Treasury and IRS Release New Round of BBA Partnership Audit Proposed Regulations

Today we welcome back guest blogger Rochelle Hodes, a Principal with Crowe LLP and a former Associate Tax Legislative Counsel in Treasury’s Office of Tax Policy.  Rochelle discusses the new proposed regulations under the BBA partnership audit rules that were released just before Thanksgiving.  While the proposed rules primarily address special enforcement matters, the proposed rules would also amend the final BBA regulations in significant and consequential ways that practitioners and taxpayers ought to be attune to.  Rochelle would like to thank her former government colleague Greg Armstrong, a Director with KPMG LLP, for his helpful review and comments.  Rochelle and Greg worked together on, and continue to update, Chapter 8A in Saltzman Book IRS Practice and Procedure regarding the BBA partnership audit rules. Les

On November 24, 2020, Treasury and the IRS published proposed regulations under the centralized partnership audit regime enacted by the Bipartisan Budget Act of 2015 (BBA).  The BBA regime generally applies to partnership tax years beginning in 2018.  This post addresses proposed §301.6221(b)-1(b)(3)(ii)(G) regarding eligibility to elect out of BBA if a partner is a qualified S corporation subsidiary (QSub), proposed §301.6241-3 regarding treatment of partnerships that cease to exist, and proposed §301.6241-7 regarding treatment of special enforcement matters. In general, the proposed applicability date for these rules is November 20, 2020.

These proposed regulations are being released at the end of a presidential administration.  It is unclear how finalizing these proposed regulations will fit into the new administration’s priorities and whether policy decisions embedded in the proposed regulations will be reconsidered.  However, even with this uncertainty, the proposed regulations are important because they give taxpayers and practitioners a window into the IRS’s thinking on the BBA rules at a time when it is increasing its focus on partnership reporting and compliance.

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QSubs

All partnerships required to file Form 1065 are subject to the BBA regime unless the partnership is eligible to elect out of the regime and does so on its timely filed original return.  The election out of BBA is an annual election.  

A partnership is eligible to elect out of BBA if the partnership has 100 or fewer eligible partners.  Partnerships, trusts (including grantor trusts), disregarded entities, and nominees are not eligible partners and therefore partnerships with these types of partners cannot elect out of BBA. 

Section 6221(b) specifically provides that an S corporation is an eligible partner.  However, in the case of an S corporation a special rule applies for purposes of determining whether the partnership has 100 or fewer partners.  Under the special rule, all shareholders to whom the S corporation is required to furnish a Schedules K-1, plus the S corporation itself, are counted as a partner to determine whether the number of partners exceeds 100.  

Under the proposed regulations, a QSub is not an eligible partner, and therefore, a partnership with a QSub cannot elect out of BBA.  This is a reversal of the position taken by the IRS and Treasury in Notice 2019-06.  In Notice 2019-06, the IRS identified partnerships that are owned by a QSub as a special enforcement issue because such partnerships could have more than 100 owners when looking through the QSub to the S corporation and its shareholders. Accordingly, Notice 2019-06 stated that generally a partnership with a QSub as a partner would not be eligible to elect out of BBA, but that Treasury and the IRS intended to publish proposed regulations to allow partnerships with QSub partners to elect out of BBA under rules similar to S corporations.   But why did Treasury and the IRS reverse its position in Notice 2019-06?  It appears that a long simmering debate among practitioners about the nature of a QSub may be the cause.  The preamble includes a discussion of two comments addressing a rationale not to prohibit partnerships held directly by a QSub from electing out of BBA: one that relies on the fact that a QSub is a C corporation and the other that relies on the fact that for partnership reporting the S corporation, not the QSub, is treated as the partner.  The preamble then describes the reason for changing the government’s position in Notice 2019-6 as follows:

“Although Notice 2019-06 states that the proposed regulations would have applied a rule similar to the rules for S corporations under section 6221(b)(2)(A) to partnerships with a QSub as a partner, the Treasury Department and the IRS have reconsidered that approach.  Under § 301.6221(b)-1(b)(3)(ii), partnerships that have disregarded entities as partners may not elect out of the centralized partnership audit regime.  QSubs are treated similarly to disregarded entities for most purposes under the Code in that both QSubs and disregarded entities do not file income tax returns but instead report their items of income and loss on the returns of the person who wholly owns the entity.”  

