Partnerships are an enigma under federal tax law. Although the partnership files an annual income tax return (i.e., Form 1065), the partners report their allocable share of the partnership’s tax items on their income tax returns (e.g., Form 1040). Due to the complexity inherent in partnership income tax reporting, Congress has historically struggled in attempting to find an appropriate examination tool to provide to the IRS to audit partnerships.
After more than three decades under the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), Congress changed the partnership audit and collection rules through passage of the Bipartisan Budget Act of 2015 (BBA). Under the BBA, the IRS must generally audit the partnership unless the partnership qualifies for and makes a timely election out of the BBA centralized partnership audit regime. Significantly, the BBA audit provisions also allow the IRS to collect taxes directly from the partnership unless the partnership makes a timely election to “push out” the adjustments to its partners.
The new BBA partnership audit rules are complex and provide ample opportunities to mess up, including missing an election. This article discusses five components of the BBA audit provisions that every tax professional should recognize and understand.
BBA Partnership Audit Notices
The IRS generally issues four notices during a BBA partnership audit. These notices include: (i) notices of selection for examination; (ii) notices of administrative proceeding (NAP); (iii) notices of proposed partnership adjustment (NOPPA); and (iv) notices of final partnership adjustments (FPA).
To commence a BBA examination, the IRS issues the partnership a notice of selection for examination. Roughly thirty days after this notice, the IRS issues the NAP. After the NAP is issued, neither the partnership nor its partners may file an administrative adjustment request or notice of inconsistent statement, either of which often seeks to change the partnership’s income tax reporting.
If the IRS examiner concludes that adjustments are necessary to the partnership return, the agency will issue a NOPPA that contains and details the proposed partnership adjustments. As discussed more below, the IRS will first allow the partnership an opportunity to an administrative appeal prior to issuance of the NOPPA. After issuance of the NOPPA, the partnership has a 270-day window to request modifications to the proposed partnership-level tax, which is known as an “imputed underpayment.” Generally, the partnership representative makes the modification requests by electronically filing an IRS Form 8980, Partnership Request for Modification of Imputed Underpayment Under IRC Section 6225(c).
If the partnership and the IRS continue to disagree on the proposed adjustments, the IRS issues an FPA. The FPA triggers two important deadlines. First, the partnership representative may elect to “push out” the FPA’s adjustments to the partners if an election is made within 45 days of the FPA. Second, the FPA starts a 90-day deadline for the partnership representative to contest the FPA’s determinations in federal court.
BBA Partnership Push-Out Election
A timely push-out election can significantly reduce overall income tax. If the partnership representative makes the election, any proposed adjustments resulting in an imputed underpayment are pushed out to the reviewed-year partners, i.e., the persons who were partners for the year under IRS scrutiny. Because a push-out election results in a higher applicable interest rate, however, partnerships should consult with their tax advisors to determine the impact of the push-out election prior to making it. Given the 45-day deadline, there is not much time here to make the analysis—so tax advisers should be engaged early on after the IRS issues the FPA.
A partnership representative makes a push-out election by completing and electronically filing an IRS Form 8988, Election to Alternative to Payment of the Imputed Underpayment – IRC Section 6226. In addition to filing this form, the partnership representative must provide the partners with certain information concerning the push-out adjustments. These push-out statements must be provided to the partners generally within 150 days of the FPA if the partnership representative accepts the proposed adjustments and does not seek judicial review. If the partnership representative files a timely petition for readjustment in federal court, the push-out statements must generally be provided to the partners within 60 days from the date the court enters its final decision.
In either instance, the partnership representative provides its partners with IRS Forms 8985, Pass-Through – Statement Transmittal / Partnership Adjustment Tracking Report (Required Under Sections 6226 and 6227), and 8986, Partner’s Share of Adjustment(s) to Partnership-Related Items(s) (Required Under Sections 6226 and 6227). If these statements are not provided timely, the IRS may attempt to revoke the push-out election.
BBA Partnership Audits And Deposits
A BBA partnership dispute can last a long time—even more so if the partnership representative contests the proposed adjustments in federal court. If the partnership representative makes a push-out election and ultimately loses on the merits at federal court, the partners may be responsible for significant interest on the resulting income taxes.
Section 6603 of the Code, which governs deposits, may be helpful here. When a taxpayer makes a deposit, it stops interest from accruing on potential taxes owed. BBA partners can make deposits of tax to stop interest, but they must follow special rules.
Under IRS guidance, a BBA partner can make a section 6603 deposit by submitting a payment of the estimated tax and submitting a statement to the IRS designating the payment as a deposit. In the statement, the partner should include: (i) the name and TIN of the partnership under examination; (ii) the reviewed year of the partnership under examination; (iii) the audit control number of the partnership under examination; (iv) a statement of the amount and basis of the disputable tax; and (v) the partner’s estimated allocable share of the adjustments and the tax, interest, and penalty computations.
IRS Appeals Rights In BBA Partnership Audits
The IRS Independent Office of Appeals (IRS Appeals) provides taxpayers with an impartial administrative forum to resolve their tax disputes with the IRS. IRS Appeals hears non-docketed cases and docketed cases. Non-docketed cases are those, as applicable to BBA partnership audits, where no petition for readjustment has been filed. Docketed cases are those pending in a federal district court.
Generally, the IRS will issue a “30-Day Letter” to the partnership representative after the conclusion of the examination. The 30-Day Letter notifies the partnership of the proposed partnership adjustments and offers the partnership a right to appeal the adjustments with IRS Appeals. To request an appeals conference, the partnership representative must submit a timely protest. In addition, IRS Appeals will only accept cases where there is sufficient time remaining on the statute of limitations for the IRS to make an assessment. Accordingly, the IRS often asks for a statute of limitations extension waiver from the partnership representative in these circumstances.
If the partnership representative submits a timely protest, the partnership has an opportunity to discuss disputes associated with the proposed adjustments with IRS Appeals. These disputes can relate to issues of fact or law. IRS Appeals reviews the parties’ contentions to determine whether a settlement may be reached without judicial intervention.
Regardless of settlement, IRS Appeals issues the NOPPA at the conclusion of the appeals conference, which as mentioned above triggers the 270-day modification period. If the partnership representative requests modifications and the IRS refuses to grant them, the case may be forwarded again to IRS Appeals solely to review the modification requests. Thereafter, IRS Appeals issues the FPA.
Similar to non-docketed cases, IRS Appeals seeks to resolve disputes between the partnership representative and the IRS in docketed cases.
BBA Partnership Audits And Judicial Review
When the agency issues an FPA, the partnership representative has 90 days to file a petition for readjustment with the proper federal court, which is either the U.S. Tax Court, the district court in which the partnership’s principal place of business is located, or the Court of Federal Claims. Partnerships do not have to pay the imputed underpayment prior to filing a petition in the U.S. Tax Court. But for a federal district court or the Court of Federal Claims to have jurisdiction, the partnership must make a deposit of the proposed imputed underpayment with the IRS on or before the petition filing date. By statute, the partnership must also pay any proposed penalties and “additional amounts.”
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