Partnership Audit Rules Clarified by the Consolidated Appropriations Act

by Butler Snow LLP

Butler Snow LLP

Technical corrections to the partnership audit rules were included in the 2018 Consolidated Appropriations Act signed by President Trump on March 23rd (the “Appropriations Act”).  These corrections clarify certain provisions of the centralized partnership audit rules that were passed as part of the Bipartisan Budget Act of 2015, but were only effective as of January 1, 2018.

These corrections are briefly summarized as follows:

  1. Scope of Items- Current law provides that the audit rules apply to adjustments to “partnership income, gain, loss, deduction and credit.” The revisions substitute the phrase any “partnership-related item.”  A “partnership related item” is defined in amended Section 6241 as “any item that is relevant in determining the income tax liability of any person, without regard to whether the item or amount appears on the partnership’s tax return.” The effect of this revision is to broaden the applicability of the partnership audit rules to items that affect a person, even if the item or amount isn’t shown on the return. An example of such an item might be a basis adjustment.
  1. Taxes Excluded- The partnership audit rules will not directly apply to self-employment taxes, net investment income taxes, withholding taxes on nonresident alien individuals or foreign corporations, and withholding taxes on foreign accounts. If a partnership adjustment ultimately results in a modification to these tax liabilities, however, then such adjustment is relevant in determining the tax liability under any of these specific tax provisions.
  1. Netting Underpayments- Capital gain and ordinary income items will not be netted for purposes of determining an underpayment.
  1. Computation of Underpayments- If an adjustment that flows through to a partner could be subject to a limitation at the partner level, then the adjustment will not be taken into account in determining the partnership’s deemed underpayment (unless otherwise provided by the IRS).
  1. Amended Partner Tax Returns- Section 6225(c)(2) allows reviewed-year partners to take adjustments into account in an amended tax return. The Appropriations Act provides that for this approach to be effective: (i) the partner must file an amended tax return that includes the end of the partnership’s reviewed tax year and also for any other year in which the partner is affected because of the adjustment; (ii) amended returns must include all such adjustments allocable to that partner; and (iii) the partner must pay all additional tax liabilities plus interest and penalties.
  1. “Pull-In Method”- The Appropriations Act includes an alternative method (the “pull-in“ method) to the actual filing of amended returns. After the IRS determines the underpayment, the reviewed year partners would (i) pay any tax that would be due on an amended return, (ii) make applicable changes to their tax attributes; and (iii) provide sufficient information to the IRS to substantiate the payment of the correct tax. The partners would not actually file amended tax returns.  The participation of all reviewed-year partners apparently would not be required.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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