Understanding the New Partnership Audit Rules

Transcription

1 Understanding the New Partnership Audit Rules Dallas Bar Tax Section February 1, 2016 Mary A. McNulty, Thompson & Knight LLP, Dallas, TX Todd D. Keator, Thompson & Knight LLP, Dallas, TX

2 Overview Summary of New Partnership Audit Rules Open Issues Drafting Considerations in Partnership Agreements and Other Agreements 2

3 Bipartisan Budget Act of 2015 Congress repealed and replaced the 1982 Tax Equity and Fiscal Responsibility Act (TEFRA) and electing large partnership (ELP) rules with a new regime for partnership adjustments and audits that is focused on partnership-level assessments and collections. Game changer that is going to force most partnerships to amend partnership agreements to take into account the potential partnership entity level assessments. 3

4 Purpose of the Bipartisan Budget Act of 2015 TEFRA - IRS did not have the resources or capability to audit large partnerships and multi-tiered partnerships because of the complexity of allocating adjustments to ultimate partners and assessing tax. - The use of partnerships and LLCs has increased dramatically, but IRS audits of partnerships have not increased to keep up with these trends because administrative burdens in auditing partnerships prevented the IRS from increasing partnership audits. Electing Large Partnership (ELP) Rules - Enacted to provide an elective alternative regime for large partnerships that avoids some of the administrative complexities but less than 1% of large partnerships elected to be subject to these rules. Congress estimates partnership audits under the new rules will generate approximately $10 billion in tax revenue. 4

5 Effective Date of New Partnership Audit Procedures Effective for partnership tax years beginning after 2017 Partnerships may elect to have the rules apply earlier (for tax years beginning after November 2, 2015) The delayed effective date does not mean that partnership tax advisors can take a siesta until the end of The changes have profound implications for partnership agreements drafted today and afterward and also for partnership agreements drafted yesterday and before. Terry Cuff. 5

6 DRAFTING POINTS Address in new partnership and LLC agreements prospectively. Amend prior agreements? Will partners agree? Who do you represent? Other relevant agreements: - Purchase and Sale Agreements; - Contribution Agreements; - Redemption and Dissolution Agreements; - Merger Agreements; - Disclosure documents; - Loan Agreements. 6

7 Highlights of New Partnership Audit Procedures Audits and Litigation. Requires partnership-level resolution of all items of partnership income, deduction, gain, loss or credit. Assessment and Collection. Default rule is that the partnership is assessed tax liability on the Imputed Underpayment Amount - Partnership is generally assessed tax at the highest rate applicable to individuals, unless it can demonstrate that the tax should be lower (corporate partners or individual partners subject to lower capital gains or dividend rate) - Imputed Underpayment Amount is reduced to the extent partners for the reviewed year file amended returns and pay the tax - Partnership can elect to file adjusted partner statements (equivalent to amended K-1s) for each partner for the reviewed year 7

8 Partnership Level Determination and Assessment: Key Definitions Reviewed Year Partnership tax year or return under audit Adjustment Year Year in which the adjustment for the reviewed year : - Year in which partnership adjustment becomes final under a court decision; - Year in which an adjustment is made pursuant to an administrative adjustment request; or - In all other cases, the year in which the final partnership adjustment is mailed. Imputed Underpayment Amount Net non-favorable adjustments to the partnership tax year multiplied by the applicable tax rate(s) Partnership Representative Party selected to represent the partnership before the IRS and to make tax decisions on behalf of the partnership 8

9 Partnership Representative Each partnership must designate a Partnership Representative (PR) The PR has the sole authority to act on behalf of the partnership PR must be a person with a substantial U.S. presence - Under 7701(a)(1), the term person includes, an individual, trust, estate, partnership, association, company, or corporation - Guidance is needed as to who can act on behalf of an entity that is designated as the PR - See Treas. Reg (b)-1 for guidance on substantial U.S. presence - PR is not required to be a partner in the partnership IRS will appoint a PR if the partnership does not designate one 9

