Page 117 - The TEFRA Partnership Audit Rules Repeal:

ALI CLE Live Video Webcast / “The TEFRA Partnership Audit Rules Repeal: Partnership and Partner Impacts” June 7, 2016, Jerald David August and Terence Floyd Cuff
7. Election out.
a. Effect of Election Out.
A critical aspect of the new rules is that many small and medium sized partnerships can elect out of the new rules. In that event, the partnership will not be subject to the consolidated audit rules, but rather any audit of partnership activities will be part of an audit at the partner level. This takes many partnerships out of the entity level audit rules. Election out is made on an annual basis.
The partnership may annually elect out of the new audit regime if the partnership meets the requirements. A qualifying partnership that elects out of the new regime is not subject to audit at the partnership level. Instead, an audit of the partnership must be undertaken as part of an audit of a partner. An election out constitutes an election out of partnership level deficiency proceedings.
One of the areas of the new rules that conspicuously has been untouched is how a partnership audit will be conducted (if at all) if the partnership has elected out of the new rules.
Partnership activities still can be audited (in theory, at least) as part of an audit of the partner.
A partner may own a small interest in a partnership and yet the audit can be expanded to a full audit of the partnership activities. (This is a matter of conjecture. The Internal Revenue Service may simply give the partner a “pass”
return filed by the partnership, though it is an information return, is treated as if it were a tax return where necessary to implement examination, assessment, and collection of the tax due and any penalties, additions to tax, and interest.
A basis adjustment (reduction) to a partner’s basis in its partnership interest is made to reflect the nondeductible payment by the partnership of the tax. Specifically, present-law section 705(a)(2)(B) applies, providing that the adjusted basis of a partner’s interest in a partnership is the basis of the interest determined under applicable rules relating to contributions and transfers, and decreased (but not below zero) by expenditures of the partnership that are not deductible in computing its taxable income and not properly chargeable to capital account. Concomitantly, the partnership’s total adjusted basis in its assets is reduced by the cash payment of the tax. Thus, parallel basis reductions are made to outside and inside basis to reflect the partnership’s payment of the tax. Partners, former partners, and the partnership may have entered into indemnification agreements under the partnership agreement with respect to the risk of tax liability of former or new partners being borne economically by new or former partners, respectively. Because the payment of tax by a partnership under the centralized system is nondeductible, payments under an indemnification or similar agreement with respect to or arising from the tax are nondeductible.
© Terence Floyd Cuff and Jerald David August, 2016
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