2016 Partnership Tax Update Edward K. Zollars, CPA www.currentfederaltaxdevelopments.com 2016 Oklahoma Tax Institute

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BBA Changes to Partnership Exams • Assessments not economically viable for IRS for huge partnerships • Congress now will have partnerships presented with a tax bill at the end of an exam • Also, switches to an opt-out system for partnerships that can be exempt from rules

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Effective Date • Mandatory for tax years beginning on or after 1/1/2018 • Can elect to use rules for tax years beginning after date of enactment • Will likely require modification of all existing partnership agreements

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Determination at Partnership Level • TEFRA – Centralized examination of the partnership – IRS had to compute and assess tax on each partner

• New System – Still a centralized examination process – Once adjustments done, IRS calculates deemed tax (generally at maximum individual rates) – Partnership • Present evidence to allow for lower rates or • Can opt to push adjustments to each partner

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Opting Out of the New System • Qualified partnership can opt out on timely filed Form 1065 – Furnish 100 or fewer Schedule K-1s – Each partner must be an individual, C corporation, foreign entity that would be taxed as a C corporation, S corporation and estate of deceased partner (IRS can expand the list but have indicated unlikely to add a large number of other partner types) – Election must list name and ID number of each partner and notify each partner of election

• S corporation partner-must identity each shareholder

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Consistent Treatment Rules • Similar to old TEFRA rules – must report in same manner as partnership unless file notice of inconsistent treatment with return • If K-1 received not the one the IRS received, have option to treat as if elected inconsistent treatment • If no notice of inconsistent treatment filed, IRS can adjust as a math error

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Partnership Representative • Successor to ”Tax Matters Partner” – Doesn’t need to be a partner – Must have a substantial U.S. presence

• If partnership doesn’t designate one, IRS can do so • Partnership representative’s actions are binding on the partnership and has the sole right to act on behalf of the partnership

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Adjustment of Partnership Items by IRS • IRS computes an “imputed underpayment” – Net positive adjustment times highest individual rate – Increased/decreased by changes in credits – If a positive number, the partnership is presented with a bill, otherwise flows out to partners

• IRS can publish procedures for modifications • Voluntary amended returns by partners affect amount • Can submit rate information for 270 days following IRS billing

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Alternative to Payment of Imputed Underpayment • Election within 45 days to push out statements to partners for the reviewed year statement of adjustment (with copy to the IRS) • Partner reports in the year the statement is issued • Includes impact on intervening years • Penalties and interest applied at the partner level and trace back to year tax would have changed

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Partnership Voluntary Request for Adjustment • Same pair of options exist for partnership initiated changes – Cannot have amendment by some partners to reduce payment – No 270 day period for adjustments – If use alternative method higher rate for underpayments won’t apply

• Note, if reduces tax have to use the “alternative” method • If using imputed underpayment method must pay with request

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Regulations on Early Election into BBA Examination Routine • Election to be made after receipt of notice of examination – Deadline is 30 days after notification – Must be made in writing using title “Election Under Section 1101(g)(4)”

• Specific terms of election outlined in notice (and in manual) • IRS will issue Notice of Administrative Proceeding • Cannot use request for administrative adjustment under new law early • Cannot opt into BBA if have previously revised partnership return

12/1/2016

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Blue Book Indicates Congress Believes It’s Fine for IRS to Limit Opt-Out for Disregarded Entity Partners • Have option for certain partnerships to “opt out” of new audit regime • Law provides list of allowed partners – Blue Book makes clear that “disregarded entities” (SMLLCs, grantor trusts) are not necessarily OK – IRS had previously disallowed such partners from qualifying for TEFRA small partnership treatment (Revenue Ruling 2004-88)

• IRS has indicated a preference for limiting opt-out options

12/1/2016

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IRS Asked for Ideas on Partnership Audit Regulations • Notice 2016-23 • Asked for suggestions for – – – –

Opt out rules Imputed underpayment calculations Mechanics of modification of imputed underpayment How to elect the alternative method

• Did not ask for guidance on early election option • Has recently announced expects guidance early enough in 2017 to allow for planning (not sure what that really means)

12/1/2016

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Disregarded Entities Cannot Independently Apply §108 Exclusions • TD 9771, 6/10/16 • Finalized regulations that clarify disregarded entities treated like partnerships for this purpose • Deemed owner therefore must – File bankruptcy for bankruptcy exclusion – Be insolvent for insolvency exclusion

• Does not consider this a change in the law

12/1/2016

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Not Receiving a K-1 No Excuse for Not Reporting Partnership Income • Lamas-Richie v. Commissioner, TC Memo 2016-63, 4/11/16 – Taxpayer had founded a gossip site that became popular – Created partnership with “money guy” and continued to run site – File 2011 tax return in April 2012 • Partnership had never shown income • He didn’t receive K-1 by filing date – On extension partnership filed return, prepared K-1 showing income for taxpayer – Taxpayer gave up interest in 2013 and never received distributions – Still had to report income

