Page 12 - Repeal of the TEFRA Entity Level Audit Rules Under the Bipartisan Budget Act of 2015

REPEAL OF THE TEFRA ENTITY LEVEL AUDIT RULES
Thus, there seems to be the potential for a “new game” to be played in shifting potential tax liabilities from the partners to the partnership from the reviewed years to the adjustment year by having the partnership left obligated to pay the tax on the imputed underpayment and of course, by not invoking application of Code Sec. 6225(c)(2). Some may try to use the partnership form place deferred
tax liabilities in a partnership (and not just a C corpora- tion) to dump recapture amounts on an entity that is responsible for the tax which may not have sufficient liquidity or value to pay the tax. Perhaps the potential for gamesmanship in this area will be considered by both the IRS and Congress, through aid of hindsight, to be the potential “ugly” byproduct of the new regime.
ENDNOTES
1 See, in general, August and Cuff, The TEFRA Partnership Audit Rules Repeal: Partnership and Partner Impacts, ALI-CLE Video Webcast (July 17, 2016);August,TheGoodTheBad,andPossiblythe Ugly in the New Audit Rules: Congress Rescues the IRS From Its Inability to Audit Large Partnerships, Business Entities (WG & L) (May–June 2016); August, Entity-Level Audit Rules Continue to Pose challenges for Partners, Parts 1 and 2, Business Entities (WG & L) (Nov.–Dec. 2014) (July–Aug. 2015). Act Sec. 1101 of the Bipartisan Budget Act of 2015 (P.L. No. 114-74). Act Sec. 1101 repeals the current rules governing partnership audits with a new centralized partnership audit regime that, in general, assesses and collects tax at the partnership level. On the new audit provisions generally, see New York State Bar Association, Tax Section, Report No. 1347, Report on the Partnership Audit Rules of the Bipartisan Budget Act of 2015 (May 25, 2016).
2 For background to the new legislation, see August and Cuff, supra note 1, fn. 2 and accom- panying text.
3 The use of the word “streamlined” is to allow the resulting acronym “SELA” to reflect the new set of entity level audit rules for. The TEFRA ELA rules were set forth in Code Secs. 6221 through 6234. The electing large partnership rules were contained in Code Secs. 771 through 777 and Code Secs. 6240 through 6255. The new SELA rules are primarily contained in Code Secs. 6221 through 6241 although there are various conforming amendments and changes in other parts of the Code.
4 Act Sec. 1101(g)(4) of the Bipartisan Budget Act of 2015 generally provides that a partnership may elect (in the time and manner prescribed by the Treasury or its delegate) for parts of the new rules to apply to partnership tax years beginning after November 2, 2015 and before January 1, 2018. As discussed below, the IRS released guidance in August in temporary regulations for partnerships which want to “elect-in” to the new rules for tax year beginning on or after November 2, 2015.
5 Payment by the partnership for the adjustment year indirectly is borne by the current partners, which set of partners may be different or hold different percentage ownership interests than the set of partners for the reviewed year or years.
