Newsflash: Newly Proposed Partnership Audit Rules Allow for Multiple-Tier “Push-Out” Election

The U.S. Department of the Treasury (the “Treasury”) and the U.S. Internal Revenue Service (the “IRS”) have issued a new installment of proposed regulations under the centralized partnership audit regime included in the Bipartisan Budget Act of 2015 (the “Bipartisan Budget Act”). The newly proposed regulations address how certain pass-through partners take into account adjustments under the “push-out” election of Section 6226 of the U.S. Internal Revenue Code of 1986, as amended (the “Code”), as amended by the Bipartisan Budget Act. The proposed regulations also provide rules regarding assessment and collection, penalties and interest, and period of limitations under the new centralized partnership audit regime, as well as rules for seeking judicial review of adjustments made pursuant to the new regime. 

The Bipartisan Budget Act, which was signed into law on November 2, 2015, includes new centralized partnership audit provisions that are scheduled to replace the existing rules pertaining to partnership audit proceedings, effective for partnership taxable years beginning after 2017. To facilitate the collection of tax by the IRS, the newly enacted partnership audit provisions generally will require partnership audits to be conducted at the partnership level. Any resulting adjustments to partnership tax items generally will be taken into account by, and any related taxes collected from, the partnership, rather than the individual partners, in the year in which the audit is concluded. 

Certain partnerships may elect alternative treatment. One such “push-out” election, to be made by an audited partnership within 45 days of a final adjustment, will allow the partnership to issue adjusted Schedule K-1 reports to those who were partners during the year under audit; those partners would then reflect the resulting adjustment to partnership tax items in their own tax returns for the year in which the audit is concluded. Under this election, interest is charged at the federal short-term rate plus five percent (an increase of three percentage points over the interest rate generally applicable to underpayments). 

Application of “Push-Out” Election to Tiered Partnerships and Other Pass-Through Partners 

The Bipartisan Budget Act did not address how the “push-out” election will apply to an audited partnership’s partners that are themselves partnerships or other pass-through entities. Technical corrections to the centralized audit regime introduced by the U.S. Congress on December 6, 2016, but never enacted, would have allowed pass-through partners to take adjustments into account under a “push-out” election by either paying an entity-level tax or passing the adjustments along to their partners or other owners for the year under audit. Proposed regulations issued on June 13, 2017, reserved on this issue. The newly proposed regulations, issued December 15, 2017, provide rules for pushing the adjustments through tiers of partners that are pass-through partners. 

• For this purpose, the term “pass-through partner” includes partnerships, S corporations, certain trusts and estates of decedents. 
• Each pass-through partner in a chain of ownership may choose to either pay entity-level tax or push the adjustments through to its partners or other owners. 
• To ensure compliance by each pass-through partner in the chain of ownership, the newly proposed regulations contain a mechanism to collect tax due from a non-compliant pass-through partner. 
• Similar rules apply to pass-through partners of partnerships that elect (or are required) to have partners take into account adjustments resulting from an administrative adjustment request, as opposed to an audit. 

Treatment of Penalties under a “Push-Out” Election 

The newly proposed regulations amend the previously proposed regulations by requiring partner-level calculations, and permitting partner-level defenses, in respect of penalties, additions to tax and additional charges relating to a partnership adjustment under a “push-out” election. 

Elimination of Safe Harbor Amounts and Interest Safe Harbor 

The newly proposed regulations amend the previously proposed regulations to remove provisions providing a safe harbor amount and an interest safe harbor that partners could pay in lieu of computing amounts owed pursuant to a “push-out” election. The previously proposed safe harbor rules were perceived as overly complex and burdensome, particularly when pushing adjustments out through multiple tiers of pass-through partners, as now permitted in the newly proposed regulations. 

General Administrative and Procedural Provisions 

The newly proposed regulations contain a number of administrative and procedural provisions of general application under the new centralized partnership audit regime, including rules imposing a time limit on when adjustments may be proposed for a particular partnership taxable year, and addressing other matters such as the computation of partnership-level penalties, the judicial review of adjustments, and the period of limitations (including extensions) for making adjustments.