Adjustments taken into account by partners

Adjustments taken into account by partners

The manner in which adjustments are taken into account by partners covers several areas, including: (1) the calculation of the additional reporting year tax; (2) penalties, additions to tax, and additional amounts; (3) pass-through partners; and (4) qualified investment entities and master limited partnerships (MLPs).

Calculation of the Additional Reporting Year Tax

§301.6226-3(b) provides that each reviewed year partner’s chapter 1 tax for the reporting year is increased or decreased by the additional reporting year tax, as appropriate. Under §301.6226-3(b)(2) and (3), the correction amounts are the amounts by which the partner’s chapter 1 tax would increase or decrease if the partner’s taxable income for that year were recomputed by taking into account the partner’s share of the partnership adjustments. Under §301.6226-3(b)(1), a correction amount for the first affected year or any intervening year may be less than zero, and any correction amount less than zero may reduce any other correction amount. 

§301.6226-3(b)(1) also provides that nothing in §301.6226-3 entitles any partner to a refund of tax imposed by chapter 1 to which such partner is not entitled. This language clarifies that the rules under section 6226 and 6227 are consistent insofar as those rules concern the ability of a partner to claim a refund of an overpayment when taking into account partnership adjustments. See §301.6227-3(b)(1).

Under §§301.6226-3(b)(2)(ii)(B) and (b)(3)(ii)(B), the amounts under those provisions include not only the amounts described in §1.6664-2(d), but also any amounts not included on the return of a partner which are assessed against and collected from the partners. Such amounts include amounts paid as part of modification under §301.6225-2, including under the alternative procedure or in accordance with a closing agreement. Such amounts do not include, however, any amounts paid with an amended return filed as part of modification because those amounts are included with the amounts shown on a return or amended return under §§301.6226-3(b)(2)(ii)(A) and (b)(3)(ii)(A). 

Consistent with section 6226(b)(2)(B), §301.6226-3(b)(3) provides that a correction amount for an intervening year is the amount the partner’s chapter 1 tax for such year would increase or decrease after taking into account any adjustments to tax attributes that resulted from taking into account the partnership adjustments in the first affected year. Accordingly, in order to determine an intervening year correction amount, the partner needs to know the partnership adjustments for the reviewed year, which is information provided on the push out statement furnished to the partner. See §301.6226-2(e). 

§301.6226-3(b)(2) and (3) provide precise rules for calculating the correction amounts. Those rules are consistent with how underpayments and overpayments are generally calculated elsewhere in the Code and regulations and thus provide for the method the comment recommended. See, for example, §1.6664-2. 

§301.6225-2(d)(2) allows for modification of the imputed underpayment via partner amended returns for taxable years for which the period of limitations would otherwise be expired. See section 6225(c)(2)(D). 

Section 6226(b)(1) provides that each partner’s “tax imposed by chapter 1” shall be adjusted by the aggregate of the correction amounts determined under section 6226(b)(2). Both section 6226(b)(2)(A) and (B) describe the correction amounts as amounts by which the partner’s “tax imposed under chapter 1” would increase if the partner’s share of the adjustments were taken into account. Consistent with section 6226(b), §301.6226-3(b) provides that each partner’s chapter 1 tax for the reporting year is increased or decreased by the amounts by which the partner’s chapter 1 tax would increase or decrease were the adjustments taken into account. The statute and the regulations provide that a reviewed year partner only increases its chapter 1 reporting year tax by the aggregate of the correction amounts, which are calculated by reference to the amounts by which the partner’s chapter 1 tax would increase or decrease for the first affected year or any intervening year. Furthermore, the regulations do not require payment of chapter 2 or 2A taxes when a partner takes into account adjustments under section 6226(b).

Penalties, Additions to Tax, and Additional Amounts

§301.6226-3(d)(2) provides that a reviewed year partner calculates the amount of any penalty, addition to tax, or additional amount at the partner level by treating a correction amount determined under §301.6226-3(b) as if it were an underpayment or understatement for the first affected year or intervening year, as applicable. If, after taking into account the partnership adjustments, the reviewed year partner did not have an underpayment, or had an underpayment that fell below the applicable threshold for the imposition of a penalty, no penalty would be due from the reviewed year partner. §301.6226-3(d)(2). Accordingly, the regulations provide that a partner’s penalty is not based on the imputed underpayment amount determined at the partnership level.

