Congress makes changes to partnership audit and adjustment rules

Tucked into the two-year budget deal passed by Congress on Friday are some major provisions affecting partnerships (Bipartisan Budget Act of 2015, H.R. 1314). The new rules would apply to partnership returns filed for tax years beginning after Dec. 31, 2017. President Barack Obama is expected to sign the bill into law quickly.

The act replaces the current TEFRA partnership audit rules (Subchapter C of Chapter 63 of the Code, Secs. 6221 through 6234) 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 new 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)).

New 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 could be collected at the highest individual tax rate.

New Sec. 6222 requires that a partner must treat “each item of income, gain, loss, deduction, or credit attributable to a partnership” consistently with how those item are treated on the partnership return. 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. Partners can avoid this provision if, before filing their return, they notify the IRS that there will be an inconsistency.

New Sec. 6223 requires partnerships to designate a partnership representative, “who shall have the sole authority to act on behalf of the partnership in this subchapter.” 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.

—Alistair Nevius (anevius@aicpa.org) is the JofA’s editor-in-chief, tax.