10 DRAFTING POINTS Standards for selecting, terminating and replacing the Partnership Representative. Current practice has been to include a Partnership Representative provision in the TMP section. Scope of Partnership Representative provision depends on who you represent (i.e., total authority vs. partner consent at some level). Key issues include: notice to partners; duty to inform; extending the statute of limitations; settling an audit; filing a petition for readjustment; other material concessions. Decisions to pay tax or make push up election? Must partners approve? Which partners? What threshold? De minimis payments? Other considerations? Indemnification of Partnership Representative? 10

11 DRAFTING POINTS Partnership Representative Provision (Simple): With respect to tax years beginning after December 31, 2017, the partnership representative of the Partnership pursuant to Code Section 6223(a) shall be, or any Partner or other person with a substantial presence in the United States designated by the General Partner in the manner prescribed by the Internal Revenue Service. 11

12 DRAFTING POINTS Partnership Representative Provision (More Complex): (a) For tax years beginning on or before December 31, 2017: The Tax Matters Member, with the approval of a majority of the Board of Managers, may elect (at such time and in such form and manner as the Internal Revenue Service may prescribe) for the amendments to Sections made by Section 1101 of the Bipartisan Budget Act of 2015 (H.R. 1315) to apply to any return of the partnership filed for partnership taxable years beginning after November 2, 2015 and before January 1, (b) With respect to tax years beginning after December 31, 2017, the partnership representative of the Company pursuant to Section 6223(a) of the Internal Revenue Code shall be any Member or other person with a substantial presence in the United States designated by the Board of Managers in the manner prescribed by the Internal Revenue Service. (Any person who is designated as the partnership representative is referred to herein as the Partnership Representative ). The Partnership Representative is authorized to take such actions and to execute and file all statements and forms on behalf of the Company which may be permitted or required by the applicable provisions of the Internal Revenue Code or Treasury Regulations issued thereunder, provided that the Partnership Representative may file suit only with the approval of a majority of the Board of Managers. The Partnership Representative shall have the sole authority to act on behalf of the Company under Subchapter C of Section 63 of the Internal Revenue Code (relating to IRS partnership audit proceedings) and in any tax proceedings brought by other taxing authorities, and the Company and all Members shall be bound by the actions taken by the Partnership Representative in such capacity. The Partnership Representative shall be reimbursed by the Company for all expenses incurred in connection with all examinations of the Company s affairs by tax authorities, including resulting Proceedings, and is authorized to expend Company funds for professional services and costs associated therewith. If an audit results in an imputed underpayment by the Company as determined under Section 6225 of the Internal Revenue Code, the Partnership Representative, with the approval of a majority of the Board of Managers, may make the election under Section 6226(a) of the Internal Revenue Code within 45 days after the date of the notice of final partnership adjustment in the manner provided by the Internal Revenue Service. If such an election is made, the Company shall furnish to each Member of the Company for the year under audit a statement reflecting the Member s share of the adjusted items as determined in the notice of final partnership adjustment, and each such Member shall take such adjustment into account as required under Section 6226(b) of the Internal Revenue Code and shall be liable for any related interest, penalty, addition to tax, or additional amount. 12

13 Partnership Level Determination All partners are bound by a final resolution in the partnership proceeding Unlike under TEFRA, partners do not have the right to participate in the proceeding or receive notice of the proceedings from the IRS Penalties determined at the partnership level; no partner level defenses to penalties Only partnership-level statute of limitations relevant a partner s statute of limitations is no longer taken into account, unless the partnership elects out of the new rules 13

14 Partnership Tax Assessment Imputed Underpayment Amount Computation of Imputed Underpayment Amount - All adjustments to income, gain, deduction, and loss are netted and multiplied by the highest rate in Code Section 1 or 11 - Any increase or decrease in loss is treated as a decrease or increase in income - After the Imputed Underpayment Amount is calculated, changes in credits are taken into account as a increase or decrease in the Imputed Underpayment Amount, as appropriate under the circumstances - Tax assessment is made for the Adjustment Year; not the Reviewed Year 14