Penalty defenses.

§301.6226-3(i) provides that the calculation of a partner’s penalty amount in the case of a push out election is based on the characteristics of, and facts and circumstances applicable to, the reviewed year partner. In addition, a reviewed year partner claiming that a penalty, addition to tax, or additional amount is not due because of a partner-level defense may raise that defense, but must first pay the penalty and file a claim for refund for the reporting year. See §301.6226-3(d)(3). 

Under §301.6233(a)-1(c)(1), a partner-level defense may not be raised in a proceeding of the partnership, including a partnership that makes an election under section 6226, except as otherwise provided in guidance prescribed by the IRS.

Under the centralized partnership audit regime, the applicability of penalties, additions to tax, and additional amounts that relate to partnership adjustments is determined at the partnership level. Section 6221(a). A push out statement furnished to a partner under §301.6226-2 will include any penalties, additions to tax, or additional amounts determined at the partnership level that are applicable to the adjustments pushed out to that partner. The applicability of such penalties, additions to tax, and additional amounts as set forth in the push out statement furnished to the partner are binding on the partner pursuant to section 6223. See §301.6226-1(e). 

§301.6226-3(d)(3) defines partner-level defenses as those defenses that are personal to the reviewed year partner and based on the facts and circumstances applicable to that partner (for example, a reasonable cause and good faith defense under section 6664(c) based on facts specific to a particular partner). Partners will have an opportunity to raise defenses specific to their facts and circumstances. 

The centralized partnership audit regime does not alter the existing law under the Code, regulations, or applicable case law relating to reasonable cause and good faith determinations. Any defense that is based on the conduct or actions of the partnership is a partnership-level defense that must be raised by the partnership during the partnership proceeding. See §301.6233(a)-1(c)(2)(v).

Partnership payment of penalties on behalf of partners

Section 6226(c)(1) provides that any penalties, additions to tax, or additional amounts shall be determined as provided under section 6221, and the partners of the partnership for the reviewed year shall be liable for any such penalty, addition to tax, or additional amount

The partnership and its partners may enter into a business arrangement whereby the partnership makes a payment towards the partner’s penalty liabilities, or whereby the partnership remits an amount to each partner to compensate for any potential penalties, additions to tax, or additional amounts. Nothing in the regulations under §301.6226-3 prohibits or disturbs those types of arrangements. 

Interest on penalties, additions to tax, and additional amounts.

Section 6226(c)(2) provides that in the case of a push out election, interest shall be determined at the partner level from the due date of the return for the taxable year to which the increase in chapter 1 tax is attributable. §301.6226-3(c)(1) provides that interest on each correction amount greater than zero is calculated from the due date (without extension) of the reviewed year partner’s return for the applicable taxable year until the amount is paid. For purposes of calculating interest on any penalties, additions to tax, or additional amounts, §301.6226-3(c)(2) similarly provided that such interest is calculated from the due date (without extension) of the reviewed year partner’s return for the applicable taxable year until the amount is paid. 

§301.6226-3(c)(2) provides that interest on any penalties, additions to tax, or additional amounts is calculated from the due date (including any extension) of the reviewed year partner’s return for the applicable tax year until the amount is paid.

Interest on the additional reporting year tax.

Section 6226(c)(2) provides that interest in the case of a section 6226 election is determined at the partner level, from the due date of the return for the taxable year to which the increase in chapter 1 tax is attributable, and at the underpayment rate under section 6621(a)(2) (substituting 5 percent for 3 percent). Interest only applies to the increases in the chapter 1 tax that would have resulted from taking into account the partnership adjustments under section 6226. No provision under the centralized partnership audit regime provides for interest on a decrease in chapter 1 tax that would have resulted in the first affected year or any intervening year if the adjustments were taken into account in those years. Accordingly, §301.6226- 3(c)(1) provides that interest on the correction amounts determined under proposed §301.6226-3(b) is only calculated for taxable years for which there is a correction amount greater than zero, that is, taxable years for which there would have been an increase in chapter 1 tax if the adjustments were taken into account. 

