The CARES Act, enacted on March 27, 2020,1 provides important relief for partnerships including a correction to the bonus depreciation rules for qualified improvement property (QIP) under Section 168(e) and relief relating to the business interest expense limitation under Section 163(j). Earlier this month, the IRS issued guidance addressing several key issues impacting partnerships under the CARES Act. Under Revenue Procedure 2020-25, released April 17, 2020, the IRS is now allowing taxpayers to make or revoke an "election out" of bonus depreciation for 2018, 2019 and 2020, and to make or withdraw an election to use the alternative depreciation system (ADS) for 2018, 2019 and 2020, in each case by either filing an amended tax return, an administrative adjustment request (AAR) or IRS Form 3115 requesting an automatic change in accounting method. Under Revenue Procedure 2020-23, released April 8, 2020, the IRS outlines procedures for filing amended returns or AARs for taxable years beginning in 2018 or 2019 to claim bonus depreciation deductions for QIP. Under Revenue Procedure 2020-22, released on April 10, 2020, the IRS describes procedures for making elections under the CARES Act relief provisions pertaining to the business interest expense limitation under Section 163(j). Partnerships claiming depreciation on QIP or interest deductions should pay close attention to these rules for the reasons discussed below.
Procedural Rules for Obtaining CARES Act Relief for Past Years
As discussed below, the IRS is providing administrative relief to partnerships subject to the partnership audit regime enacted as part of the Bipartisan Budget Act of 2015 (BBA partnerships) to enable partners to monetize in 2020 the tax benefits arising from the retroactive tax relief provided by the CARES Act, including relief for taxable years beginning in 2018 and 2019. While partners generally may take positions that are inconsistent with a Schedule K-1 by filing IRS Form 8082 with an original or amended return,2 doing so may be challenging or create certain risks. For example, partners may be contractually prohibited by the partnership agreement from taking inconsistent positions, or in the case of a BBA partnership or a partnership taxable year subject to the unified partnership audit and litigation rules enacted by the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA)3 (the TEFRA rules), filing an IRS Form 8082 may increase the risk that the IRS will select the returns of the partners and/or the partnership for audit or otherwise delay the payment of refunds claimed by the partners. Furthermore, some of the relief provided by the CARES Act depends upon prior-year elections made (or not made) at the partnership level, with the result that in some cases partners cannot fully benefit from the CARES Act without the partnership filing one or more amended returns or AARs. For example, any partnership that has not elected out of bonus depreciation for 2018 will lose the benefit of depreciation deductions on any QIP placed in service that year unless the partnership amends its return or submits an AAR for 2018, or retroactively elects out of bonus depreciation by filing IRS Form 3115 requesting an automatic change in accounting method with respect to QIP and any other property with a similar 15-year class life the partnership placed in service during 2018.
BBA Partnerships Generally Prohibited from Filing Amended Partnership Returns
Before the IRS issued Rev. Proc. 2020-23, BBA partnerships that already filed their partnership tax returns for an affected year were unable to take advantage of the CARES Act relief applicable to that year except by filing one or more AARs that generally would, if approved by the IRS, allow the partners to benefit on the current taxable year's partner-level return.4 Importantly, a partner in a BBA partnership should benefit from the approval of relief adjustments reported on an AAR by claiming, on the partner's return for the current taxable year, such partner's share of the relief adjustments as a reduction to its current or "reporting" year tax liability.5 If the partner's share of relief adjustments exceed the partner's reporting year tax liability, the partner will owe no income tax for the reporting year and generally may make a separate claim for refund with respect to any overpayment.6 Thus, for example, if an AAR were filed by a BBA partnership during its taxable year ending December 31, 2020 to claim CARES Act relief related to its taxable year ending December 31, 2018, the partnership would provide each partner with a statement setting forth such partner's share of the relief adjustment(s) and the partner would claim such adjustment(s) on its partner-level return for the 2020 taxable year, which generally would be filed in 2021. In the case of a partner that is itself a partnership, the upper-tier partnership cannot claim the adjustment(s), but must instead furnish information statements to its affected partners7 so that the affected partners can calculate and claim the adjustments arising from the lower-tier partnership's AAR on their current year returns.8
Partnerships Allowed to File Amended Returns for Years not Subject to BBA or TEFRA9
Partnerships not subject to BBA or TEFRA, including those that elect out of the centralized partnership audit procedures enacted by the BBA for a taxable year beginning after December 31, 2017, are permitted to file amended returns for such year to facilitate timely refund claims by their partners. A partnership may elect out of the BBA for a year if it has no more than 100 partners for the entire year and all partners during such year are "eligible partners," meaning individuals, C corporations, S corporations or estates of deceased partners.
