At the end of October 2015, Congress passed the Bipartisan Budget Act of 2015 (BBA), which was signed into law November 2.   Section 1101 of the BBA contains a thorough revision of the existing laws governing audits of large partnerships and collection of amounts determined to be owed.

Under the audit procedures enacted as part of the Tax Equity and Fiscal Responsibility Act of 1982 and in force until 2018, a Tax Matters Partner (TMP) is appointed as the primary representative of the whole partnership, and the IRS works with that partner.  Certain other partners may have notification rights at points along the way of the audit and may challenge IRS findings in court if the TMP does not.  Any audit adjustment determined under the TEFRA rules was passed through to the taxable partners who were partners during the year being audited.   Under another audit regime available to partnerships with 100 or more partners, the Electing Large Partnership (ELP) rules, the adjustment was passed through to those who are partners in the year of the audit adjustment.

Beginning in 2018, the BBA provisions eliminate the TEFRA and ELP audit rules for all partnerships with more than 100 partners and establish a new audit regime in which:

• A partnership under audit must designate a partnership representative with sole authority to act on behalf of the partnership (section 6223).  The IRS will examine all tax items for the year under review (reviewed year) and determine whether adjustments should be made.
• If adjustments for the reviewed year are made, under the default rule, all adjustments are netted and an imputed amount of underpayment (imputed underpayment) is determined at the partnership level (section 6225(b)).
• A partnership will be able to modify the imputed underpayment to the extent reviewed year partners have filed amended returns and to take into account the tax rates of reviewed year partners (individuals, tax-exempt organizations, etc.), the type of income in question, and other factors (section 6225(c)).
• The imputed underpayment, as modified, will be paid by the partnership in the year the audit is completed (adjustment year) (section 6225(a)).
• This will result in the adjustment year partners paying the tax for a reviewed year deficiency rather than the reviewed year partners who benefitted from the underpayment.
• Alternatively, the partnership may elect to “push out” the adjustment to the reviewed-year partners by sending them statements informing them of their share of any adjustments.  The reviewed-year partners are then required to include their share of the adjustments without modification in their adjustment-year returns.   This election to push out the adjustment to the reviewed year partners must be made within 45 days of the notice of final partnership adjustment. Under this election, the additional tax and interest are determined and paid at the partner level, and the underpayment rate is increased from 3% to 5% (section 6226).
• A partnership may also file a request for an administrative adjustment (AAR) of one or more items of income, gain, loss, deduction, or credit for any year and take the adjustment into account in the year the AAR is made.  The partnership would have the option of paying the adjustment or sending adjusted returns to the partners in the year of the adjustment.  An AAR may not be filed if an audit of the partnership has begun (section 6227).

The new provisions are effective for tax years beginning after December 31, 2017.

Post-Enactment Issues

Since the enactment of the BBA, MLPA’s representatives have been working with tax committee members and staff, as well as IRS and Treasury Department officials, to identify issues raised by the BBA provisions and to resolve them through legislation or regulatory guidance so that the new law will not unduly burden MLPs.

While many of these issues apply to all partnerships, some are  particular to MLPs.  The first to be addressed was whether a partnership may include in its underpayment calculations its partners’ passive losses under section 469(k), something that MLPs are uniquely able to do.  MLPA  worked  during the last months of 2015 to clarify that partner passive losses may be included, with the assistance of Ways and Means Chairman Brady’s staff.   Senate Finance Committee Chairman Hatch specifically mentioned this issue in a statement on the Senate floor, thus providing legislative history to support our position.  In December 2015 the provision was included along with some other technical changes in an end-of-the-year tax extenders bill, the “Protecting Americans from Tax Hikes Act of 2015,” which in turn was incorporated in an omnibus spending bill (P.L. 114-113).

Another, critical issue was whether the push-out election may be used by more than one tier in a tiered partnership, which includes all MLPs.  If an audit adjustment is “pushed out” to an MLP from a lower-tier partnership, must it pay the tax, or can it push the adjustment out to its own partners? 

MLPA believed that the push-out should extend through all tiers.  However, in March 2016 the JCT issued its “Bluebook” describing tax legislation passed the previous year.  The Bluebook description of the partnership audit provisions implied that the push-out election is not available to an upper-level partnership that has adjustments pushed out from a lower tier partnership under section 6226:  “The recipient partnership pays the tax attributable to adjustments with respect to the reviewed year and the intervening years, calculated as if it were an individual.”  In other words, in JCT’s view, the push-out is only available to an audited partnership, and any partnerships that are partners in the audited partnership are not allowed to make a section 6226 election.   Further, it appears that any such upper tier partnership would have to pay the pushed out amount of tax without the benefit of the modifications allowed under section 6225.   The IRS indicated a preference for this interpretation.

