A new federal law and process for federal audits of partnerships will likely require states to amend their laws to ensure their tax agencies can administer their state taxes in conjunction with the new federal regime. Without a model statute, there is potential for substantial variance across the nation as states consider legislation.
With the many state tax issues involved, the AICPA worked with several organizations over the past two years to develop a model state statute for reporting federal tax changes to the states, including the new partnership audit process. For a state to collect its share of liabilities flowing from an IRS partnership audit and not face substantial legal and administrative concerns, the state should adopt the model statute. IRS audits under the new federal regime will not begin until late 2019, and the first completed IRS audits are unlikely to occur until late 2020 or early 2021. States should have sufficient time to establish any necessary guidance or procedures before any audits are completed at the federal level under the new regime.
States are likely to consider this issue over the next year. State CPA societies are encouraged to work with their state legislatures and tax authorities on adopting the model statute, which is available at tinyurl.com/y9wfwno4.
In December 2017, this column discussed the federal and state rules (see Jensen, Sherr, and Stanton, "Developing a Uniform State Approach to the New Federal Partnership Audit Regime," 48 The Tax Adviser 888 (December 2017), available at tinyurl.com/y98nu22y). Now this column takes a look at the model statute.
Draft state model statute
The state model statute is titled "Model Uniform Statute and Regulation for Reporting Adjustments to Federal Taxable Income and Federal Partnership Audit Adjustments." The model statute was designed to provide states with a uniform, simplified method to apply the results of a partnership audit conducted by the IRS under the new federal procedures in effect for tax years beginning Jan. 1,2018. The model statute provides uniformity and incorporates the changes needed for states to conform to the regime, and it establishes more uniform standards for reporting federal audit adjustments for all taxpayers to the states. The model statute also addresses the changes made to federal audit procedures by the regime that affect state-specific issues, such as residency and apportionment.
Broad state adoption of the model statute will provide greater uniformity among the states and increased compliance, which will ensure states receive taxes owed quicker and with greater accuracy. The goal is to have fair, reasonable, and administrable state partnership audit rules that minimize the complexities and burdens for taxpayers, CPAs, and state tax authorities.
The model statute is designed to work irrespective of which options are selected by a partnership within the new federal process.
The model statute is a result of negotiations between the AICPA and various organizations with the Multistate Tax Commission (MTC) and many of the state departments of revenue on various drafts over the past two years.
Update on developments
On March 23,2018, Congress approved a package of technical corrections to the regime as part of the Consolidated Appropriations Act, 2018. (1) The changes enacted provided for a new "pull-in" procedure in lieu of partners filing amended returns, clarified that tiered partnerships may elect to use the "push-out" procedures, and included a number of revised definitions.
Over the past year, the IRS issued several regulations regarding partnership audits. First, the Treasury and the IRS, on Jan. 2,2018, issued final regulations (T.D. 9829) on the opt-out election. Second, on Aug. 6,2018,Treasury and the IRS issued final regulations on partnership representatives and the election to apply the regime (T.D. 9839). Finally, on Aug. 17, 2018, Treasury and the IRS published in the Federal Register updated proposed regulations that withdraw and repropose certain portions of previously issued proposed regulations implementing the centralized partnership audit regime that Treasury and the IRS had not yet finalized to reflect the changes made by the Consolidated Appropriations Act, 2018. (2)
Over the past few years, the AICPA submitted many comments to Congress and to the IRS on the proposed federal rules. (3) Michael Greenwald, chair of the AICPA Partnership Taxation Technical Resource Panel, testified on behalf of the AICPA at the Oct. 9,2018, IRS hearing on the proposed regulations issued in August 2018. (4) Additional Treasury and IRS proposed guidance was expected later this year on several areas not yet addressed. Final Treasury and IRS regulations are expected in late 2018 or early 2019.
More details regarding the new federal regime and the AICPA comments on the proposed regulations are provided in an article published in The Tax Adviser (see Freeman, "A Glimpse Into the New Partnership Audit Rules," 47 The Tax Adviser 756 (October 2016), available at tinyurl.com/yddkl2nf; see also the AICPA Partnership Audit and Adjustment Rules webpage, available at tinyurl.com/yaer8wnl).
In addition to the federal developments over the past year, the AICPA and other organizations (including the Master Limited Partnership Association (MLPA) as well as the groups mentioned in part 1 of this discussion in the December 2017 issue) have come to an agreement with the MTC (and obtained input from various state departments of revenue) on the model statute. In 2018, Georgia (5) and California (6) enacted legislation similar to the model statute. In 2018, Hawaii enacted legislation, (7) but it did not follow the model statute, and Minnesota and Missouri considered, but did not enact, bills that did not follow the model statute.
The impact of the 2018 Hawaii legislation on partnerships subject to a federal audit is unclear, and it is likely that the state legislature will need to amend the statute. (8) The 2018 Minnesota bill contained some significant differences from the model statute and was amended several times during the legislative session. (9) Ultimately, the governor vetoed an omnibus tax bill containing the partnership audit provisions. The 2018 Missouri bill did not include any provisions from the model statute and was not considered further by the legislature. (10)
On July 24,2018, the MTC's Uniformity Committee voted to move forward with the model statute. The MTC's Executive Committee held a public hearing on the model statute on Oct. 15. A report from that hearing is available at tinyurl.com/ydgflldo.
A number of state tax departments have indicated formally or informally that they anticipate waiting until the 2019 legislative session to pursue partnership audit conformity legislation. These states include Alabama, Indiana, Kentucky, Missouri, New York, and Oregon.
In September 2018, the AICPA updated a position paper (available at tinyurl.com/ybd68ug7) and one-pager (available at tinyurl.com/y71tyyjd) on this issue.
Guiding principles and issues addressed in the model statute
The guiding principles behind the model statute, and the issues that state CPA societies should consider as they work with state legislatures and tax authorities are:
* Allow a partnership the ability to make different elections under the regime for state purposes than the partnership makes for federal tax purposes, notably for the push-out or "pay-up" elections. (11) However, it is recommended that the states require partnerships that elect out of the regime at the federal level also to opt out at the state level.
* Base the apportionment and allocation of the federal adjustment on the apportionment and allocation factors of the reviewed year. (12) Use the original apportionment and allocation factors of the reviewed year, adjusted for any federal audit changes. Determine the state-specific tax treatment of items based on the reviewed year apportionment factor.
* For the pay-up election, apply apportionment factors at the partnership level for all adjustments allocable to all partners except direct resident partners.
* For tiered structures, allow flexibility and options to each tier for reporting and payment elections that mirror the federal options.
* For administrative ease, offer partnerships the ability to use alternative reporting and payment solutions subject to state approval.
* Provide for a single partnership representative for all states regardless of the state of residence of the partnership representatives. One partnership representative should apply for both federal and state purposes. The...