Page 3 - Repeal of the TEFRA Entity Level Audit Rules Under the Bipartisan Budget Act of 2015

with “consolidated” audit, assessment and collection rules, including rules for administrative and judicial review.
Congress Agreed with the IRS and Treasury That Legislative Reform of the Partnership Procedural Rules and Collection Process
Was Required
The IRS went to Congress for relief. Congress responded by enacting a new audit regime for large partnerships generally effective for partnership tax years beginning after 2017. The new scheme also is intended to be a substantial source of increased revenues.
The general rule under the consolidated audit approach is that underpayments in prior years, i.e., reviewed years, with respect to partner income taxes in a partnership, would be borne by the partnership. Under the new law, the audit would still focus on the prior tax years (the “reviewed year audits”). The proposed and resulting deficiency in tax would be assessed against and paid by the partnership in the “adjustment year.” The partnership assessment becomes final, subject to a set of complex payment rules and excep- tions. This fundamental change in federal tax procedure to assess and collect federal income tax in “open” years against the partnership entity appears to be a paradigm shift in treating a partnership for federal income tax purposes as a separate tax entity instead of a flow-through entity, at least for assessment and collection purposes.13
The new partnership audit rules, which are generally ef- fective for partnership tax years beginning after December 31, 2017,14 replace both the TEFRA audit rules and the electing large partnership rules. The hallmark of the new rules is that the partnership itself will be liable for any imputed underpayment in tax for one or more “reviewed year audits.” This is what the Treasury and the IRS clearly wanted Congress to do in order to facilitate audits of large partnerships, including funds of funds and multi-tiered part- nerships. The ability to elect-out of the new SELA regime has been greatly enlarged from the small partnership exception contained in Code Sec. 6231(a)(1)(B).15 The new partner- ship audit rules, however, make it easier for partnerships with between 11 and 100 partners, actually counted on a per K-1 basis, to elect out of the new audit regime.16 Since many partnerships will want to elect out of the SELA rules audit rules undoubtedly more audits will have to be con- ducted at the individual partner level than under TEFRA. The result of the greatly widened election-out rule, and the difficulties in auditing on a partner-by-partner basis may
have the IRS having to answer to Congress for a potential revenue loss rather than a revenue gain, in assessing the budget impact of the new legislation.
In addition to the “election-out” rule, the partnership may timely elect, for each reviewed year, to “push-out” the proposed partnership assessment made in the adjustment year to the partners for the reviewed years.17 It is not yet clear how many partnerships will elect to push out part- nership level adjustments to the partners with respect to one or more reviewed year audits with the concomitant obligation to pay the taxes and additions to tax due.18
There is the issue of course of whether the states will adopt the new partnership audit rules. Some states which automatically adopt changes in the Code should fall in line with the SELA rules. Other states, however, will need special legislation to adopt the new partnership audit rules. Some states may not adopt the new audit rules at all.
The “Basics” of the New Streamlined Entity Level Audit Rules: An Overview
The SELA rules are generally applicable to all partner- ships. In form, the IRS will audit the partnership under the revised ELA rules. But under the general rule con- tained in new Code Sec. 6225, the partnership will be responsible to make payment of any resulting imputed underpayment from one or more partnership adjust- ments for the reviewed year or years. There is a major exception, and that pertains to certain partnerships that have 100 or fewer partners. Under new Code Sec. 6221(b), a partnership having “100 or less” partners may elect out of the new audit rules for any tax year provided all partners are individuals, C corporations, foreign entities, which would be treated as a C corporations were they domestic entities under the check-the-box regulations, and S corporations having certain types of shareholders or estates of deceased partners. Where any partner is a partnership, trust or even a single member LLC or defective entity, unless guidance in the regula- tions liberalizes the operative language in the statute, the election out of the new rules cannot be made. Therefore, for partnerships unable to elect out due to their owner- ship structure, additional stress will be placed in making sure the partner payment of the adjustment amount under Code Sec. 6225(c) is made to avoid a partnership assessment. There are important notification provisions both to the IRS and to the partners that must be made by the partnership representative. The election out must be made annually and timely.
AUGUST–SEPTEMBER 2016 © 2016 CCH INCORPORATED AND ITS AFFILLIATES. ALL RIGHTS RESERVED. 57