AICPA prods IRS to change rules for centralized partnership audit regime

The American Institute of CPAs testified Tuesday at an Internal Revenue Service hearing about the problems the AICPA is anticipating from the IRS and Treasury Department’s proposed rules for auditing large partnerships.

The Bipartisan Budget Act of 2015 included a provision allowing the IRS to audit large partnerships, such as hedge funds and private equity firms, as a whole rather than auditing each individual partner. The new regime promises to make it easier for the IRS to audit such partnerships, but the process has run into complications as groups have tried to influence how the IRS goes about doing the audits. The tax law that Congress passed last December adds further complications.

The AICPA’s testimony focused on the proposed rules concerning the partner-level penalty defenses, an audited partnership’s access to the IRS Office of Appeals and the Tax Cuts and Jobs Act’s impact on the proposed regulations. Michael Greenwald, who chairs the AICPA’s Partnership Taxation Technical Resource Panel, testified to the IRS about those concerns. The AICPA also released a related comment letter identifying a dozen areas where it believes further guidance or clarification is needed to implement the regime and made some recommendations on that guidance.

AICPA building in Durham, N.C.

“Under the proposed regulations, a partner can only assert a penalty defense, such as reasonable cause or good faith, if the partner first pays the tax and penalty due and then files a claim for refund of the penalty,” said Greenwald. “This process will result in the needless expenditure of additional resources by the taxpayer and the IRS, while further extending the length of time until final resolution of the case.”

Greenwald noted that the new audit regime “significantly changes the way adjustments made by the IRS during an exam are assessed and paid.” By default, he pointed out, a partnership is liable for any imputed underpayment. The underpayment is potentially reduced through requested modifications (such as, the filing of amended returns by partners). As an alternative, a partnership can elect to ‘push-out’ an adjustment to its partners, who must then prepare and file ‘adjustment statements’ for the audited and affected tax years.”

“We recommend allowing partnerships to submit defenses on behalf of the partners (both direct and indirect) during the modification period,” said Greenwald. “In the case of a partnership electing the ‘push-out’ procedures, the IRS should allow the direct and indirect partners to submit a statement supporting a partner-level defense. They could submit it with their reporting year return.”

“It is both fair and more efficient for the IRS to consider the validity of any partner-level defense early in the process,” said Greenwald. “Otherwise, the agency would force some partners to unnecessarily pay the proposed penalties.”

In terms of the need for guidance about an audited partnership’s right to file a challenge with the IRS Office of Appeals, Greenwald observed, “The appeals process is a vital option for taxpayers to resolve an issue without having to go to Tax Court.” He argued that the regime creates a “significant number” of new elections that apply to partnerships under examination and establishes new procedures and stringent statutory deadlines. “Together these changes will create issues for taxpayers wishing to challenge IRS decisions under the Regime,” said Greenwald.

He added that the comment letter submitted by the AICPA Tuesday on the proposed regulations highlighted eight actions or determinations by the IRS that taxpayers should, at a minimum, be able to challenge. For example, according to Greenwald, taxpayers need the ability to appeal a decision on the validity of an opt-out election, a denial of a requested modification or the proposed audit adjustments among other issues.

Generally, he said, taxpayers should have the right to appeal any decision by the IRS that directly affects the proposed audit adjustments, the calculation of imputed underpayment, or the ability of a partnership to make any valid election under the new partnership audit regime. It’s also important that the appeals process is both fair and equitable, he stated.

Greenwald also said taxpayers and their tax preparers need guidance on the impact of the new partnership-related provisions of the Tax Cuts and Jobs Act to the regime. The TCJA includes several new provisions that can affect partnerships and the distributive shares of income and expenses to their partners, Greenwald pointed out. Specifically, section 163(j) on interest expense limitations, section 199A for the Qualified Business Income deduction, and section 954A on GILTI, all include significant new partnership reporting and calculation elements.

“We need guidance as soon as possible, including examples of how the Regime’s adjustments to partnership items and tax attributes specific to these new provisions are treated under sections 6225 and 6226 by partnerships and their partners,” said Greenwald.

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