6 See supra note 2.
7 Code Sec. 6226(b).
8 Certain investment entities, joint extraction
undertakings for profit under may still elect “out” of partnership status in accordance with the regulations to Code Sec. 761, in which case suchenterpriseisalsonottreatedasapartner- ship under the TEFRA audit rules. Reg. §1.761-2. See Code Sec. 7701(a)(2); L.L. Powell, 26 TCM 161, Dec. 28,348(M), TC Memo. 1967-32 (1967); Rev. Rul. 68-344, 1968-1 CB 569; Rev. Rul. 82-61, 1982-1 CB 13. But see Bentex Oil Corp., 20 TC 565, Dec. 19,707 (1953); Madison Gas & Electric Co., CA-7, 80-2 ustc ¶9754, 633 F2d 512. See also DJB Holding Corp., 101 TCM 1157, Dec. 58,542(M), TC Memo. 2011-36, aff’d, CA-9, 2015-2 ustc ¶50,509, 509 F3d 1014 (profit cap found to be indicative of a contingent compen- sation arrangement); Historic Boardwalk Hall, LLC, 110 AFTR 2d 2012-5710, CA-3, 2012-2 ustc ¶50,538, 694 F3d 425, rev’g and rem’d, 136 TC 1, Dec. 58,501 (2011) (investor in vehicle to transfer historic tax credits not a bona fide part- ner); CCA 20124002F (applying participation analysis to treat tax equity investor’s interest in partnership as debt). The regulations describe an “investing partnership” that may “elect out” of partnership status as one in which (1) the partners own the property as co-owners; (2) each owner reserves the right to separately take or dispose of their shares of any property acquired or retained; and (3) the owners do not actively conduct business or irrevocably authorize some person or persons acting in a representative capacity to purchase, sell or ex- change such investment property, although each separate participant may delegate authority to purchase, sell or exchange his share of any such investment property for a period of up to one year. Under Reg. §1.761-2(a)(3), a group may elect out of Subchapter K where the participants enter into an operating agreement for the joint production, extraction or use of property in which (1) the participants own the property as co-owners, either in fee or under lease or other form of contract granting exclusive operating rights; (2) the participants reserve the right separately to take in kind or dispose of their shares of any property produced, extracted or used; and (3) the participants do not jointly sell services or the property produced or extracted. The election-out mechanics are contained in Reg. §1.761-2(b). The election out would also negate application of the ELA rules under TEFRA and presumably under the BBA, subject to the issuance of regulations.
9 See Code Sec. 6229 (statute of limitations for 66 JOURNAL OF TAX PRACTICE & PROCEDURE
partnership audit does not expire until three years after the original due date of the partner- ship return or the date the return is filed, which- everislater).Asix-yearperiodwaspossiblefor substantial understatements under the more than 25-percent rule as well as no statute of limitations for fraudulently reported partnership items. Each partner’s statute of limitation was to be determined as the later in time of the normal statute of limitations on assessments under Code Sec. 6501 or the partnership statute. See Rhone-Poulenc Surfactants & Specialties LP, 114 TC 533, Dec. 53,929 (2000) (reviewing the issue and siding with the IRS’s position); AD Global Fund LLC, FedCl, 2006-1 ustc ¶50,117, 68 FedCl 663 (discussing the interaction of Code Secs. 6229 (TEFRA) and 6501 and the related case law).
10 As will be discussed below, the new rules can result in excessive taxation by treating improper allocations of income for a reviewed year as a separate adjustment in computed the “imputed underpayment” without an offsetting reduc- tion to account for the partner who essentially overpaid its tax in the reviewed year. This phe- nomenon is referred to as the “one-way up” adjustment.
11 See, however, Code Secs. 1441 (nonresident FDAP), 1442 (foreign corporation FDAP), 1445 (FIRPTA), 1446 (foreign ECI), 1471–1474 (FATCA).
12 Government Accounting Office, Large Partner- ships: With Growing Number of Partnerships, IRS Needs to Improve Audit Efficiency, GAO-14-732 (Sept. 18, 2014). The Government Accounting Office found that in the 2012 fiscal year, the IRS audited just four percent of large partnerships while it audited 27.1 percent of similarly sized corporations (non-S corporations).
13 In Notice 2016-23, 2016-12 IRB (Mar. 4, 2016), the IRS issued notice requesting comments under the new partnership rules in issuing guid- ance. The regulations projects will be quite im- portant in understanding the scope and breadth of the new statutory language. The Congress, as it typically is prone to do in the area of tax legislation, left much of the detail on the new reforms to be defined by regulation and other forms of guidance. In fact, it has been reported that the IRS was not asked by Congress to report on the legislation prior to its enactment.
14 Based on the obvious need for much published guidance from the Treasury and the IRS and the accumulating list of errors, inconsistences and perhaps unintended consequences attributable
AUGUST–SEPTEMBER 2016
or production arrangements that are joint