By Phil Jelsma
A heavy burden is placed on a partnerships and LLCs by the new IRS centralized partnership audit rules which are effective January 1, 2018. Under the new regime, all adjustments and underpayments are calculated at the partnership or LLC level instead of the partner or member level. Generally, any underpayment is paid by the partnership or LLC with interest.
This week, we will discuss the election whereby the partnership or LLC may have the adjustment pushed out to its partners or members -- so they are responsible for paying any tax and interest.
Making the election
To make the push out election, the partnership or LLC must take two steps: (1) make an election in the manner provided by the IRS no later than 45 days after a Final Partnership Adjustment (“FPA”) is mailed by the IRS; and (2) furnish a statement of each partner or member share of any adjustment as determined in the FPA to its partners or members. If both steps are taken, each partner or member must take their share of the adjustments into account. Typically if the adjustment involves a former partner or member, this may be a way of getting the former partner or member to pay the tax. If the election is not made, the partnership or LLC would need to recover the tax and interest it paid from the former partner or member.
Steps by the partners or members
Each partner or member must then take the adjustments into account increasing its share of income tax by the sum of: (1) the amount by which the partner’s or member’s income tax would increase for the reviewed year and (2) any subsequent affected years. When the push out election is made, any penalty or interest would be added to the partner’s or member’s share of income. The interest rate is the normal underpayment rate increased by five percentage points rather than the normal three percentage points for underpayments.
Affect of an election
Generally a push-out election isn’t valid unless the partnership or LLC complies with all the IRS’ requirements and is revocable only with the IRS’ consent. If the IRS decides the election is invalid, the partnership or LLC and its representative should receive notice within 30 days. The push out election must be made aggregating all adjustment amounts. Therefore, the adjustment may include not only the reviewed tax year, but also the first effective year before and after the revised tax year. The correction amounts cannot be less than zero, i.e., there must be a positive amount of tax added.
Safe harbor election
A partner or member may able to elect to pay the safe harbor amount in lieu of paying the additional tax, penalties and interest. The safe harbor amount is the amount of the underpayment with an interest payment. If the partnership or LLC disagrees with the amount shown in the FPA, it may file petition for a readjustment without affecting its rights to challenge the adjustments in court. The proposed regulations provide that the petition for readjustment must be filed within 45 days after the FPA is mailed. Partnership adjustments are finally determined on the later of the expiration of the date to file a petition for readjustment or if a petition is filed on the date the court decision becomes final.
For partnerships or LLC’s who cannot elect out of the new centralized audit provisions, a push-out election may be the next best alternative, particularly if the adjustments affect former partners or members. Not electing a push-out would result in the partnership or LLC paying the tax and seeking reimbursement or indemnity from the former partners or members. There is an open question whether tiered partnerships can avail themselves of the push-out elections. The IRS and Treasury have sought comments on this issue.
Phil Jelsma is a partner and chair of the tax practice team at Crosbie Gliner Schiffman Southard & Swanson LLC (CGS3), a San Diego-based commercial real estate law firm with offices in Los Angeles. Phil Jelsma is recognized as a leading joint venture and tax attorney, with a 30-year background in real estate exchange transactions, syndications, nonprofit corporations and international tax planning.