Page 4 - Repeal of the TEFRA Entity Level Audit Rules Under the Bipartisan Budget Act of 2015

The new partnership audit regime
or TEFRA SELA substantially depart from the existing TEFRA ELA rules which provisions continue to apply until partnership tax years beginning after December 31, 2017.
REPEAL OF THE TEFRA ENTITY LEVEL AUDIT RULES
It is indeed ironic that Congress was asked to allow the IRS more effectively audit large partnerships and enacted legislation to accomplish this but the actual legislation increases the small partnership exception from 10 or fewer “eligible” partners to 100 or fewer eligible partners. One wonders what the thought was behind this 10-times in- crease in allowing multiple member partnerships to avoid the partnership audit rules entirely by simply making an annual election to “opt-out.”
assessments in income tax resulting from the partnership audit in the year of adjustment, and not the “reviewed years” to which the partnership adjustments were at- tributable. The “partnership adjustment” is defined in new Code Sec. 6225(a).20 In such instance, the IRS will assess federal income tax against the partnership for the “imputed underpayment,” resulting from the set of part- nership adjustments, which is calculated at the highest corporate or individual rate during the tax year at issue. It is anticipated that the IRS will issue guidance in the form of interim notices and then proposed and final regulations in making the calculation of the “imputed underpayment.” There is also an important netting approach announced in computing the imputed underpayment.21
A single partnership limitation period is set forth under a revised set of statute of limitations rules, in particular new Code Sec. 6235, in replacing Code Sec. 6229. Under Code Sec. 6235 adjustments to the partnership cannot be made more than three years after the later of (1) the date on which the partnership filed its return; (2) the due date for the return; or (3) the date on which the partnership filed an administrative adjustment request (AAR). Of course, the law allows for the parties to agree to an exten- sion or waiver of the statute of limitations. There are other important procedural rules set forth in the new provisions which again will be the subject of an extensive set of rules and exceptions to be published by the IRS as guidance, proposed regulations, and then in final regulations. A six- year period will apply for substantial omissions from the partnership’s gross income and, where no return is filed by the partnership or it involves civil fraud, there will be no statute of limitations.22
Exceptions to Application of the Imputed Underpayment Rules: A Closer Look
The new law does provide three important exceptions or modifications that can shift the partnership-level tax liability back to the partners for the reviewed years in which the adjustments relate. The first exception is the annual election out for certain partnerships with 100 or fewer partners under new Code Sec. 6221(b) as previ- ously noted. In such event, the tax procedure rules on audit, assessment, and collection that were in effect prior to ELA apply—no entity level audit or assessments in tax. (Emphasis added in italics).
A second exception permits the partnership subject to assessment for the imputed underpayment, determined in accordance with Code Sec. 6225(c)(2), to produce
There are important notification provisions that must be made by the partnership representative to the IRS and the partners in qualifying for the election out of the part- nership audit rules under SELA. The election out must be made annually.19 With respect to any tax year of the partnership where any partner is a partnership, trust or even a single member LLC or defective entity, the election out provided in Code Sec. 6221(b) cannot be made. Yet, the Bluebook issued by the Joint Committee in Spring on Taxation this past Spring suggests that forthcoming guidance in this area will be liberal and may extend the list of eligible partners, including indirect partners that will qualify under the “election out.”
Where an eligible partnership elects out, the partners will be subject to the pre-TEFRA partnership audit rules requiring the IRS to deal separately with the partnership and each partner. This author speculates, in good faith, that this new and large escape route from the ELA rules was not something the IRS wanted from Congress. If so, such reform reflects “the bad” part of the new rules. On the other hand, the elect out feature undoubtedly is a “good” or favorable development for most privately owned partnerships since there was a consensus among many tax advisors and commentators that the TEFRA ELA rules were cumbersome and delegated too much power to the tax matters partner (TMP).
Where an election out is not made or is otherwise in- effective, the new law requires that the partnership will be subject to the general rule under Code Sec. 6221(a) and must directly bear the economic cost of proposed
58 JOURNAL OF TAX PRACTICE & PROCEDURE
AUGUST–SEPTEMBER 2016