New Partnership Audit Rules Amended by the Consolidated Appropriations Act, 2018
Beyond its federal funding provisions, the Consolidated Appropriations Act, 2018 (“Act”), signed into law on March 23rd, also contains a number of much-needed technical corrections to the centralized partnership audit regime enacted under the Bipartisan Budget Act of 2015. The new audit procedures are effective for partnerships (including LLCs taxed as partnerships) with tax years beginning on or after January 1, 2018. For a general discussion of the new audit procedures see our prior article, Considerations for Modifying Partnership Agreements and LLC Operating Agreements in the Wake of the New Centralized Audit Regime.
First, the Act clarifies the scope of the centralized partnership audit rules by eliminating references to adjustments of partnership income, gain, loss deduction, or credit. Instead, the Act applies the centralized partnership audit rules more broadly to all “partnership-related items,” defined as any item or amount with respect to the partnership which is relevant in determining the income tax liability of any person. This includes items that may not appear on the partnership’s tax return, including a partner’s basis in his or her partnership interest, the partnership’s basis in its assets, and a partner’s share of partnership liabilities.
The Act also clarifies items to which the centralized partnership audit rules generally do not apply. For example, these rules do not apply to audits relating to taxes on self-employment income, tax on net investment income, withholding tax on nonresident alien individuals or foreign corporation, and withholding tax for certain foreign accounts. However, partnership-related adjustments to income taxes can affect the amount of these tax liabilities and lead to additional assessments of such other types of taxes.
Additionally, the Act clarifies the requirements for reviewed-year partners (those partners who held an interest in the partnership during the year under examination) filing amended returns, and presents an alternative “pull-in procedure,” that accomplishes a similar result without the need for partners to file amended returns. Under the pull-in procedure, reviewed-year partners pay the tax that would be due with amended returns and provide the IRS with information necessary to show that the tax was correctly computed and paid. The partners must also make binding changes to their tax attributes for later years. However, in general, the pull-in procedure does not require the participation of all of the partnership’s reviewed-year partners.
Lastly, the Act clarifies procedures for netting items in determining imputed underpayments. Items of different character, i.e. capital or ordinary, are not netted together in determining the amount of the imputed underpayment. Rather, the imputed underpayment is determined by netting partnership adjustment items for the reviewed year and applying the highest rate of tax in effect for the reviewed year. When determining partners’ distributive shares, like items are separately netted.
The new centralized partnership audit regime enacted by the Bipartisan Budget Act of 2015 and amended by the Consolidated Appropriations Act, 2018, sets forth partnership audit procedures substantially different from those effective for years prior to 2018. If they haven’t already done so, partnerships and LLCs taxed as partnerships should consider amending their Partnership and Operating Agreements in order to account for these changes.