The IRS has issued final regulations regarding the new centralized partnership audit regime, referred to as the BBA regime. The regulations are effective as of yesterday, January 2, 2018.. We have blogged about the new rules here and here.
These regulations implement the rules for electing out of the new audit rules. Here, we address how the regulations were updated from the proposed regulations issued over the summer. While it acknowledged that "the new rules are a significant change in the way partnerships have been traditionally audited," the IRS rejected most of the suggestions made during the notice and comment period. It noted its inexperience in the operation of these new rules as the reason behind its rejecting most of the suggestions, but consistently left the door open for further rulemaking. Unfortunately, this does not provide certainty for taxpayers and means in the near future taxpayers must carefully review the rules to ensure they are compliant.
This is especially true for taxpayers who may wish elect out of the BBA regime. A taxpayer wishing to elect out of the BBA regime may do so if 1) it has 100 or fewer partners, and 2) all partners are eligible partners.
The 100-or-fewer partner rule
Under section 6221, a partnership is eligible to elect out of the BBA rules if it has 100 or fewer partners. Under now-final Treas. Reg. 301.6221(b)-1(b)(1)(i), a partnership has 100 or fewer partners if it is required to furnish 100 or fewer statements under section 6031(b), which generally requires a partnership to furnish a statement to each person that is a partner in the partnership during the partnership's taxable year. This is a key issue because a partnership that fails to elect out of the regime or a partnership that attempts to elect out of it but cannot will find itself unexpectedly bound by these new rules.
Notice Requirement
Several commentators had suggested that the IRS exclude pass-through entities or disregarded entities in determining whether a partnership meets the 100-partnership threshold. The IRS rejected those suggestions, noting that under section 6031, notice must be provided to each partner, regardless of whether the partner is a disregarded entity or a pass-through.
The IRS also rejected suggestions that it establish a pre-filing procedure to address qualification issues. It did, however, leave open the door to further regulations on this issue, noting that it "may reconsider whether a pre-filing procedure would be helpful after gaining experience with the election out procedures." It also left open the door for further regulations on the issue of how a partnership may elect out of the regime if it is found to be a constructive partnership or a de facto partnership. Under the regulations, if such a partnership exists and it does not file an election on a timely filed return for that taxable year, it will be bound by the new BBA rules.
Eligible Partner Requirement
Treasury Regulation 301.6221(b)-1(b)(3) describes the types of partners that are "eligible partners" for the 100-or-fewer rule. Partnerships, trusts, disregarded entities, nominees or other similar persons that hold an interest on behalf of another person, and estates other than the estate of a deceased partner are not considered eligible partners under the rules.
Commentators had requested that the IRS expand the definition of eligible partners to include partnerships, disregarded entities, trusts, individual retirement accounts, nominees , qualified pension plans, profit sharing plans , and stock bonus plans. The IRS rejected these suggestions and did not expand the definition of eligible partners because in its view "the interests of efficient tax administration outweigh" any additional administrative burdens created by a narrower definition. It appears the IRS was concerned about allowing more partnerships to elect out of the new regime, because it would require deficiency proceedings for each of the partners in such partnerships and result in substantially more audits.
Making the election
The IRS also addressed comments it had received regarding the timing for making the election and how it may be revoked. It left unchanged, for example, a partnership would be required to obtain the consent of the IRS to revoke an election out. It also did not address whether the election may be timely made on amended returns, stating that other areas of the code address this issue.
Observations
In addressing these comments, the IRS has sent a strong signal that it favors the new BBA regime and may take an aggressive stance against those partnerships that attempt to elect out of it. It also broadcasts to the tax community that it cannot at this stage address all the issues that may arise under the new regime through regulations because it lacks experience with how these rules will work in the real world. This leave taxpayers in a bind because the IRS is uncertain how these rules will work in practice but is likely to favor one particular outcome.
It is important that partnerships plan carefully and particularly if you are thinking of opting out of the BBA regime to ensure you are ready if the IRS decides to challenge that decision.
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