15 Partnership Tax Assessment Imputed Underpayment Amount Computation of Imputed Underpayment Amount - Partnership can submit evidence to reduce the imputed underpayment by the portion that would be allocable to tax exempt entities - Partnership can submit evidence to modify the Applicable Highest Tax Rate to individuals Partner receiving allocation is a corporation subject to 35% maximum tax rate Partner receiving allocation of capital gains and dividends is an individual subject to reduced tax rates S corporations are treated as individuals Applicable rate is always the highest rate with respect to the income Secretary is authorized to issue regulations or other guidance for additional modifications to the Imputed Underpayment Amount 15

16 DRAFTING POINTS Obligation of Partnership Representative to seek to lower partnership rate of tax. Authority in Partnership Agreement to request partner-specific information, and obligation to provide information. May include confidential information (e.g. tax returns). Ability to pay tax from partnership accounts, or to call capital or loans to pay the tax (and penalties for failure to contribute). Allocation of the tax burden among the partners. Indemnification and clawback from prior partners. Oil & gas tax partnerships? Who is liable if there is no juridical entity? 16

17 Partnership Tax Assessment Imputed Underpayment Amount Imputed Underpayment Amount Partner Amended Tax Returns - Partners who were partners during the Reviewed Year file amended returns taking into account their distributive share of partnership adjustments and pay the applicable tax (notwithstanding statute of limitations issues with respect to the partner s return) - Partnership is permitted to reduce the Imputed Underpayment Amount by the applicable tax attributable to the partners who filed amended returns - Reduction in Imputed Underpayment Amount is based on the partners distributive share of partnership adjustments 17

18 Partnership Tax Assessment Imputed Underpayment Amount Imputed Underpayment Amount Time for Submission of Documents and Evidence - Partnership has 270 days from the date when the Notice of Proposed Adjustment is mailed to the partnership (pursuant to Code Section 6231) to file any documents or evidence to have the Imputed Underpayment Reduced - IRS must approve any modification of the imputed underpayment amount 18

19 Partnership Audit No Imputed Underpayment Amount No Imputed Underpayment Taxpayer Favorable Adjustment - Under 6225(a)(2), the partnership takes into account the taxpayer favorable adjustment as a decrease in non-separately stated income, or an increase in non-separately stated loss. If the item is a credit, it is taken into account by the partnership as a separately stated item. - The adjustment is taken into account in the adjustment year as an adjustment to partnership income or loss and then flows through to the partners. Returns are not amended because the partnership is taking the item into account in the adjustment year. - Thus, current year partners benefit from an adjustment made for a prior tax year. Partners for the reviewed year cannot file amended returns to get the benefit from the audit adjustment. 19

20 Alternatives to Partnership-Level Assessment: Election Out for Small Partnerships Opt-Out for Small Partnerships - Partnerships with 100 partners or less can opt out of the entitylevel partnership determination Year by year election The election must include a disclosure of the name and TIN of the each partner - Partners must be individuals, C corporations (including any foreign entity that would be treated as a C corporation if domestic), S Corporations or estates of deceased partners (no upper-tier partnerships) S corporation shareholders must be counted for purposes of the 100 partner test and disclosed to the IRS 20

21 Alternatives to Partnership-Level Assessment: Election Out for Small Partnerships Opt-Out for Small Partnerships - The partnership must notify each partner of the election out. - If election is made, IRS must make determinations at the partner level (similar to the TEFRA small partnership rules) - Query whether 100 partners is still too large and will still impose an administrative burden on the IRS 21

22 DRAFTING POINTS Partnership Agreement should address election out, and criteria for choosing same. Should Partnership Representative have the authority? Should partners have approval rights? What threshold? If election out is desired, agreement should provide transfer restrictions to avoid transfers that would negate the ability to elect out. Partners should be obligated to provide requisite information to the Partnership Representative supporting the election out. Covenant in partnership agreement to remain under 100 partners? Anti-abuse rules? 22

