Page 12 - Partnership Audit Rules - Drafting Partnership Agreements: The New Partnership Representative And The Outgoing Tax Matters Partner

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Section 6226(c) provides rules for the treatment of penalties and inter- est determined under Section 6221 at the partnership level when an election is made under Section 6226. The reviewed-year partners of the partnership are liable for any such penalty, addition to tax, or ad- ditional amount.32
It is important to understand that the push-out election and notice ef- fectuates an assessment for each re- viewed partner for the taxes im- posed under chapter 1 for the tax year of the adjustment. The push- out election, which may be the rule mandated by many partnership and operating agreements, effectively shifts the economic burden of the partnership’ s obligation to be sub- ject to assessment and payment of the imputed underpayment to each reviewed partner.
The Joint Committee on Taxa- tion’ s General Explanation of T ax Legislation Enacted in 2015 (“Blue Book”)33 provides that with respect to tiered partnerships, a partnership that receives a statement (push-out election statement) from the audited partnership is treated as an “individ- ual” and must take into account the aggregate of the adjustment amounts determined for the partner’ s tax year, including the end of the re- view year, plus the adjustments to tax attributes in the succeeding tax years of the recipient partnership. It is unclear whether a second-tier partnership that is subject to a push- out election can itself make a push- out election and move the lower-tier partnership’ s aggregate adjustment amount to its partners. Some com- mentators want the push-out elec- tion to be permitted to go up as many tiers as are necessary in order to reach the ultimate taxpaying indi- viduals or entities in the entire
32 Section 6226(c)(1).
33 Staff of Joint Committee on Taxation, Gen-
eral Explanation of Tax Legislation Enacted
40D*points, Next 120D, Vjust JC1:1
chain. Alternatively, such commen- tators want each upper tier to be able to elect whether or not to push- out.
What is an awkward, if not troub- ling, feature of the new rules is that in many instances the partners pay- ing the taxes for the adjustment year may not be the same partners that enjoyed the benefit from the prior underreporting of partnership in- come, or may have a different per- centage interest between the re- viewed year and the adjustment year. Will the operating agreement for the LLC or partnership require a form of claw-back from the former partners of such tax benefits if the partnership accepts and makes pay- ment of the imputed underpayment? Will reserves be retained for such purpose?
Audited partners will often not be able to use the statutory rule in new Section 6225(c)(2) for reducing or avoiding a partnership-level tax by demonstrating that the reviewed- year partners have filed amended re- turns reporting and paying any taxes due as a result of the partnership adjustment. In most cases, a partner- ship will have no power to compel its reviewed-year partners to file amended returns, and those partners may have little economic incentive to do so.
Election Out of the New Partner- ship Audit Rules
To escape the imputed underpay- ment rules under Section 6225, as well as the alternative push-out election provision in Section 6226, Section 6221(b) provides that a partnership having 100 or fewer partners may elect out of the new audit rules for any tax year, pro- vided all partners are individuals, C corporations, foreign entities that
in 2015, JCS-1-16, March 2016 (“Blue Book”).
would be treated as C corporations were they domestic entities under the check-the-box regulations, S corporations having certain types of shareholders, or estates of deceased partners. Under the statute and pro- posed regulations, a partnership has 100 or fewer partners when it is re- quired to furnish 100 or fewer state- ments under Section 6031(b). The proposed regulations did not expand on the list of eligible partners.
Under Section 6221(b)(1)(D)(i), a partnership may elect out of the centralized partnership audit regime only on a timely filed return for a tax year (including extensions). The election out cannot be made with respect to any tax year of the part- nership where any partner is a part- nership, trust, or even a single member LLC or defective entity, such as a single member LLC that does not file a reverse default elec- tion or a grantor trust, unless the categories of eligible partners are expanded by future regulations.
;There are important provisions requiring notice to the Service and the partners that must be satisfied by the partnership representative to qualify for the election out. The election out must be made annually on a timely filed return by the part- nership representative.
Procedural Issues/Judicial Review
With respect to the statute of limita- tions, Section 6235 provides for a single partnership limitation period in contrast to the two periods of limitation under TEFRA, i.e., one at the partnership level on partnership items, and one at the partner level. Under the BBA, audit adjustments with respect to partnership items cannot be made more than three years after the later of: (1) the date on which the partnership filed its re-
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Corporate Taxation