During 2016 and 2017 MLPA representatives spent considerable time meeting with tax committee members and staff and with Treasury and IRS to persuade them that MLPs  should be able to use the push-out and can do so without the IRS losing its ability to collect taxes owed.  On December 8, 2016, The Tax Technical Corrections Act of 2016 (H.R. 6439, S. 3506) was introduced.  It included provisions addressing the push-out issue and making other technical fixes.  There was no time left in the 114th Congress to enact the bill, but it served to alert the IRS and Treasury to Congressional intent on this issue.

On June 14, 2017, after a five-month delay due to the incoming administration’s regulatory freeze, the IRS and Treasury issued proposed regulations under the new statutory regime.  On August 11, 2017, MLPA filed comments on the proposed regulations.  Focusing on issues specific to MLPs, the comments emphasize that the push-out election should be available to MLPs and include recommendations to ensure that the conditions imposed on its use not be so great as to make the election impractical.  The comments also include recommendations regarding calculation of the imputed underpayment under section 6225(c).  In March 2018 the push-out issue was resolved by the enactment of the Tax Technical Corrections Act of 2018 as part of the Consolidated Appropriations Act of 2018.

On February 2, 2018 the IRS published new partnership audit regulations  addressing how partnerships and their partners adjust tax attributes to take into account partnership adjustments under the partnership audit regime.   MLPA submitted comments on the proposed regulations on May 3, 2018.  The comments discussed the need for fungibility of MLP units and requested changes in the regulations that would allow an MLP to pay an imputed underpayment  under section 6225, or push the payment out to its partners under section 6226, without affecting fungibility.

MLPA will continue to work with the IRS and Treasury to improve the proposed regulations and ensure that the audit provisions  work well for MLPs,

Links to Useful Documents

Final partnership audit regulations, issued December 21, 2018

MLPA comments on February 2 regulations, filed May 3, 2018

Proposed partnership audit regulations published February 2, 2018

Proposed  partnership audit regulations, issued June 14, 2017

December 2016 technical corrections provisions (H.R. 6439, not enacted)

December 2015 technical corrections provisions enacted by Congress

Partnership Audit Provisions of the Bipartisan Budget Act of 2015

Summary of Budget Act of 2015–partnership audit provisions

Hatch October 29, 2015 Statement in Congressional Record  (page 37)

MLPA Proposed Legislative Language on Partner Passive Losses

Additional Background

For over three decades, IRS audits of large partnerships, including MLPs, were  conducted under audit procedures enacted as part of the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA). Under TEFRA, a Tax Matters Partner (TMP) is appointed as the primary representative of the whole partnership, and the IRS worked with that partner.  Certain other partners may have notification rights at points along the way of the audit and may challenge IRS findings in court if the TMP does not.  Any audit adjustment determined under the TEFRA rules was passed through to the taxable partners who were partners during the year being audited.   Under another audit regime available to partnerships with 100 or more partners, the Electing Large Partnership (ELP) rules, the adjustment was passed through to those who are partners in the year of the audit adjustment.

During 2014, at the request of  Senators Ron Wyden, Carl Levin (D-MI), and John McCain  (R-AZ), the General Accountability Office (GAO) released a series of reports showing that–

1. The Internal Revenue Service was auditing fewer than 1% of the tax returns filed by large partnerships (those with 100 or more direct partners and $100 million or more in assets), while the number of such partnerships was rapidly growing;
2. Roughly $91 billion per year of partnership and S corporation income was misreported by individuals for 2006 through 2009; and
3. One reason that so few large partnerships were being audited was the challenge posed the growing numbers and highly complex structures (including many layers of tiering) of large partnerships.

While MLPs are included in the number of large, complex partnerships, they are a very small part of this sector.  The GAO reported that 81% of large partnerships are in the financial and insurance sectors; 7% are in real estate rental and leasing; and 3% are in professional, scientific, and technical services.  All other sectors, including the industries in which the vast majority of MLPs operate, comprise only 8% of the total.  Only 229 of the 2,226 large partnerships in 2011 had more than 1,000 partners, and MLPs would be a subset of that group.