Rev. Proc. 2020-23 Allows BBA Partnerships to File Amended Returns for 2018 or 2019 on or Before September 29, 2020
Relief provisions applicable under Rev. Proc. 2020-23 allow for BBA partnerships to file amended partnership returns, and issue amended Schedule K-1s, for taxable years beginning in 2018 and 2019, provided that such amended returns are filed on or before September 29, 2020, and only with respect to a taxable year for which it already filed a partnership return and issued Schedule K-1s prior to April 10, 2020.10 A BBA partnership that files an amended return is still subject to the centralized partnership audit procedures enacted by the BBA.
IRS Notice 2020-26 grants a 6-month extension of time to file Form 1045 or Form 1139 to claim a tentative refund attributable to a net operating loss (NOL) that arose in a taxable year that began during calendar year 2018 and ended on or before June 30, 2019. The 6-month extension only applies to requests for a tentative refund based on an NOL carryback. As a result of the extension, taxpayers may file the applicable form up to 18 months after the close of the tax year in which their NOL arose. Thus, if a partner in a BBA partnership has NOLs for a taxable year that began during calendar year 2018 and ended on or before June 30, 2019 that are created or increased by the BBA partnership's amended return filed under Rev. Proc. 2020-23, the partner will have until 18 months after the close of such partner taxable year to file the applicable tentative refund claim form for a prior partner taxable year to which the NOLs are carried.
BBA partnerships still have the option to file an AAR for 2018 or 2019, instead of filing an amended return.
Rev. Proc. 2020-25 Allows BBA Partnerships to Change the Depreciation Method for QIP by Filing an Amended Return under Rev. Proc. 2020-23 or by Filing an AAR
Under Rev. Proc. 2020-25, any partnership with QIP placed in service during 2018 or 2019 will be deemed to use an impermissible method of accounting. Unless the partnership corrects the method of accounting by filing an amended return or AAR using the procedures described in Revenue Procedure 2020-22, discussed above, the partnership should either (i) file an amended return for each affected prior year on or before September 29, 2020 (the deadline under Rev. Proc. 2020-23), (ii) file an AAR for the year(s) in which the QIP was placed in service, generally no later than October 15, 2021, or (iii) account for the retroactive change in law by filing IRS Form 3115 with the next timely-filed partnership return reporting a single net Section 481(a) adjustment including all permitted adjustments attributable to all items of property subject to the Form 3115. Similarly, under Rev. Proc. 2020-25, BBA partnerships that have placed QIP or other depreciable property in service in 2018 or 2019 may make a late election to use ADS and/or revoke an election (or make a late election) under Section 168(k) (bonus depreciation) for 2018 or 2019 by (i) filing an amended return for each affected prior year on or before September 29, 2020, (ii) filing an AAR for the year in which the property was placed in service, generally no later than October 15, 2021, or (iii) by filing a Form 3115 with the partnership's next timely filed partnership return. Permission to revoke an election to use ADS, however, must be requested by the partnership on an amended return or an AAR; such request shall be granted by the IRS pursuant to Rev. Proc. 2020-25. Similar rules are provided for non-partnership taxpayers wishing to make these changes to their application of Section 168.
The various options under Rev. Proc. 2020-25 may yield different results for different partners. For example, if a partnership makes a Section 481(a) adjustment under Rev. Proc. 2020-25 for QIP placed in service during 2019 by filing IRS form 3115 with the partnership's 2020 tax return, the adjustment will be taken into account by the current year partners (i.e., 2020) instead of the partners for 2019 when the QIP was placed in service. Another factor distinguishing the use of a Form 3115 from the use of an AAR is that if a negative Section 481(a) adjustment (i.e., a loss) is taken into account by the current year partners for 2019 or 2020 and the loss creates or increases a partner-level NOL, the NOL generally may be carried back five years under the CARES Act, potentially allowing the partner to claim a refund for one or more prior years, whereas an AAR claiming deductions in prior years does not give any of the partners an NOL.
Assuming the IRS is not delayed in processing refunds, the filing of an amended partnership return under Rev. Proc. 2020-23 could be the quickest and surest way for the partners to realize their share of partnership-level benefits from the retroactive relief in the CARES Act, although the partners will need to file their own amended returns for the affected year(s) to claim these benefits, which may require the filing of amended state income tax returns for those year(s) as well. In the alternative, the partnership could file an AAR and the partners could calculate and claim an adjustment on their 2020 returns after the IRS approves the AAR in the amount of their negative "additional reporting year tax." But if the AAR adjustments (1) create or increase a partner-level NOL or other partner tax attribute that cannot be fully utilized by the partner in the first affected year and the intervening years or (2) result in a negative income tax liability for the reporting year, there would be uncertainty regarding whether and how the partner would realize the benefit of that tax attribute. A partnership may also want to consider changing its methods of accounting beginning with the year for which the partnership files its next return (2019 or 2020) in order to allow its current partners to take advantage of CARES Act relief by means of a negative Section 481(a) adjustment.