85 FR 74943 (November 24, 2020).

Treatment Where a Partnership Ceases to Exist

Section 6241(7) provides that if a partnership ceases to exist before a BBA partnership adjustment takes effect, such adjustment shall be taken into account by the former partners of such partnership under regulations prescribed by the Secretary.

The current regulations under §301.6241-3 generally provide that partnership adjustments take effect when all amounts due under BBA resulting from the adjustment are fully paid.  The current regulations also provide that the former partners are the partners for the adjustment year with respect to the reviewed year to which the adjustments relate, but if there are no partners in that year, the former partners are the partners during the last taxable year for which the partnership filed a return.

The proposed regulations would modify several parts of the cease-to-exist regulations, but the two most consequential are the rules for when an adjustment takes effect and who are former partners.  The proposed regulations provide that the partnership adjustments take effect when the adjustment becomes finally determined, when there is a settlement, or if the adjustment relates to an item on an administrative adjustment request (AAR), when the AAR is filed. 

Under the proposed regulations, former partners would be 1) the partners during the last taxable year for which the partnership filed a return or an AAR or 2) “the most recent persons determined to be partners of the partnership in a final determination (for example, a defaulted notice of final partnership adjustment, final court decision, or settlement agreement) binding on the partnership.”  The proposed regulations do not set up an order of priority of which condition would take precedence.

The preamble to the proposed regulations states that these changes are necessary to coordinate section 6241(7) with section 6232(f), which was enacted by the Tax Technical Corrections Act of 2018.  Section 6232(f) provides that the IRS can assess tax upon the adjustment year partners if the partnership fails to pay the imputed underpayment within 10 days of notice and demand.  Section 6232(f) includes a rule allowing assessment against former partners determined under section 6241(7) if the partnership has ceased to exist.  Though section 6232(f) has been on the Treasury and IRS Priority Guidance Plan for a while now, no guidance under this section has been issued to date.  

Special Enforcement 

Section 6241(11) generally provides that in the case of partnership-related items which involve special enforcement matters, the Secretary may prescribe regulations to provide that BBA does not apply to the items and that the items are subject to special rules necessary for the effective and efficient enforcement of the Code.  The statute lists certain special enforcement areas, including termination and jeopardy assessments, criminal investigations, and indirect methods of proof of income.  The IRS had similar statutory authority with respect to special enforcement matters under TEFRA.

In addition to the special enforcement areas described above, the proposed regulations identify other special enforcement matters:

  • Partnership-related items underlying non-partnership-related items.  This provision would allow the IRS to determine that the BBA rules do not apply to adjustments of partnership-related items if all of the following apply:
    • An examination is being conducted of a person other than the partnership,
    • A partnership-related item is adjusted, or a determination regarding a partnership-related item is made, as part of, or underlying an adjustment to a non-partnership-related item of the person whose return is being examined, and 
    • The treatment of the partnership-related item on the Schedule K-1 or the partnership’s books and records is based in whole or in part on information provided by the person whose return is being examined.  
  • Controlled partnerships and extensions of the partner’s period of limitations.  This provision would allow the IRS to adjust partnership-related items outside of BBA if the period of limitations to make partnership adjustments under section 6235 has expired but the partner’s period of limitations on assessment for chapter 1 tax has not expired.  This provision applies to direct or indirect partners that are related to the partnership under section 267(b) or section 707(b) or direct or indirect partners that consent to extend the period of limitations to adjust and assess any tax attributable to partnership-related items. 
  • Penalties and taxes imposed on the partnership under chapter 1.  This provision would allow the IRS to adjust any tax or penalty imposed on, and which is the liability of the partnership, under chapter 1 of the Code without regard to BBA.  It would also allow the IRS to “adjust any partnership-related item, without regard to [BBA], as part of any determination made to determine the amount and applicability of the tax, penalty, addition to tax, or additional amount being determined without regard to [BBA].  Any determinations under this [provision] will be treated as a determination under a chapter of the Code other than chapter 1 for purposes of § 301.6241-6 [coordination with other chapters of the Internal Revenue Code].”