23 DRAFTING POINTS Sample Election Out: The Partners agree to make the election provided in Code Section 6221(b)(1) for each taxable year of the Partnership for which the Partnership is eligible to make such election. The General Partner is authorized to make the disclosure required under Code Section 6221(b)(D)(ii) and the Partners hereby agree to provide their names and taxpayer identification numbers to the General Partner for this purposes. Additional S-Corporation Language: In the case of any Partner that is taxable as an S corporation (as defined in Code Section 1361(a)(1)), such Partner also agrees to provide the General Partner with the name and taxpayer identification number of each person with respect to whom such Partner is required to furnish a statement under Code Section 6037(b) for the taxable year of such Partner ending with or within the Partnership s taxable year for which the election out under Code Section 6221(b)(1) is made. 23

24 Alternatives to Partnership-Level Assessment: Amended Statements Partnership Election to Issue Adjusted Partner Statements under Section Any partnership may elect to issue adjusted statements (essentially amended K-1s) to the partners who were partners during the reviewed year - Election must be made within 45 days of receiving the notice of final partnership adjustment - Partnership must then furnish statements to each partner for the reviewed year and to the IRS - The partners receiving the statements are subject to tax in the year of the statement, but the tax due equals the amount of tax that would have been owed in the reviewed year and intervening years to the extent of a tax increase due to the adjustment to tax attributes - Tax attributes in the adjustment year are also adjusted 24

25 Alternatives to Partnership-Level Assessment: Amended Statements Partnership Election to Issue Amended Statements - Reviewed year partners are liable for interest and penalties - Interest is charged at higher rate (2 percentage points higher than rate in Section 6621(c) (interest charged from due date of partnership return for the reviewed year) - Reviewed year partners have no right to an administrative or judicial review Not required by statute to consent to issuance of statements Bound by partnership-level determination - No joint and several liability 25

26 DRAFTING POINTS Should the push up election be mandatory or optional? If optional, what are the standards for deciding? Some factors include fairness to current vs. prior partners, accuracy of adjustments, additional 2% interest, SECA/NII tax, additional partner level expense, and de minimis situations. Covenants that partners, whether current or former, will pay the tax. Consider whether 45 day window is realistic under the partnership agreement. Authority for PR to make push up election following liquidation and termination? Lender preference? 26

27 Notice of Partnership Proceedings IRS must mail to the partnership and the partnership representative: - Notice of any administrative proceeding initiated at the partnership level - Notice of any proposed partnership adjustment (NOPA) The IRS may rescind any NOPA with the partnership s consent. - Notice of any final partnership adjustment (FPA) May not be mailed earlier than 270 days after the date on which the NOPA is mailed No deficiency assessment may be made before the close of the 90th day after the day on which the FPA was mailed and, if the a petition is filed, the decision of the court has become final 27

28 Judicial Review Suit may be brought within 90 days of when an FPA is mailed in either: - The Tax Court, - The district court in which the partnership s principal place of business is located, or - The Court of Federal Claims. A deposit is required to bring suit in the district court or Court of Federal Claims equal to the amount of the imputed underpayment. The court has jurisdiction to determine: - all items of income, gain, loss, deduction, or credit of the partnership for the taxable year to which the FPA relates, - the proper allocation of items among partners, and - penalties, additions to tax, and other amounts for which the partnership may be liable. 28

29 Partnership Request for Administrative Adjustment Partnership Request for Administrative Adjustment - Partnership mechanism for requesting adjustments to tax year (no more amending returns) - Filed within 3 years from the later of The date that the partnership return was filed The unextended due date of the partnership return - If request shows Imputed Underpayment Amount, then Partnership must pay the Imputed Underpayment Amount when filing the requests, or Partnership issues amended K-1s similar to the procedures in Section If request does not show Imputed Underpayment Amount, then the partnership issues amended K-1s to the partners 29