Under the language of section 6226(b)(2) and (3), adjustments are not actually taken into account like they would be if an amended return was filed under §301.6225-2(d)(2). Similarly, the increases or decreases do not actually occur as they would in the amended return context and tax attributes are not actually adjusted as part of this calculation.  The additional reporting year tax is calculated under section 6226(b)(2) by reference to the amount that a partner’s chapter 1 tax “would” increase or decrease if the partner’s share of adjustments “were taken into account” in the first affected year or in the case of an intervening year, the amount by which such tax would increase or decrease by reason of the adjustment to tax attributes. An adjustment to a tax attribute is any tax attribute which “would have been affected” if the adjustments “were taken into account” in the first affected year. 

Accordingly, in the case of an increase in tax that would result in the first affected year or any intervening year if the adjustments were taken into account, no overpayment results for any year because there is an increase in tax, not a decrease. In the case of a decrease in tax that would result in the first affected year or any intervening year if the adjustments were taken into account, there is no overpayment because the determination of a decrease in tax is merely by reference to the relevant year to be taken into account as part of the total additional reporting year tax. Therefore, no overpayment interest is due and owing to the partner. 

Pass-through Partners

Section 6226(b)(4) provides that a partnership or S corporation that receives a statement under section 6226(a)(2) must file a partnership adjustment tracking report with the IRS and furnish statements under rules similar to the rules of section 6226(a)(2). If the partnership or S corporation fails to furnish such statements, the partnership or S corporation must compute and pay an imputed underpayment under rules similar to the rules of section 6225.

Statements furnished under §301.6226-3(e)(3)

§301.6226-3(e)(1) provides that each pass-through partner that is furnished a statement described in §301.6226-2 with respect to adjustments of an audited partnership must file and furnish statements to its affected partners. Affected partners are persons that held an interest in the pass-through partner at any time during the taxable year of the pass-through partner to which the adjustments in the statement relate. Consistent with section 6226(b)(4)(B), §301.6226-3(e)(3)(ii) provides that a pass-through partner must furnish such statements no later than the extended due date for the return for the adjustment year of the audited partnership. 

Section 6226(b)(4)(B) expressly provides that statements under section 6226(b)(4)(A) “shall be furnished by not later than the due date for the return for the adjustment year of the audited partnership.” The statute does not provide for an extension beyond the extended due date of the adjustment year return. Under §301.6226-3(e)(3)(ii), the adjustment year return due date is the extended due date under section 6081 regardless of whether the audited partnership is required to file a return for the adjustment year or timely files a request for an extension under section 6081 and the regulations thereunder. The regulations do not provide for discretionary extensions of the time period set forth in §301.6226-3(e)(3)(ii). 

Under §301.6226-3(e)(3)(iii), each statement furnished by a pass-through partner must include correct information concerning certain enumerated items. These items include the name and TIN of the affected partner to whom the statement is being furnished as well as any other information required by forms, instructions, and other guidance prescribed by the IRS. 

The regulations require that a push out statement furnished under §301.6226-3(e) include the partner’s TIN “or alternative form of identification as prescribed by forms, instructions, or other guidance.” See also §301.6226-2(e) (imposing the same requirement for push out statements furnished to reviewed year partners). In addition, the election under §301.6226-1 by the audited partnership must include the TIN “or alternative form of identification as prescribed by forms, instructions, or other guidance” for each reviewed year partner of the partnership. See §301.6226-1(c)(3)(ii).

§301.6226-3(e)(3)(iii)(M) provide that the information required to be included in statements furnished to affected partners regarding the applicability of penalties, additions to tax, or additional amounts are the determinations made at the audited partnership level pertaining to the applicability of penalties, additions to tax, or additional amounts. This is consistent with the concept that the applicability of penalties is determined at the audited partnership level and that penalties attach to adjustments as they are pushed out through the tiers. An affected partner that pays an imputed underpayment or additional reporting year tax independently determines the amount of any penalty applicable to adjustments that are taken into account by the affected partner. 