ACA Penalty Notices May Not Meet Section 6751(b) Requirements

We welcome back guest blogger Rochelle Hodes.  Rochelle is a Principal in Washington National Tax at Crowe LLP and was previously Associate Tax Legislative Counsel with Treasury. As we prepare to gear back up for IRS enforcement activity, she provides a timely discussion of the ever popular IRC 6751(b) and another way it may help your client when the IRS seeks to penalize.  Keith

Section 6751(b)(1) generally provides that no penalty can be assessed unless the initial determination of such assessment is personally approved in writing by the immediate supervisor of the individual making such determination or such higher level official as the Secretary may designate.  Written supervisory approval is not required to impose a penalty under Section 6651, 6654, or 6655.  Written supervisory approval also is not required to impose a penalty that is automatically calculated through electronic means. 

Section 6751(b) has been covered many times in the Procedurally Taxing blog. Generally, the Tax Court will not sustain the IRS’s assertion of a penalty if the IRS cannot demonstrate that written supervisory approval is not obtained prior to the initial determination of assessment of the penalty.  The latest in this line of cases is Kroner v. Commissioner, T.C. Memo. 2020-73 (June 1, 2020), which further fine-tunes earlier holdings regarding when the initial determination of the penalty is made. 

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Prior to Kroner, the Tax Court ruled in Clay v. Commissioner, 152 T.C. 223, 249 (2019), blogged here, and Belair Woods, LLC v. Commissioner, 154 T.C. ___ (Jan. 6, 2020), blogged here, that the initial determination is the date on which the IRS formally communicates to the taxpayer Examination’s determination to assert a penalty and notifies the taxpayer of their right to appeal that determination.  In Clay, that court held that the initial determination was the date that the IRS issued the revenue agent’s report (RAR) and the 30-day letter. In Belair, the court held that the initial determination was the date that the IRS issued the 60-day letter, which in the case of a TEFRA partnership is the notice that communicates Examination’s determination that penalties should be imposed and notifies the taxpayer of their right to go to Appeals. 

In Kroner, the IRS issued a Letter 915, which is an examination report transmittal, to notify the taxpayer that Examination is proposing penalties and that the taxpayer has a right to go to Appeals.  Later, the IRS sent the taxpayer an RAR and a 30-day letter.  The written supervisory approval for penalties was issued after the Letter 915 was sent and before the RAR and 30-day letter were sent.  The Tax Court held that regardless of what the IRS calls the notice that provides the taxpayer with its determination of penalties and notification of the right to go to Appeals and regardless of the IRS’s intent, the initial determination for purposes of section 6751(b) is the first time examination determines that it will assert the penalty and notifies the taxpayer that they have a right to appeal that determination.  In Kroner, the court held that this occurred when the IRS issued the Letter 915.  Accordingly, written supervisory approval was issued after the initial determination for purposes of section 6751(b), and the penalty was not sustained.

On May 20, 2020, the IRS issued an immediately effective interim IRM 20.1.1.2.3.1 on the timing of supervisory approval:

For all penalties subject to section 6751(b)(1), written supervisory approval required under section 6751(b)(1) must be obtained prior to issuing any written communication of penalties to a taxpayer that offers the taxpayer an opportunity to sign an agreement or consent to assessment or proposal of the penalty.

Not long before Kroner was decided and the interim IRM guidance above was released, I had a client who received an IRS form letter, Form 5005-A (Rev 7-2018), imposing immediately assessable information reporting penalties under section 6721 and section 6722 for 2017 for failure to timely file Forms 1094-C and 1095-C.  This letter is one of several form letters that are being issued under the IRS’s ACA employer compliance initiative. Under section 6056, employers are required to file and furnish these ACA-related forms to report offers of health coverage. 