12/1/2016

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IRS Backs Off Bad Boy Memo • Chief Counsel Memorandum AM-2016-001, 4/15/16, Chief Counsel Advice 201606027, 2/5/16 – In February issued memorandum indicating that certain “bad boy” provisions would covert debt to recourse – Would have had effect of allocating all debt away from investors in real estate partnerships – Uproar followed, as whole concept of qualified nonrecourse financing would have collapsed – April memorandum backed off this view and instead gave list of “acceptable” bad boy provisions

12/1/2016

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Payments to Proceed Are Partnership Liabilities • PLR 201608005, 2/19/16 – Contractor received payments at start of contract which were “payments to proceed” – Payments made before any work began – While had right to take action if work not done properly, did not specifically allow taking back payments to proceed – Even though there was no specific loan, ruled that a liability still exists

12/1/2016

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IRS Attacks Use of Guaranteed Payments to Fix Maximum Self-Employment Income • Chief Counsel Advice 201640014, 9/30/16 – General rule • Partners pay self-employment tax on partnership income • Limited partners do not generally – Guaranteed payment issue • Made guaranteed payments tied to services performed (reasonable compensation) • Argued remaining flow through income not self-employment income – IRS memo takes position that this does not work • Cites general rule of §1402(a) • Also cites results in Renkemeyer and Riether cases – This is a memo only, but also suggests that the IRS is beginning to take a hard line 12/1/2016

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Partners Cannot Be Employees of SMLLC Owned by Partnership • Temporary Regulation §301.7701-2T(e)(8)(i ) (TD 9766), Proposed Regulation §301.7701-2T(e)(8)(i), (REG-11430715), 5/4/16 – IRS discovered some partnerships were • Forming SMLLCs • Hiring partners in such SMLLCs – IRS reiterates position that partners cannot be employees – IRS required this to be fixed this past summer – Fact IRS restated “partners cannot be employees” suggest that other mechanisms attempting to put partners on the payroll may also face IRS objections

12/1/2016

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Lack of Reliable Information About Partnership Activity Reasonable Cause for Late Filing • In re: Refco Public Community Pool LP, Banktruptcy Court for the District of Delaware, Case No. 14-11216, 118 AFTR 2d ¶ 2016-5085 , 8/2/16 – Partnership invested in another partnership that had major problem with undisclosed related party receivable – Accounting records of that partnership found to be in total disarray – Liquidators found 23 issues that needed to be resolved – IRS contends could have obtained unaudited information and summaries – Court agreed with taxpayer that such information was flagged as inherently unreliable and entity faced potential penalties and liabilities if those amounts were materially misstated—as appeared was very likely.

12/1/2016

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Tax Court Can Determine Statute Remains Open in TEFRA Proceeding • MK Hillside Partners, et al v. Commissioner, No. 14-71504, CA9, 2016 TNT 122-8, 6/27/16 – IRS argued that the partnership was a sham – IRS came in late, argued 6 year statute was open (25% rule) – Taxpayer asked court to rule IRS was too late—but Court ruled taxpayer had actually omitted 25%, thus statute open – Taxpayer argued Tax Court had no right to rule on that issue but only on whether statute was closed – Ninth Circuit found Tax Court not so limited in its jurisdiction

12/1/2016

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Fact TMP Was Defunct Did Not Invalidate FPAA • Berkshire 2006-5 LLP et al. v. Commissioner, TC Memo 201625, 2/17/16 – – – –

Sent notice of FPAA to defunct TMP IRS also sent informaiton to notice partner Notice partner failed to timely file a petition so sought to invalidate FPAA IRS sending notice to last known address was good enough even if aware TMP no longer existed – IRS also under no obligation to appoint new TMP

12/1/2016

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Managing Partner Can Still Raise Partner Level Reasonable Cause Defense • McNeill v. United States, CA10, No. 15-8095, 9/6/16 – McNeill was TMP in TEFRA examination – Partnership had raised reasonable cause defense, IRS rejected – Partnership did not contest this result, but taxpayer raised the matter as a partner level defense – Majority did not find that managing partner bound by partnership level decision even if it was basically the same issue

12/1/2016

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IRS Failure to Abide by Closing Agreement Does Not Invalidate Assessment • Davis v. United States, CA9, No. 13-16458, 117 AFTR 2d ¶ 2016-368, 1/25/16 – Exam related to Oakland Raiders NFL team – IRS agreed to provide minimum time periods for Mr. Davis to object to IRS calculations – IRS ran into statute constraint, did not issue adjustments in time to allow for entire review period – Trial court invalidated assessment – Ninth Circuit disagreed • IRS faced contractual damages only such as cost of going to court to dispute assessment calculations • Since Davis did not contend assessment was in error, there were no damages 12/1/2016

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Initial Election for LLC Takes Place Only When Becomes Active • PLR 201622020, 5/27/16 – – – –

12/1/2016

LLC formed but went unused for an extended period Once began to use, filed an entity election Apparently now wanted to change less than five years later IRS ruled that the election when actually started doing something was an initial election, so five year rule did not yet apply

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