The Bipartisan Budget Act of 2015 introduced the centralized partnership audit regime (“CPAR”) for tax years beginning after December 31, 2017. These rules reshape how an M&A tax advisor thinks about tax due diligence of partnerships. Under the CPAR, the IRS is able to determine, assess, and collect tax on partnership underpayments from the partnership itself. In an M&A tax context, a typical solution to mitigate this risk for a buyer is to require the partnership to make an election under section 6226 (the “push-out election”) such that the imputed underpayments are collected from the partners of the partnership in the tax year under audit. However, minority interest buyers may not have the influence to cause the partnership to make this election. In such cases, tax due diligence with respect to historical partnership tax exposures require heavier scrutinization. In the letter below, Monte discusses how the revised statutes appear to overlook how the CPAR operates when considering tax items that are determined at the partner level. When alternatives to mitigate tax exposures under the CPAR are unavailable, buyers and their M&A tax advisor should factor in the ambiguity of the CPAR when completing tax due diligence and negotiations with respect to partnerships.
To the Editor:
I read with interest the recent comments submitted to the government and published in the pages of Tax Notes over the past several weeks dealing with the new partnership audit regime. I also read with interest a very recent article in these pages on the same topic (Donald B. Susswein and Ryan P. McCormick, “Getting the Partnership Audit Rules Up and Running,” Tax Notes, Apr. 25, 2016, p. 495). The commentary is generally excellent, and it is not my purpose here to address or evaluate those comments. Rather, my purpose is to highlight some important issues that have not been addressed in the public commentary to date.
Why is it that from all of the commentary that has been sent into the government on this provision providing comments on rules that should be issued, there is no discussion, or perhaps I missed it, as to how the statute should or would operate in cases where the status and taxation of the tax item is statutorily determined at the partner level? The statute says that the default rule for adjustments to items of income, deduction, etc., is that the partnership pays an imputed underpayment on the items of the partnership that are so adjusted, but the statute does not address how to deal with partner level issues of determining the status of items at the partner level. There is guidance in the statute about dealing with tax rate differentials particular to a partner or to the status of the partner (say as tax exempt), but I see nothing telling me what to do if I have a taxable partner where the status of an item is determined at the partner level and no adjustment at the partnership level will have an impact on the partner level provision (with the exception, of course, of changing the amount of a distributive share of a partner’s partnership items).
I have seen this issue addressed in comment letters in the context of tax credit recapture where another statute imposes tax at the partner level but no discussion dealing with these other partner level status issues.
So, for example, take the proposed carried interest proposals under proposed section 710 where the distributive share of a particular partner is recharacterized from capital to ordinary. This adjustment applies only to the particular partner and is applied to that partner only. This provision does not seem to have anything to do with an item determined at the partnership level. Thus, it would seem that if the carried interest proposal goes forward, the approach of section 710 as proposed would need to be changed to a special tax rate provision (a new increased rate of tax) instead of a recharacterization of a distributive share from the partnership provision — no?
The same can be said of current law section 1411. I have seen it discussed that if section 6225 applies then section 1411 will not apply but that section 1411 will apply if section 6226 applies. It would again seem to me that the new audit regime would, on the face of the statutes of sections 1411, 6221, and 6225, not apply to cases under section 1411 where the item is determinative of its status at the partner level — no? One could say the same thing about sections 465, 469, and 704(d), to take just a few examples. I know a technical change was made dealing with section 469(k) but what of the rest of section 469 as it relates to the new audit regime? And when section 743(b) applies, presumably there will be rules that adjust the imputed underpayment for particular 743(b) adjustments of some partners — no?
And finally, the new statute does not continue the concept of “partnership item” that exists under the TEFRA regime. As a result, it seems that inconsistent positions on transactions that do not directly result in an item of partnership income, gain, loss or deduction will not technically be precluded and so the partnership could conceivably take one position and the partner the other position. For example, an issue could arise as to whether a transfer to a partnership is a loan, lease, license, or contribution and the same issue could arise on putative distributions from the partnership. This would in turn lead to the potential of (see new sections 6221(a) and 6222(c)) inconsistent positions being technically allowable under the new statute in determining a partner’s outside basis in his partnership interest and the partnership’s basis in its assets. It would also seem that partner capital accounts could end up being inconsistently determinable by both the partner and the partnership.
This type of regime does not seem to be what Congress had in mind when the new statute was enacted. Hopefully, most, if not all, of these issues will be addressed when regulations are written on the new statute.