The Form 5005-A states that the taxpayer can agree with the penalty and pay it.  If the taxpayer disagrees, the letter states that the taxpayer will “have the opportunity to appeal the penalties after we send you a formal request for payment.” A Form 866-A, Explanation of Items, is attached explaining the basis for assertion of penalties.  The conclusion section states: “Subject to managerial approval, because the Employer failed to file Form(s) 1094-C and 1095-C and furnish Forms 1095-C as required pursuant to section 6056, the employer is subject to the penalties under IRC 6721 and IRC 6722 calculated above.”

The Letter 5005-A and Form 866-A are striking in three regards:  1) The letters clearly communicate Examination’s determination to impose the penalty; 2) the Letter 5005-A is less clear about the opportunity to go to appeals because it delays the opportunity until a formal request for payment is made, but there is clear notification that the right to go to Appeals exists and can be exercised; and 3) the Form 866-A takes the guess work out of whether there was supervisory approval—it states affirmatively that there has not yet been supervisory approval. 

Kroner makes it clear that the name or number of the form the IRS uses to communicate the determination and right to appeal is of no consequence.  As applied to the Letter 5005-A, there is a determination and arguably there is notification of the right to appeal, therefore, the date of this notice is the initial determination of the penalty.  Since according to the Form 866-A there was no supervisory approval before the date the Letter 5005-A was issued, the IRS has failed to satisfy section 6751(b) and the penalties should not apply. 

Even if the “notice of the right to go to Appeals” prong of Kroner is not satisfied, the Letter 5005-A clearly meets the standard for when supervisory approval is required under the interim IRM provisions because the taxpayer is provided the opportunity to agree with and pay the penalty.  While the interim IRM provisions were issued on May 20, 2020, they represent the IRS interpretation of how they should be complying with section 6751(b).  Therefore, failure to comply with the interim IRM provisions in the past should be a failure to comply with section 6751(b). 

IRS is currently sending penalty notices that were being held back due to the pandemic.  For penalties other than sections 6651, 6654, and 6655, practitioners should carefully review notices to evaluate whether section 6751(b) applies and if so, whether the letter is an initial determination required to be preceded by written supervisory approval.

Tax Court Adopts Final Rules For BBA Partnership Audit Regime

Today we welcome Greg Armstrong and Rochelle Hodes to the community of Procedurally Taxing guest posters. Greg is a Director with KPMG, LLP Washington National Tax in the Practice, Procedure, & Administration group in Washington D.C. and former Senior Technician Reviewer with the IRS Office of Chief Counsel. Rochelle is a Principal in Washington National Tax at Crowe LLP and was previously Associate Tax Legislative Counsel with Treasury.  Both Greg and Rochelle in their immediate prior positions with IRS and Treasury respectively spent considerable time working on the new partnership audit regime enacted to replace TEFRA as part of the Bipartisan Budget Act of 2015 (BBA) and as revised in subsequent technical legislative corrections. Rochelle is a Contributing Author on the BBA chapter that will be published this fall for Saltzman and Book IRS Practice & Procedure, and Greg has contributed over the years in updating and revising the treatise.

In this post, Greg and Rochelle discuss the Tax Court’s amendments to its Rules of Practice as relating to the BBA regime. Les

On July 15, 2019 the United States Tax Court announced that it had adopted final amendments to its Rules of Practice and Procedure to address actions under the new partnership audit regime enacted by BBA. The final amendments, which were first introduced as proposed and interim amendments on December 19, 2018, add a new Title XXIV.A (Partnership Actions under BBA Section 1101) and also make conforming and miscellaneous amendments.  New Title XXIV.A is effective as of December 19, 2018 and generally applies to partnership actions commenced with respect to notices of final partnership adjustment (FPAs) for partnership taxable years beginning after December 31, 2017.  The new rules also apply to actions commenced with respect to FPAs for partnership taxable years for which an election under §301.9100-22 is in effect.    

The following post offers a high level summary of the highlights of the Court’s new rules with respect to the BBA regime.  Because this post is focused on the new Tax Court rules, only a summary of the BBA provisions relevant to understanding the Court’s rules are discussed.  For a more robust discussion of the BBA provisions, see the latest update to Saltzman and Book, IRS Practice and Procedure, which includes a new chapter 8A entitled “Examination of Partnership Tax Returns under the Bipartisan Budget Act of 2015”.

