Page 10 - Repeal of the TEFRA Entity Level Audit Rules Under the Bipartisan Budget Act of 2015

REPEAL OF THE TEFRA ENTITY LEVEL AUDIT RULES
underpayment amounts, it is clear much help is needed overall for taxpayers and their advisors to fully grasp and apply the new regime. Although the IRS may be pleased with its enhanced ability to audit large partnerships, which have partnerships in one or more tiers above as partners, the new rules will only generate more uncertainty and complexity. Ironically, for partnerships with 100 or less eligible partners, the IRS will suffer from the same tax administration problems that led to the enactment of the TEFRA ELA rules in 1982 by removing application of the ELA rules but only for a partnership year in which such election is made.
Areas for guidance will include application of the rules, including the election out provisions, to passthrough en- tities, trusts, S corporations and single-member entities, as well as characterization issues where the partnership is required to adjust a prior year’s allocation of long-term capital gain to ordinary income or Code Sec. 1250 or Code Sec. 1245 recapture. In addition, rules for designating and removing the designated representative are needed. In this regard, is a current TMP going to be deemed to be the “designated partnership representative” in the absence of a specific appointment? If a corporation is selected as the “designated partnership representative,” which corporate officer is permitted to act in such a capacity?
Special consideration needs to be given to situations in which the reporting partnership is no longer in existence at the time that the audit commences its audit. Who then is the designated representative? Who bears the cost of the imputed adjustment? In this regard, Code Sec. 6241 states that “if a partnership ceases to exist before a partnership adjustment under this subchapter takes effect, such adjust- ment shall be taking into account by the former partners of such partnership under regulations prescribed by the Treasury.” The IRS, in this instance, should be able to is- sue adjusted Schedules K-1 to the partnership’s historical partners based on their allocation of the items adjusted with respect to the original return. Such details must be addressed in the forthcoming regulations.
Guidance is required for partnerships filing amended returns reporting additional income or reducing the amount of a refund in tax or tax credit. Presumably the partnership can remit payment itself or, alternatively, issue adjusted Schedules K-1. Special rules need to be provided for the proper treatment, including identifying the proper “claimant,” with respect to claims for refund attributable to reviewed years.
There obviously will be a host of additional problems that will need to be addressed, including whether state tax revenue departments will adopt the new rules for state income tax purposes.
Integration of the New SELA Regime with Partnership and Operating Agreements
It is not too soon to begin the process of evaluating whether and to what extent existing partnerships and LLCS should presently amend their existing agreement. Obviously, the first question is whether to elect in before 2018. Another question is whether the partnership will have the flexibility to pay the imputed underpayment or will be required to make the adjusted Schedule K-1 election under Code Sec. 6226(b). This “new world” of partnership income tax procedure due to go into effect for partnership tax years beginning after 2017 is going to wreak havoc to existing partnership agreements as well as heighten the scrutiny required to buy into a partnership.
As a starting point, many if not most carefully designed partnership agreements contained tax procedure provi- sions which included naming the TMP in accordance with Code Sec. 6231(a)(7) and the regulations. The Code and regulations call for the TMP to be a general partner. However, in a member-managed LLC, the TMP may be any member. In a manager-managed LLC, the TMP must be a member who is a manager, or if no manager is a member, a nonmanager member. Now, under Code Sec. 6223(a), a “partnership representative” must be des- ignated in the manner set forth in new guidance issued by the IRS. The “partnership representative can be a partner (or member of an LLC) but does not have to be as is the case with certain manager-managed LLCs under current regulations. The partnership representative has the “sole authority to act on behalf of the partnership.” Where no partnership representative has been designated, the IRS can select the partnership representative. Will a TMP be treated as the “partnership representative” by the IRS where the partnership or LLC operating agreement does not make specific reference to “new” Code Sec. 6223(a)?
Moving further, with the new partnership assessment and payment rule, should the operating agreement contain a “clawback” to contractually require former partners or partners whose percentage interest has decreased from that in the “reviewed years,” to reimburse the partnership for its payments in tax made to the IRS, or grant rights of con- tribution to the other partners, including new partners? Even if the partnership makes an election under Code Sec. 6226(a) to shift the burden of an imputed underpay- ment (assessment in tax for a reviewed year), what if the subject partners fail to make all required payments in tax, interest and penalties? What contractual remedies will the partnership be provided? Suppose it is known when the
64 JOURNAL OF TAX PRACTICE & PROCEDURE
AUGUST–SEPTEMBER 2016