Retroactive Bonus Depreciation on QIP
Under the TCJA, Congress modified Section 168 to expand the definition of QIP. As modified by the TCJA, QIP covers any improvement to an interior portion of a nonresidential building that is not attributable to the enlargement of the building, any elevator or escalator, or the internal structural framework of the building.11 Unfortunately, due to an apparent drafting error dubbed the "retail glitch," Congress failed to assign QIP a 15-year recovery period under the TCJA modifications to Section 168(e), rendering QIP ineligible for bonus depreciation under Section 168(k).
Technical Correction to TCJA in the CARES Act
The CARES Act corrects the retail glitch by assigning a 15-year recovery period to QIP under Section 168(e). After such correction, taxpayers can claim bonus depreciation under Section 168(k) on QIP. Furthermore, the CARES Act made the change retroactive to the effective date of the TCJA, i.e., January 1, 2018. As a result, any partnership not electing out of bonus depreciation under Section 168(k) on an originally filed return must now claim bonus depreciation on QIP placed in service during taxable years beginning in 2018 or 2019. As discussed below, affected partnerships should claim retroactive bonus depreciation by filing an amended return or AAR. Failing to file an amended return or AAR can have unintended consequences, including that an affected partnership placing QIP in service in 2018 or 2019 likely would be required to reduce its basis in the QIP to zero, so that it would not be entitled to any depreciation in any later year.
Consequences of Election Out of Bonus Depreciation
For partnerships electing out of bonus depreciation under Section 168(k) for 2018 or 2019, the CARES Act now treats QIP as 15-year property under MACRS (reduced from 39 years under the Tax Cuts and Jobs Act (TCJA)), or 20-year property under the alternative depreciation system (ADS) (reduced from 40 years under the TCJA). The 20-year property designation under ADS may be relevant to taxpayers who have made an Electing Real Property Trade or Business (ERPTOB) election, or would consider making a retroactive ERPTOB election, as discussed below. In this regard, a partnership engaging in a real property trade or business described under Section 469(c)(7)(C) that seeks to make an ERPTOB election must adopt ADS in accordance with Section 168(g)(1)(F). As discussed below, a partnership may find it beneficial to extend the recovery period on QIP from 15 years (under MACRS) to 20 years (under ADS) in exchange for avoiding the interest expense limitations under Section 163(j). Depending on the facts, other partnerships may seek to revoke a prior ERPTOB election for the opposite reason.
Limitation on the Deductibility of Business Interest Expense under Section 163(j)
The interest expense limitations under Section 163(j) were amended pursuant to the TCJA such that most taxpayers generally may deduct their net business interest expense only up to 30% of their adjusted taxable income (ATI). In the case of business interest expense of a partnership, the Section 163(j) limitation generally is applied at the partnership level.
Increase in the Limitation to 50% of ATI for 2019 and 2020
For 2019 and 2020, the CARES Act increases the business interest expense limitation to 50% (rather than 30%) of the taxpayer's ATI. A taxpayer may elect not to apply the 50% limitation to any taxable year beginning in 2019 or 2020, and instead apply the 30% ATI limitation. In the case of a partnership, the election out of the increased 50% limitation must be made by the partnership (rather than its partners) and may be made only for taxable years beginning in 2020. For a partnership's taxable year beginning in 2019, 50% of the partnership's excess business interest expense (EBIE) allocated to a partner will be deductible by the partner in its taxable year beginning in 2020 without limitation under Section 163(j) (the EBIE rule), with the remaining 50% of the partnership's EBIE allocated to the partner being subject to limitation under Section 163(j) in the same manner as EBIE allocated in any other year. Nevertheless, a partner may elect out of the EBIE rule by timely filing or amending its Federal income tax return or Form 1065 or filing an AAR for the partner's first taxable year beginning in 2020, and not applying the EBIE rule in determining its Section 163(j) limitation.
Election to Use 2019 ATI in 2020 Taxable Year
In addition, the CARES Act permits a taxpayer to elect to use its 2019 ATI to determine its Section 163(j) limitation for 2020, thereby potentially allowing a taxpayer to deduct additional interest expense in the event that the taxpayer's ATI during 2019 exceeds its ATI for 2020. In the case of a partnership, the election to use 2019 ATI is made by the partnership. No formal statement is required to make the election to use 2019 ATI. Rather, a taxpayer makes the election by timely filing or amending its Federal income tax return or Form 1065 or filing an AAR for its taxable year beginning in 2020 using its 2019 ATI.