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The Tax Court’s rules reflect the prominent and powerful role of the partnership representative (PR) under the BBA.  The PR is the individual or entity that has the sole authority to act on behalf of the partnership for purposes of the BBA and replaces the Tax Matters Partner (TMP) concept that existed under TEFRA.  Pursuant to section 6223(a) and the regulations thereunder, a partnership subject to BBA must designate a PR for each taxable year.  If the IRS determines that there is no PR designation in effect for the taxable year, the IRS may select the PR.  If the partnership designates an entity as the PR, the regulations require that the partnership also appoint a designated individual to act on behalf of the entity PR.

Rule 255.2 provides that a BBA partnership action is commenced like any other action in the Tax Court – by filing a petition.  The caption of the petition, and any other paper filed in a BBA partnership action, must state the name of the partnership as well as the name of the PR.  Rule 255.1(d).  This is consistent with TEFRA Rule 240(d), Form and Style of Papers, which requires the caption to state the name of the partnership and the partner filing the petition, and whether the partner is the TMP.  Since under BBA only a PR can bring a partnership action in Tax Court, and because no partner (unless they are the PR) can file a petition, it makes sense that the PR is named in the caption in addition to the partnership.  The body of the petition must also identify the PR’s place of legal residence or principal place of business if the PR is not an individual.  Rule 255.2(b).  Interestingly, Rule 255.2(b) does not require the petition to provide the name or address of the designated individual.  The rule does require the petition to indicate whether the PR was designated by the partnership or selected by the IRS.

Identification and Removal of a Partnership Representative by the Court

New Rule 255.1(b)(3) defines the PR for purposes of BBA partnership actions to mean the partner (or other person) designated by the partnership or selected by the IRS pursuant to section 6223(a), “or designated by the Court pursuant to Rule 255.6.”  Rule 255.6 sets out circumstances in which the Court may act to identify or remove a PR in a partnership action under BBA.  The first such circumstance is if at the time of commencement of the action the PR is not identified in the petition.  Rule 255.6(a).  The second such circumstance is if after the commencement of the case the Court “may for cause remove a partnership representative for purposes of the partnership action.”  Rule 255.6(b).  The Court’s rule requires that before removal there must be notice and an opportunity for a hearing.  Neither Rule 255.6(b) nor the explanation to the rule delineate what causes would warrant removal.

Rule 255.6(a) provides that where there is no PR identified in the petition at the beginning of the case, the Court “will take such action as may be necessary to establish the identity” of the PR.  Rule 255.6(a) is vague as to what action might be necessary to establish the identity of the PR.  If no PR is identified, one possible outcome may be that the case is dismissed on the ground that a proper party did not file the petition.

Rule 255.6(b) provides that “if a partnership representative’s status is terminated for any reason, including removal by the Court, the partnership shall then designate a successor partnership representative in accordance with the requirements of section 6223 within such period as the Court may direct.”  Rule 255.6(b) does not address what happens if the partnership is unable or unwilling to designate a successor PR.  It is also interesting that Rule 255.6(b), while referencing the requirements of section 6223, only cites the authority of the partnership to designate a PR, and does not cite the Commissioner’s authority to select a PR.  The ability of the Commissioner to select a PR for the partnership raises intriguing issues that also arose in the early days of TEFRA.  See, e.g., Computer Programs Lambda v. Comm’r, 90 TC 1124, 1127-28 (1988).

Per the explanation to Rule 255.6, the authority to identify or remove a PR “flows from the Court’s inherent supervisory authority over cases docketed in the Court.” The explanation to Rule 255.6 also states, however, that the rule “does not take a position on whether the Court may appoint a partnership representative.”  In the context of a TEFRA partnership action, Rule 250 permits the Court to appoint a TMP in certain circumstances.  Notably, Rule 250(a) provides that if there is no TMP at the outset of the TEFRA action, the Court “will effect the appointment of a tax matters partner.”  Similarly, Rule 250(b) provides that where the TMP has been removed by the Court or the TMP’s status has otherwise terminated, the Court “may appoint another partner as the tax matters partner” if the partnership has not designated one in the time frame prescribed by the court.  Consistent with the explanation to Rule 255.6, and unlike Rule 250, Rule 255.6 does not contain language permitting the Court to appoint a partnership representative.   However, the explanation to Rule 255.6 appears to leave the door open for the Court to appoint a PR if the facts warrant such action, though it is unclear what those facts might be.

