Jamie C. Yesnowitz
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During a special meeting on Jan. 24, 2019, the Multistate Tax Commission (MTC) approved a model statute for reporting adjustments to federal taxable income and federal partnership audit adjustments.1
States may enact this statute to provide a uniform approach for taxpayers to follow, as a means to pay and report state taxes in response to tax adjustments under the new federal partnership audit and assessment procedures.
The Bipartisan Budget Act of 2015 enacted new federal partnership audit and assessment procedures for tax years beginning after Dec. 31, 2017.2
As explained in the MTC Hearing Officer Report, the new procedures shift the burden for assessing tax after a partnership-level adjustment from the Internal Revenue Service (IRS) to the partnership. Audits are conducted at the partnership level through a partnership representative.3
The adjustments to partnership income may change the income tax calculation in states that follow federal tax law. States generally have a process for taxpayers to report and pay state taxes or claim refunds in response to a federal adjustment. This process may be complicated for multistate taxpayers because state tax laws substantially vary. Taxpayers usually have state filing and payment requirements when they file an amended return or receive an assessment from the IRS. Because federal tax on partnership audit adjustments may be assessed without partners filing amended returns or receiving assessments, states need authority and a process for assessing state tax liabilities following these adjustments.
Uniform model statute
The MTC model uniform statute provides a series of definitions and a general rule for reporting adjustments to federal taxable income to states, but the focus of the statute is on how to report federal adjustments to states following a partnership-level audit.
General rule for reporting adjustments to federal taxable income
Under the model statute, general reporting and payment provisions apply to taxpayers with federal adjustments that are not subject to the federal partnership audit provisions discussed below or final federal adjustments required to be reported under IRC Sec. 6225(a)(2).4
These taxpayers must report and pay any state tax liability resulting from final federal adjustments by filing a federal adjustments report5
with the state tax authority no later than 180 days after the final determination date. 6
Reporting adjustments following federal partnership audits
Except for adjustments required to be reported for federal purposes under IRC Sec. 6225(a)(2) and the distributive share of adjustments reported under the general provisions discussed above, the model statute provides procedures for partnerships and partners to report final federal adjustments and make payments arising from a partnership-level audit or an administrative adjustment request.7
The state partnership representative for the reviewed year has the sole authority to act on behalf of the partnership.8
The partnership’s direct partners9
and indirect partners10
are bound by the representative’s actions. The state partnership representative is the federal partnership representative11
unless the partnership designates another person in writing. A state tax agency may establish reasonable qualifications for and procedures for designating a person, other than the federal partnership representative, to be the state partnership representative.
The model statute provides reporting and payment requirements for partnerships subject to a final federal adjustment and their direct partners.12
Within 90 days after the final determination date, the partnership must: (1) file a completed federal adjustments report with the state taxing agency; (2) notify each direct partner of its distributive share of the final federal adjustments; and (3) file an amended composite return for the direct partners and pay the additional amount that would have been due if the final federal adjustments had been properly reported.13
No later than 180 days after the final determination date, each direct partner that is taxed under state law must: (1) file a federal adjustments report that reports its distributive share of the adjustments; and (2) pay any additional amount of tax as if the final federal adjustments had been properly reported, plus any penalty and interest due under state law and less any credit for related amounts paid on behalf of the partner by the partnership.14
Rather than following the reporting and payment procedures outlined above, a partnership may elect to pay the tax itself.15
No later than 90 days after the final determination date, an audited partnership must file a completed federal adjustments report and notify the state tax authority that it is making the election. Within 180 days after the final determination date, the partnership must pay an amount in lieu of taxes owed by its direct and indirect partners. The model statute provides detailed procedures for computing this amount.16
Tiered partners also may make this election.17
In addition, an audited partnership or tiered partner may enter into an agreement with the state to use an alternative reporting and payment method if necessary to reasonably report and pay taxes, penalty and interest.18
The partnership-pays election and modified method election generally are irrevocable. 19
Other procedural provisions
The remaining sections of the model statute cover further administrative procedures. To provide some level of administrative convenience, the model statute allows a state tax authority to promulgate regulations to establish a de minimis
amount upon which a taxpayer is not required to comply with the general or partnership procedures.20
The model statute addresses the applicable statute of limitations for assessments of additional tax, interest and penalties arising from adjustments to federal taxable income.21
If a taxpayer timely reports a federal adjustment, the state may assess amounts within the state’s statutory limitation period or one year of filing the federal adjustments report with the state. If the taxpayer does not file federal adjustments on a timely basis, the state may assess amounts by the latest of: (1) the expiration of the state’s limitations period; (2) the expiration of the one-year period following the filing of the federal adjustments report with the state; or (3) absent fraud, the expiration of the six-year period following the final determination date. Taxpayers are allowed to make estimated state tax payments during the course of a federal audit.22
Also, the model statute provides procedures for taxpayers to claim a refund or credits of tax arising from federal adjustments.23
The final section of the model statute addresses the scope of assessments and extensions of time.24
The adoption of the MTC model statute is a positive step in pursuing uniformity in state procedures following federal partnership audit adjustments. As discussed above, the new federal procedures are intended to shift the burden for assessing tax after a partnership-level adjustment from the IRS to the partnership. A federal partnership audit that produces an adjustment may change corresponding state tax liability, and often proves to be problematic for several reasons. For example, the identity of the partners in the partnership may change between the tax year in which the adjustment occurs, and the tax year in which liability is finally fixed. In addition, while states have not had much opportunity to react to the new federal rules, a lack of uniformity in this area could make things extremely unwieldy for multistate partnerships and their partners.
The adoption of the federal approach by states has been widely endorsed and the model statute is the product of a collaboration of business and governmental groups.25
Due to the need for state uniformity in this area, it is expected that some states will consider and enact the model uniform statute this year. Several states, including Arizona,26
, have already enacted their own statutes to adopt the new federal partnership audit provisions. The adoption of the model statute may encourage other states to follow this trend.
At this point, it is unclear how at least one provision of the model statute will operate in practice. Federal audits are conducted at the partnership level through a federal partnership representative. Under the model statute, a state partnership representative has the sole authority to act on behalf of the partnership. A state partnership representative generally is the federal representative, but a different state representative may be designated. Because a partnership could have multiple representatives, there could be conflicts concerning which representative has the ultimate authority for the partnership.
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