Updates and guidance on key IRS practice developments.

• Author: Chambers, Valrie

Partnerships, a pandemic, and Rev. Proc. 2020-23

Partnerships subject to the centralized partnership audit rules of the Bipartisan Budget Act of 2015 (BBA), P.L. 114-74, now can file amended returns for tax years beginning in 2018 and 2019. To the uninitiated, the filing of an amended return may not seem like a cause for celebration or note, but for BBA partnerships, it reflects a significant development. Adjusting a partnership tax return under the BBA is not a simple task for the partnership or its partners.

Rev. Proc. 2020-23, issued April 8, allows BBA partnerships to avoid having to file an administrative adjustment request (AAR), which, prior to this guidance, was the only way for a BBA partnership to make an adjustment to a previously filed tax return. The filing of an AAR can be a complex undertaking.

This discussion first provides an overview of the AAR process and then explains why BBA partnerships do not need to rely on AARs to adjust their 2018 or 2019 tax returns under the relief granted in Rev. Proc. 2020-23. Whether the partnership should file an amended return, however, is a more complex question.

The AAR process in general

The centralized partnership audit procedures went into effect for partnership tax years beginning after Dec. 31,2017 (though partnerships could also elect to apply BBA procedures for certain prior tax years as well). The new procedures were enacted as a response to the fact that, among other things, the IRS had difficulty in conducting examinations of large, especially tiered, partnerships, where the collection of tax may be far removed from the partners of the partnership under exam.

Under the BBA, and much like under the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), P.L. 97-248, the IRS conducts examinations at the partnership level to determine the accuracy of a partnership's tax return. Unlike under TEFRA, if the examination results in an imputed underpayment of tax, a BBA partnership may pay the underpayment on behalf of the partners under Sec. 6225.This is the default rule of the BBA. If the partnership does not want to pay the underpayment, it can elect to "push out" the underpayment, and responsibility for payment, to the individual partners under Sec. 6226.

The determination of whether a partnership should pay under the default rule of Sec. 6225 or push out under Sec. 6226 should be based on the facts and circumstances of each partnership and its partners and should not be taken lightly. Those considerations are outside of the scope of this discussion, but partnerships should analyze their situation carefully.

If a partnership determines that a previously filed tax return should be adjusted, whether to reflect a negative or a positive adjustment, each of which could have an impact on the partners, the partnership has two options. If the due date for filing the return has not yet passed, a partnership need do no more than file a superseding Form 1065, U. S. Return of Partnership Income, and its supporting Schedules K-l, Partners Share of Income, Deductions, Credits, etc. If the due date for filing the return has passed, the partnership must file an AAR because Sec. 6031(b) prohibits a partnership from changing a previously filed Form 1065 or Schedule K-l unless it is through an AAR (except when an exception applies, such as Rev. Proc. 2020-23).

Under the BBA, much like under TEFRA, a partner's return must be consistent with the partnership's return. Unlike under TEFRA, the IRS can make a computational adjustment to a partner's return (i.e., correct a math error) if it is filed inconsistently with the partnership under Sec. 6222. A partner can always give notice to the IRS by filing Form 8082, Notice of Inconsistent Treatment or Administrative Adjustment Request (AAR), and take the inconsistent position to avoid a math error adjustment.

Sec. 6227, which governs the filing of AARs, requires that any adjustment be taken into account for the partnership tax year in which the AAR is filed (the so-called reporting year), under Sec. 6227(b). A partnership can pay an adjustment that results in an imputed underpayment with the filing of an AAR, but favorable adjustments are required to be pushed out under Regs. Sec. 301.6227-2(d).

To submit an AAR, the partnership electronically files an amended Form 1065 with a Form 8082 (or paper files a Form 1065X, Amended Return or Administrative Adjustment Request (AAR)), which describes the adjustments to be made to the previously filed return, as well as certain other forms, including but not limited to:

* Form 8985, Pass-Through Statement--Transmittal/Partnership Adjustment Tracking Report, and

* Form 8986, Partners Share of Adjustment(s) to Partnership-Related Item(s).

The partners receiving the AAR statement and these other forms are then required to determine the correction amounts for the year being adjusted, as well as all intervening years, and report the correction amounts on their returns for the reporting year using Form 8978, Partner's Additional Reporting Year Tax. Even then, however, the AAR may not result in an actual "refund" to the partner. Under Regs. Sec. 301.6227-3(b), the additional reporting year tax, if negative, only serves to reduce the Chapter 1 tax of the partner in the reporting year--effectively limiting the refund to the tax paid in by that partner. This is illustrated in Regs. Sec. 301.6227-3(b)(2) (ii). For example, if the reporting year is a loss year and the partner has limited the amount of estimated tax he or she is paying, a large "refund" from the adjustment year may not create much benefit to the partner.

The additional reporting-year tax may not be carried forward or back. In other words, the adjustment on the AAR is treated like a nonrefundable credit to the partner. Therefore, a partner may be better off without the partnership filing an AAR, given the adjustment is treated similarly to a nonrefundable credit. (See, generally, Kraus, "The Push-Out Election and AARs Might Not Get You Back to Kansas," 165 Tax Notes Federal 1429 (Dec. 2, 2019))

A process in theory but not practice

Practically speaking, the AAR process has raised numerous concerns for both partnerships and partners, not the least of which is, "How do I do this?" Although the BBA rules technically have been in effect for partnership tax years beginning after Dec. 31,2017, partnerships and partners have little experience in filing an AAR under the BBA mostly because many of them have not yet had to. This is because the IRS has granted many BBA partnerships temporary relief from the AAR process, first to help with the transition to the new system and, more recently, as will be discussed later, due to the COVID-19 crisis.

In July 2019, the IRS granted transition relief in response to concerns by partnerships and tax professionals about the AAR process and how to use it to correct previously filed Forms 1065 to reflect the treatment of certain items such as the Sec. 199A qualified business income deduction and the global intangible low-taxed income (GILTI) tax. The relief in Rev. Proc. 2019-32 provided for a deemed extension period for BBA partnerships that had filed 2018 partnership returns but had not requested extensions. Those partnerships that had filed on or before the uncxtended due date of March 15,2019, could file a superseding Form 1065 and issue corrected Schedules K-l on or before the extended due date of Sept. 16,2019.

Without such transition relief, the IRS explained, some partnerships that had already filed a return and had not requested an extension could not amend the Form 1065 or the Schedules K-l because of the restriction of Sec. 6031(b). After Rev. Proc. 2019-32, however, BBA partnerships that otherwise would have had to consider filing AARs could instead take the easier path of...