Jurisdiction Over the Imputed Underpayment and Modifications

Rule 255.2(b) also reflects the fact that the partnership as a result of an action under BBA may be liable for tax, i.e., an imputed underpayment determined under section 6225.  An imputed underpayment is initially computed by the IRS during the administrative proceeding, but may be modified if timely requested by the partnership and approved by the IRS.  The modified imputed underpayment and any modifications approved or denied by the IRS will be reflected in the FPA mailed to the partnership. 

Rule 255.2(b)(5) requires that the petition reflect the amount of the imputed underpayment determined by the Commissioner and “if different from the Commissioner’s determination, the approximate amount of the imputed underpayment in controversy, including any proposed modification of the imputed underpayment that was not approved by the Commissioner.”  Further, Rule 255.2(b)(6) requires the petition to clearly and concisely state each error that the Commissioner allegedly committed in the FPA “and each and every proposed modification of the imputed underpayment to which the Commissioner did not consent.”  Rule 255.2(b)(7) provides the petition should also include “[c]lear and concise lettered statements of the facts on which the petitioner bases the assignments of error and the proposed modifications.”

The petition requirements set forth in Rule 255.2(b) make clear that the Tax Court will have jurisdiction to redetermine an imputed underpayment reflected in the FPA, including any “proposed modifications” to the imputed underpayment that were not approved by the Commissioner.  Prior to the Tax Technical Corrections Act of 2018, Public Law 115-141 (TTCA), the issue of jurisdiction over imputed underpayments and modifications was unsettled.  By amending the definition of partnership-related item to specifically include an imputed underpayment while also amending section 6234(c) to provide the court with jurisdiction “to determine all partnership-related items” for the taxable year to which the FPA relates, the TTCA amendments make clear that the court has jurisdiction to determine an imputed underpayment.  Therefore, the Code provides the court with jurisdiction to determine an imputed underpayment, including any modifications to that imputed underpayment that were denied by the Commissioner.  This is reflected in Rule 255.2(b).   

Binding Effect of Tax Court’s Decision

Rule 255.7 provides that any decision that the Tax Court enters in a partnership action under BBA is binding on the partnership and all of its partners.  The term “partner” is not defined under New Title XXIV.A.  However, under Rule 240 “partner” is defined for purposes of a TEFRA action to mean “a person who was a partner as defined in Code section 6231(a)(2)” at any time during the taxable year before the Court.  Section 6231(a)(2), prior to amendment by the BBA, defined partner for TEFRA purposes to mean a partner in the partnership and “any other person whose income tax liability under subtitle A is determined in whole or in part by taking into account directly or indirectly partnership items of the partnership.” 

Unlike TEFRA, the BBA does not define the term “partner”.  However, the BBA does define a partnership-related item broadly to include items or amounts “relevant in determining the tax liability of any person” under chapter 1 (emphasis added).  See section 6241(2)(B)(i).  In addition, the Joint Committee on Taxation explanation accompanying TTCA explicitly states that the scope of BBA is not narrower than TEFRA, “but rather, [is] intended to have a scope sufficient to address those items described as partnership items, affected items, and computational items in the TEFRA context…, as well as any other items meeting the statutory definition of a partnership-related item.” See Technical Explanation of the Revenue Provisions of the House Amendment to the Senate Amendment to H.R. 1625 (Rules Committee Print 115-66), p.37, JCX-6-19 (March 22, 2018). 

Consistent with the broad scope of partnership-related item under BBA, when describing the binding nature of final decisions in proceedings under the BBA, Treas. Reg. §301.6223-2(a) provides that such decisions are binding on the partnership, its partners, and “any other person whose tax liability is determined in whole or in part by taking into account directly or indirectly adjustments determined under the [BBA]”.   Whether the Tax Court follows this regulation in extending the binding effect of its own decisions in BBA partnership actions remains to be seen.