‘Moreover, because their tax reporting directly affects the tax returns of their investors, and any issues must be disclosed and may affect their market value, MLPs do not take aggressive tax positions. Actual audits have shown that MLPs are highly tax compliant and take conservative tax positions.

Initial Partnership Audit Legislation

Concern over this issue has led to legislative proposals to revise the rules for auditing large partnerships, including one in the Administration’s budget and one included in the 2014 Camp tax reform legislation.  In June 2015  a proposal was introduced as the Partnership Audit Simplification Act (H.R. 2821) by Rep. Jim Renacci (R-OH), a member of the House Ways and Means Committee.  In late June and early July it was discussed as a possible revenue offset, estimated to raise $13.4 billion over ten years, for a highway reauthorization bil.  Under this bill:

• Partners must treat partnership items on their returns in a manner that is consistent with the partnership’s treatment of such items.
• The TEFRA and ELP rules would be repealed and replaced with one audit regime under which audits would be conducted at the partnership level (partnerships with 100 or fewer partners could opt out), with a representative  designated by the partnership.
• Any adjustment would be paid by the partnership, with the highest income tax rate applied regardless of partners’ actual tax positions.
• All partners, whether or not they were partners during the year reviewed and regardless of their level of ownership,  would be jointly and severally liable for the underpayment and any penalties.  This meant that even a partner with a tiny ownership interest could be liable for the entire underpayment amount.

MLPA strongly opposed H.R. 2821, as the entity level tax payment would violate MLPs’ passthrough status and joint and several liability would be unfair to unitholders and deter investors from purchasing MLPs units.  As did a number of groups with an interest in partnerships, MLPA representatives contacted  supporters on the Ways and Means Committee and made clear that these provisions were damaging to MLPs and should be rejected.

In addition MLPA’s legislative team contacted Senators and their staffs to voice their concerns with H.R. 2821.  In July a group of MLPA representatives, including  MLP reporting experts from PricewaterhouseCoopers, met with the Finance Committee and Joint Committee on Taxation (JCT) staff to discuss the technical problems with the proposed legislation and the reasons it should not be imposed on MLPs.

The bill was not included in legislation at that time, but it was made clear that partnership audit legislation would be acted upon at some point.  MLPA representatives continued monitoring the legislation and discussing it on Capitol Hill.

Bipartisan Budget Act

The week of October 26, quite unexpectedly, it was revealed that outgoing House speaker John Boehner had been in nogotiations with the administration, along with Senate Majority Leader McConnell, and had reached agreement on a deal that would avoid the threat of government default or shutdown for two years by agreeing on spending totals and suspension of the debt ceiling through 2017.    Among the revenue provisions in the deal was large partnership audit reform.  The Bipartisan Budget Act of 2015 (BBA) was approved by Congress and signed by the President on November 2, 2015.

This version of the partnership audit legislation, section 1101 of the BBA, eliminated the most serious issues raised by the Partnership Audit Simplification Act.  In summary:

• As in H.R. 2821, the BBA requires partners to treat partnership items on their returns in a manner that is consistent with the partnership’s treatment of such items
• Also as in H.R. 2821, the BBA repeals the TEFRA and ELP rules  and replaces them with one audit regime under which audits would be conducted at the partnership level (partnerships with 100 or fewer partners could opt out) with a representative  designated by the partnership.
• While the BBA provides for partnership payment of amounts owed after an audit adjustment, partnerships may also elect to report on the adjustment to the partners in the year reviewed and have the partners pay the additional amount, along with any penalties, on their next tax return (known as the “push-out election.”
• Partners are not subject to  joint and several liability for the tax owed.
• In calculating the underpayment amount to be paid by a partnership, the amount may be adjusted to reflect 1)any payments made by a partner on an amended return that properly reflects the adjustment; and 2) the portion of the underpayment that would be allocable to a tax-exempt partner.  In addition, Treasury may issue guidance providig for additional procedures to modify the underpayment amounts on the basis of other factors.
• The applicable tax rate on a payment by the partnership is reduced to account for ordinary income allocated to C corporation partners and capital gains and qualified income allocated to individuals.

The new provisions do not take effect until 2018, giving Treasury time to issue guidance and partnerships to amend their partnership agreements and take other steps necessary to comply with the new law.  While the partnership audit provisions of the BBA were an improvement over earlier versions, a number of questions remain as to how they will work in practice.    Over the intervening months, both the government and tax practitioners, including MLPA’s experts have been working to identify and answer these questions via technical corrections legislation, IRS/Treasury regulations, or other means (see “Post-Enactment Issues” above.