When released as part of the Bipartisan Budget Act of 2015 (the BBA), several elements of the IRS audit rules for partnerships and LLCs were unclear, including opt out rules, methods for modifying an imputed underpayment, and allocation of imputed underpayments. Despite these and other provisions that partnerships hoped the IRS would clarify before the centralized audit regime went into effect, the new rules were applicable starting with the 2018 tax year.
Proposed and final regulations and updates to the regime have been released piecemeal since then, and another round of guidance was issued in November 2020. The following describes how these latest items may affect private equity (PE) and venture capital (VC) firms.
The IRS’s 2020 proposed regulations help clarify the opt out rule when the partnership has qualified subchapter S subsidiary (QSub) partners, nuances involved with the selection of various methods to modify an imputed underpayment, and the allocation of imputed underpayments among partners when their interests in the partnership have changed between the reviewed year and the adjustment year.
Applicability of Centralized Audit Regime
The latest round of proposed regulations clarify that partnerships with QSub partner are not eligible to elect out of the centralized partnership audit regime. This rule reflects the IRS’s view that QSubs are by definition not subject to the special S corporation rules and thus need to be put on par with other disregarded entity partners.
Sometimes IRS examinations of a person outside of the partnership may result in a change to a partnership-related item. Recently proposed regulations clarify that the centralized audit regime would not apply to the partnership in situations where:
- The person being examined is not the partnership;
- The adjustment to the partnership-related item is being is part of, or underlies, a non-partnership related item; and
- The partnership-related item being affected fell under the control or was affected by information of the non-partnership person being examined.
Other Imputed Underpayments
The centralized audit regime establishes that if there is an adjustment during an IRS examination or when the partnership files an administrative adjustment request (AAR) that results in an imputed underpayment, the partnership may elect to “push out” these imputed underpayments to the partners. Guidance in November’s proposed regulations clarify AAR procedures and rules for calculating the imputed underpayment. Most notably, the recently proposed regulations add Section 301.6226-2(g)(4) that would require the partnership to pay any income taxes, penalties, additions to tax, and additional amounts imposed on the partnership (rather than the partners), even if the partnership elects to push out the imputed underpayment to its partners. The extent to which an adjustment can give rise to an amount that is imposed on the partnership is unclear, since income taxes are only imposed on the partners.
The proposed regulations also reflect related and clarifying amendments to the final regulations under the centralized partnership audit regime, including the cease-to-exist rules under Section 6241.
What to Anticipate
These regulations have been issued in proposed form and the IRS and Treasury are currently evaluating comments on the proposed rules. If finalized, these regulations would become effective within 60 days of the final version being published in the Federal Register.
For more information about how the proposed partnership audit regime changes affect your PE/VC firm, please contact Claudia Mullen or a member of our team.
Published on February 18, 2021