IRS proposes regulations for adjusting tax attributes under new partnership audit regime

Tax Hot Topics newsletterThe IRS has issued proposed regulations (REG-118067-17) containing rules for how partnerships and partners would adjust their tax attributes with respect to partnership adjustments arising under the new partnership audit regime enacted by the Bipartisan Budget Act of 2015 (BBA). These proposed regulations supplement prior proposed regulations that were issued in June 2017 and cover situations in which a partnership pays an imputed underpayment, as well as when the partnership elects to push the adjustments out to the reviewed-year partners.

The proposed regulations state that the partnership and its adjustment-year partners will generally adjust their “specified tax attributes” to reflect an imputed underpayment paid by the partnership. The specified tax attributes are defined as the tax basis and book value of the partnership’s property, amounts determined under Section 704(c), and the adjustment-year partners’ capital accounts and outside basis in their partnership interests. The term specified tax attributes does not include holding periods, the character of items of income, gain, deduction, loss, or credit, or carryover amounts of such items.

In making adjustments to the specified tax attributes, the proposed regulations state that the book value and tax basis of partnership property are adjusted first. The partnership then creates “notional items” with respect to the partnership adjustment and these notional items are allocated among the adjustment-year partners. These notional items are solely for the purpose of affecting partner-level specified tax attributes and they are not considered items for other purposes. Although the allocation of a notional item does not have substantial economic effect, the allocation of such an item will be deemed to be in accordance with the partners’ interests in the partnership if it is allocated in the same manner it would have been allocated if it was taken into account in the reviewed year. Similar rules apply to the allocation of items that a partnership elects to push out to its reviewed-year partners.

The proposed regulations also contain rules for allocating the adjustments to the successors of a reviewed-year partner who leaves the partnership before the adjustment year, for instance by selling its interest to a new partner. There are also rules for situations in which an adjustment year partner acquired a partnership interest from a reviewed-year partner that was tax-exempt and rules dealing with the impact of non-deductible partnership expenses.

By requiring an adjustment-year partner to increase its outside basis in its partnership interest by the amount of notional items allocated to them, the proposed regulations would attempt to prevent a partner from being effectively taxed twice on the same item of income: once, indirectly on the payment of the imputed underpayment and, again, on the disposition of the partnership interest or on a distribution of cash by the partnership. Similar rules apply if a partnership pushes out items to a pass-through partner, and that pass-through partner elects to pay the adjustment rather than pushing it out to its own partners.

The proposed regulations also provide that if a partnership elects to push a partnership adjustment out to its reviewed-year partners, both the partnership and the reviewed-year partners adjust the tax attributes that are affected by reason of the pushed-out item in the adjustment year. If a reviewed-year partner subsequently disposed of its partnership interest prior to the reporting year, that partner may file an amended return (if otherwise allowable) to reflect any adjustment to the outside basis of its partnership interest. A push-out election will require a reviewed-year partner to adjust all of his or her tax attributes, not just specified tax attributes as is the case if the partnership does not make a push-out election.

The proposed regulations would be effective for all partnership taxable years beginning after Dec. 31, 2017.

Contact Grace Kim
Principal, Partnership Tax Technical Leader, Washington National Tax Office
T +1 202 521 1590

Jose Carrasco
Senior Manager, National Tax Standards Group, Washington National Tax Office
T +1 202 521 1552

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