The Trump administration ordered the Internal Revenue Service Jan. 20 to withdraw regulations it proposed two days earlier outlining how it planned to carry out audits and adjustments at the partnership level, throwing more uncertainty into the picture.

COST is a Washington, D.C.-based nonprofit that represents more than 600 major corporations.

Revenue Losses, Compliance Problems

FTB officials said the potential federal rules raise compliance issues that could reduce state revenue.

The tax agency is seeing an uptick in the number of partnerships with many partners, even hundreds of thousands, Bruce Langston, director of the FTB Technical Resources Bureau, said at the Feb. 3 hearing. If partnerships facing assessments choose an option in the rules to “push out” the assessment to the partners, the FTB is concerned about its ability to collect tax.

“It’s impossible to push out an assessment and get any kind of reasonable compliance,” Langston said. “If we have a $100,000 adjustment and 10,000 partners, it’s a lot easier to get the adjustment from the partnership.”

Langston said the FTB is also concerned that if the IRS makes an adjustment to a partnership’s tax liability, states will be unable to “pick up” the adjustments. This could be an issue with partnerships in which some partners file returns in California but the partnership doesn’t file a state return, and the partnership pays the adjustment.

“The revenue could be large, especially as more people do this,” he said. “The concern is that the state doesn’t want to be caught if we actually do need legislation to assess at the partnership level, yet we want to wait” until the federal rules are clear.

Tell IRS

Dobay urged the state officials to examine the IRS proposed rules and comment on them to raise their concerns.

Also unclear is whether a California bill to conform to the federal rules would require a two-thirds majority in both houses to reach the governor’s desk. California law requires a two-thirds vote threshold if a tax measure increases the tax burden on any taxpayer. Attorneys in the Legislative Counsel’s office would determine whether a bill requires a two-thirds vote, the panelists said.

When California does act to conform to the federal rules, Dobay suggested how to make the state’s rules work better. California could offer a separate election for partnerships to choose whether to push out an adjustment to partners or pay the assessment at the partnership level. What makes sense at the federal level may not at the state level, she said.

California could also allow partnerships to choose a different partnership representative than the one it designates with the IRS so partnerships could bring in a representative with state expertise, she said.

State Bar Panel

Dobay and Langston made their comments at a forum at the state Capitol organized by the Sacramento delegation of the State Bar of California Taxation Section. State bar representatives presented legislative ideas and concerns to a panel of officials from the FTB, the Senate Committee on Governance and Finance and the Assembly Committee on Revenue and Taxation.

Dobay presented panelists with a paper outlining the issues California should consider under the new federal partnership audit rules.

California lawmakers are just starting their 2017 session and have until Feb. 17 to introduce new bills, although bills can be amended throughout the session to contain new proposals.

To contact the reporter on this story: Laura Mahoney in Sacramento, Calif., at LMahoney@bna.com

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

For More Information

Text of the COST paper is at http://src.bna.com/l0k.

Copyright © 2017 The Bureau of National Affairs, Inc. All Rights Reserved.

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