30 Open Issues: Election to Apply New Partnership Audit Rules Now Procedure to elect to have the new partnership audit rules apply now - In what circumstances would a partnership want to have the new partnership audit rules apply now? 30

31 Open Issues: Election to Opt-Out Procedure to elect out of the new partnership audit rules - If a partner is a disregarded entity and its owner is an individual, C corporation, or S corporation, or estate, can the partnership elect out? - If a partner is a grantor trust, can the partnership elect out? - What about S corporation partners with trusts as shareholders? - Should every partnership with 100 or less qualifying partners elect out? - In what circumstances would a partnership not want to elect out? - Does the IRS have the authority to extend the election out rules to tiered partnerships? - Can partnership with over 100 partners divide into two partnerships to qualify for election out? 31

32 Open Issues: Partnership Representative What are the procedures for designating a PR (on the return)? How frequently can a partnership change its PR designation? If the partnership does not designate a PR, what rules or guidelines will govern the IRS s PR designation? What happens if PR requires partner consent for actions but does not receive it? Can partnership agreement preclude appointment of PR without partner consent? 32

33 Open Issues: Imputed Underpayment Amount What procedures will apply to reduce the Imputed Underpayment Amount by taxes paid by the partners on amended returns? The Imputed Underpayment Amount can be reduced if allocable to a tax-exempt partner, corporate partner or in the case of a qualified dividend or capital gain an individual. Does this refer to the partners in the Reviewed Year or the Adjustment Year? - Note: Section 6225(c)(4)(B) refers to the partner s distributive share in the reviewed year Does the Imputed Underpayment Amount take into account adjustments that result from changes to tax attributes in the years following the reviewed year? If not, how are such adjustments taken into account? 33

34 Open Issues: Reallocations Among Partners How is the Imputed Underpayment Amount computed when the adjustment is a reallocation among the partners? Who pays the tax? Former partners who does the reference to former partners in Sec. 6241(7) refer to? 34

35 Open Issues: Election to Issue Amended Statements How will the Election to Issue Amended Statements work in a tiered setting? - E.g. Will the election apply to a partnership tier such that the partnership is required to issue amended statements or can it pay the entity-level assessment? Will the IRS require that the first tier pay the entity-level assessment? - What if one of the tiers from the Reviewed Year has terminated before the Adjustment Year? How is the tax computed if the tax would decrease in the intervening years due to an adjustment to tax attributes? What happens if all of the reviewed year partners don t pay? 35

36 Impact on Partnership Governance and Partnership Agreements Should amendments be made now to existing partnership agreements? Should provisions be added now to new partnership agreements? 36

37 Impact on Partnership Governance and Partnership Agreements 1. Provisions for selecting Partnership Representative and restrictions on actions taken by PR a. Statute extensions b. Settlements c. Election out d. Amended statements 2. Provisions allowing or requiring an election out of the partnership entity-level assessment pursuant to Section Escrow and indemnification provisions when partners sell their interests 4. Provisions requiring upper-tier flow-through entities to share identifying information about their owners 37

38 Impact on Partnership Governance and Partnership Agreements 5. Provisions regarding adjusted partner statements a. Notice? b. Consent of partners for reviewed year? 6. Information-sharing provisions to allow partnership to determine if ultimate owners are: a. Corporations b. Individuals entitled to lower capital gain and dividend rates c. Tax exempt entities 7. Provisions specially allocating tax payments among partners 38

