Congress changes partnership audit and adjustment rules

Tucked into the two-year budget deal passed by Congress and signed by President Barack Obama on Nov. 2 are some major provisions affecting partnerships (Bipartisan Budget Act of 2015, P.L. 114-74). The new rules apply to partnership returns filed for tax years beginning after Dec. 31, 2017.

The act replaces the current TEFRA partnership audit rules (Subchapter C of Chapter 63 of the Code, Secs. 6221 through 6235) with new rules. It also repeals the current special rules for electing large partnerships (Part IV of Subchapter K, Secs. 771 through 777, and Subchapter D of Chapter 63, Secs. 6240 through 6255).

In their place, the act introduces rules governing partnership-level adjustments that are designed to collect adjustments from the partnership rather than from the partners. This adopts a recommendation of the U.S. Government Accountability Office, which last year found that the IRS audits few large partnerships and suggested ways to improve audit efficiency (GAO Rep’t GAO-14-732 (September 2014)).

As amended, Sec. 6221 provides that:

Any adjustment to items of income, gain, loss, deduction, or credit of a partnership for a partnership taxable year (and any partner’s distributive share thereof) shall be determined, any tax attributable thereto shall be assessed and collected, and the applicability of any penalty, addition to tax, or additional amount which relates to an adjustment to any such item or share shall be determined, at the partnership level.

This expands on the current language of Sec. 6221, which provides that “the tax treatment of any partnership item (and the applicability of any penalty, addition to tax, or additional amount which relates to an adjustment to a partnership item) shall be determined at the partnership level.”

Certain partnerships with 100 or fewer partners can elect out of this provision.

For adjustments that result in tax underpayments, new Sec. 6225 allows the IRS to collect the additional tax directly from the partnership in the year of an adjustment. The tax on the underpayment can, with certain exceptions, be imposed at the highest individual or corporate tax rate.

Amended Sec. 6222(a) requires a partner to treat “each item of income, gain, loss, deduction, or credit attributable to a partnership” consistently with how those items are treated on the partnership return. Under amended Sec. 6222(b), any underpayment resulting from a partner’s failure to treat an item consistently with the partnership return will be assessed as a math error on the partner’s return. A partner can avoid these provisions if the partner files a statement with the IRS identifying the inconsistency.

Sec. 6223 as amended requires partnerships to designate a partnership representative, “who shall have the sole authority to act on behalf of the partnership under this subchapter.” If the partnership does not have a designation in effect, the IRS may select any person to be the partnership representative. The partnerships and all partners will be bound by the actions of the partnership and by any final decision in a proceeding with respect to the partnership.

The act also introduces new procedural rules regarding notices of proceedings and adjustment; assessment, collection, and payment; interest and penalties; judicial review of partnership adjustments; and the limitation period on making adjustments.

• Bipartisan Budget Act of 2015, P.L. 114-74

—By Alistair Nevius, J.D., the JofA‘s editor-in-chief, tax.