§301.6226-3(e)(4)(iv)(B) provides that when determining interest on an imputed underpayment paid by a pass-through partner, the imputed underpayment is treated as if it were a correction amount for the first affected year. This conforms §301.6226-3(e)(4)(iv)(B) with the language in §301.6226-3(c) regarding interest on correction amounts.

Modifications available to pass-through partner paying an imputed underpayment.

If a pass-through partner does not furnish statements, the pass-through partner must compute and pay an imputed underpayment in accordance with §301.6226-3(e)(4). Section 6226(b)(4)(A)(ii)(II); §301.6226-3(e)(2). Pursuant to §301.6226-3(e)(4)(iii), this imputed underpayment is computed in the same manner as an imputed underpayment under section 6225 and §301.6225-1. In calculating an imputed underpayment under §301.6226-3(e)(4)(iii), a modification is taken into account if it was approved by the IRS under §301.6225-2 with respect to the pass-through partner (or any relevant partner holding its interest in the audited partnership through the pass-through partner) and it is reflected on the statement furnished to the pass-through partner. Any modification that was not approved by the IRS under §301.6225-2 may not be taken into account. §301.6226-3(e)(4)(iii). 

Section 6226(b)(4)(A)(ii)(II) provides that a partnership may compute and pay an imputed underpayment under rules similar to the rules of section 6225 (other than section 6225(c)(2), (7), and (9)). Section 6226(b)(4)(A)(ii)(II) does not explicitly carve out section 6225(c)(8), which provides that any modification of the imputed underpayment amount under section 6225(c) shall be made only upon approval of such modification by the Secretary. Consistent with section 6225(c)(8), §301.6226- 3(e)(4)(iii) only allows modifications approved by the IRS under proposed §301.6225-2 to be taken into account in calculating an imputed underpayment with respect to a pass- through partner. Modifications approved by the IRS under §301.6225-2 are only those modifications requested by the audited partnership and approved during the administrative proceeding with respect to the audited partnership. See §301.6225-2(b). A pass-through partner may not use modifications that were not requested or approved in the administrative proceeding with respect to the audited partnership in calculating its imputed underpayment under §301.6226-3(e)(4). 

Partnership adjustments are determined at the partnership level. Section 6221(a). The imputed underpayment is a partnership-related item and therefore modifications to the imputed underpayment are determined at the partnership level. The modification provisions under §301.6225-2 provide the method for determining whether and to what extent a modification should be allowed. 

Payment of additional reporting year tax by affected partners

§301.6226-3(e)(3)(iv) provides that affected partners that are not pass-through partners must take into account their share of adjustments reflected on a statement furnished under §301.6226-3(e)(3) in accordance with §301.6226-3(e). When taking into account the adjustments, an affected partner that is not a pass-through partner bases its reporting year on the date the audited partnership furnished its statements to its reviewed year partners. As a result, the reporting year of an affected partner that is not a pass-through partner will be the same taxable year as the reporting year of a reviewed year partner that is also not a pass-through partner. 

§301.6226-3(e)(3)(iv) provides that the IRS will not impose any additions to tax under section 6651 related to any additional reporting year tax if an affected partner that is not a pass-through partner reports and pays any additional reporting year tax within 30 days of the extended due date for the return for the adjustment year of the audited partnership. 

An affected partner may also request that any additions to tax under section 6651 be abated due to reasonable cause. Nothing in the regulations under the centralized partnership audit regime alters the mechanisms by which a taxpayer may raise a reasonable cause defense in response to a proposed penalty. Existing regulations under §301.6651-1(c)(1) and the Internal Revenue Manual provide procedures for raising a reasonable cause defense to avoid an addition to tax under section 6651. If an addition to tax under section 6651 is asserted because a taxpayer did not pay the entire additional reporting year tax within 30 days of the extended due date of the audited partnership’s adjustment year return, the taxpayer may follow those  existing procedures to raise any reasonable cause and good faith defense that may be applicable to the taxpayer’s delay in payment.

Qualified Investment Entities and MLPs

§301.6226-3(b)(4) provides rules for qualified investment entities (QIEs), such as real estate investment trusts and regulated investment companies, to utilize the deficiency dividend procedures under section 860 when taking into account the adjustments under section 6226(b).