39 Impact on Other Agreements Disclosure documents (from Shell Midstream Partners): Risk Factor: If the IRS makes audit adjustments to our income tax returns for tax years beginning after 2017, it may collect any resulting taxes (including any applicable penalties and interest) directly from us, in which case our cash available for distribution to our unitholders might be substantially reduced. Pursuant to the Bipartisan Budget Act of 2015, if the IRS makes audit adjustments to our income tax returns for tax years beginning after 2017, it may collect any resulting taxes (including any applicable penalties and interest) directly from us. We will generally have the ability to shift any such tax liability to our general partner and our unitholders in accordance with their interests in us during the year under audit, but there can be no assurance that we will be able to do so under all circumstances. If we are required to make payments of taxes, penalties and interest resulting from audit adjustments, our cash available for distribution to our unitholders might be substantially reduced. Tax Disclosure: Entity-level Audits and Adjustments. Pursuant to the Bipartisan Budget Act of 2015, if the IRS makes audit adjustments to our income tax returns for tax years beginning after 2017, it may collect any resulting taxes (including any applicable penalties and interest) directly from us. We will generally have the ability to shift any such tax liability to our general partner and our unitholders in accordance with their interests in us during the year under audit, but there can be no assurance that we will be able to do so under all circumstances. If we are required to make payments of taxes, penalties and interest resulting from audit adjustments, our cash available for distribution to our unitholders might be substantially reduced. Pursuant to this new legislation, we will designate a person (our general partner) to act as the partnership representative who shall have the sole authority to act on behalf of the partnership with respect to dealings with the IRS under these new audit procedures. 39

40 Impact on Other Agreements Loan Documents. Lenders likely will desire covenant to make election or to make push up election. Purchase and Sale Agreements. - More due diligence? - Additional representations about partnership level taxes? - Covenants/indemnfication addressing pre-closing tax liability imposed on the Partnership or Buyer? - Covenants to make push up election? Contribution Agreements same issues. Redemption and Dissolution Agreements same issues. - If partnership liquidates, consider provision appointing PR for audits occurring post-termination and procedures for push up election. 40

41 Atlas Growth Partners, LP 4.02(f). Bipartisan Budget Act of For taxable years beginning after December 31, 2017 (or any earlier year, if the General Partner so elects) (i) the General Partner will be designated, and will be specifically authorized to act as, the Partnership Representative, and (ii) the Partnership Representative will apply the provisions of subchapter C of Chapter 63 of the Code, as amended by the 2015 Act (or any successor rules thereto) with respect to any audit, imputed underpayment, other adjustment, or any such decision or action by the Internal Revenue Service with respect to the Partnership or the Partners for such taxable years, in the manner determined by the Partnership Representative. For the avoidance of doubt, the Partnership Representative may (A) elect to apply the rules in subchapter C of Chapter 63 of the Code, as amended by the 2015 Act, for taxable years prior to January 1, 2018, or (B) elect to apply Section 6221(b) (if applicable) or Section 6226 of the Code or elect to file an administrative adjustment pursuant to Section 6227 of the Code, in each case as amended by the 2015 Act and in the manner determined by the Partnership Representative. Each Partner does hereby agree to indemnify and hold harmless the Partnership from and against any liability with respect to its share of any tax deficiency paid or payable by the Partnership that is allocable to the Partner (as reasonably determined by the General Partner) with respect to an audited or reviewed taxable year for which such Partner was a Partner in the Partnership (for the avoidance of doubt, including any applicable interest and penalties). The obligations set forth in this Section 4.02(f) will survive such Partner s ceasing to be a Partner in the Partnership and/or the termination, dissolution, liquidation and winding up of the Partnership. 4.02(g) Cooperation. Each Partner will provide such cooperation and assistance, including executing and filing forms or other statements and providing information about the Partner, as is reasonably requested by the Tax Matters Partner or Partnership Representative, as applicable, to enable the Partnership to satisfy any applicable tax reporting or compliance requirements, to make any tax election or to qualify for an exception from or reduced rate of tax or other tax benefit or be relieved of liability for any tax regardless of whether such requirement, tax benefit or tax liability existed on the date such Partner was admitted to the Partnership. If a Partner fails to provide any such forms, statements, or other information requested by the Tax Matters Partner or Partnership Representative, as applicable, such Partner will be required to indemnify the Partnership for the share of any tax deficiency paid or payable by the Partnership that is due to such failure (as reasonably determined by the General Partner). The obligations set forth in this Section 4.02(g) will survive such Partner s ceasing to be a Partner in the Partnership and/or the termination, dissolution, liquidation and winding up of the Partnership. 41