Extension of Time to File, and Opportunity to Withdraw, an Electing Real Property Trade or Business Election
Interest allocable to an ERPTOB,12 although making such an election requires the ERPTOB to use ADS to depreciate its property (and thus prevents such a taxpayer from being entitled to 100% bonus depreciation).
Revenue Procedure 2020-22 provides two types of relief with respect to elections to be treated as an ERPTOB.
First, the Revenue Procedure generally allows a taxpayer that was otherwise qualified to make an ERPTOB election to make a late election to be treated as an ERPTOB for its taxable year beginning in 2018, 2019 or 2020 by filing an amended Federal income tax return, amended Form 1065 or AAR as applicable. An amended Federal income tax return or amended Form 1065 (other than a return of a BBA partnership) generally must be filed on or before October 15, 2021. In the case of a BBA partnership that chooses not to file an amended Form 1065 as permitted under Rev. Proc. 2020-23, the BBA partnership generally may make a late ERPTOB election by filing an AAR on or before October 15, 2021.
Second, a taxpayer that made an ERPTOB election with its timely filed tax return or Form 1065 is permitted to withdraw such election by timely filing an amended Federal income tax return, amended Form 1065 or AAR for the taxable year in which the election was made, with an election withdrawal statement. Such filing generally must occur on or before October 15, 2021. In the case of a BBA partnership that chooses not to file an amended Form 1065 as permitted under Rev. Proc. 2020-23, the BBA partnership generally may withdraw the ERPTOB election by filing an AAR on or before October 15, 2021.
The ability to withdraw an ERPTOB election is particularly important in light of the fix in the CARES Act of the so-called "retail glitch," so taxpayers now (and retroactive to 2018) may benefit from 100% bonus depreciation for QIP, retroactive to the enactment of the TCJA. The benefit of such accelerated depreciation is not available, however, for an ERPTOB, so it may benefit some businesses that had previously elected to be treated as ERPTOBs to withdraw their elections in order to benefit from the retail glitch fix, as well as the other Section 163(j) relief provided for 2019 and 2020.
1 For an overview of the CARES Act tax relief provisions, see our prior client publication dated March 26, 2020 entitled "Tax Relief Provisions in the CARES Act Stimulus Package."
2 See Section 6222(c); Treas. Reg. § 301.6222(b)-1; Instructions to IRS Form 8082.
3 P.L. 97–248 (September 3, 1982).
4 Section 6031(b) prohibits BBA partnerships from amending the information required to be furnished to their partners after the due date of the return, unless specifically provided by Treasury.
5 See Treas. Reg. § 301.6227-3(b)(2)(i).
6 Treas. Reg. § 301.6227-3(b)(2)(ii) provides an example where an application of the partners' share of AAR adjustments results in negative "additional reporting year tax" for the reporting year thereby reducing the partner's reporting year tax under sections 1–1400Z-2 (chapter 1 tax) to –$25, that is, negative $25, with the result that the partner owes no chapter 1 tax for the reporting year. The example indicates the partner "may make a claim for refund with respect to any overpayment" but does not specify the procedure for calculating or claiming the overpayment.
7 See Treas. Reg. § 301.6227-3(c)(2).
8 See Treas. Reg. § 301.6227-3(c)(4).
9 There is a narrow set of circumstances where the QIP modifications under the CARES Act may affect fiscal year partnerships subject to TEFRA. For example, consider a fiscal year partnership subject to the TEFRA rules that placed QIP into service in its fiscal year ending September 30, 2018. Under the TEFRA rules, that partnership cannot file an amended return for such year, and must instead file an AAR. A partner in such a partnership also may file an AAR. See Section 6227(a) as in effect prior to the BBA. A successful AAR with respect to a TEFRA partnership taxable year adjusts partnership items for such year and therefore may result in a refund of any partner's overpayment for the partner's year in or with which such partnership year ends; unlike an AAR of a BBA partnership, the results of an AAR of a TEFRA partnership are not taken into account in the year when the AAR was filed. To be timely filed, an AAR must be filed prior to the IRS mailing to the tax matters partner a notice of final partnership administrative adjustment with respect to the partnership taxable year.
10 If a BBA partnership is currently under IRS audit for a taxable year for which it will file an amended return pursuant to Rev. Proc. 2020-23, the partnership must notify the revenue agent coordinating the partnership's audit in writing at or before the time the partnership files the amended return and must also provide the revenue agent a copy of the amended return upon filing.
11 The CARES Act modifies Section 168(e) by limiting the definition of QIP to "improvements made by the taxpayer," thus preventing any improvement property acquired by the taxpayer from a third party after construction is complete from treatment as QIP.
12 Substantially identical rules apply to electing farm businesses.
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