Monday, February 10 Login

Taxpayers often use entities characterized as partnerships for federal income tax purposes to conduct their business activities. In addition to offering limited liability (e.g., limited liability companies and limited partnerships), these entities provide flexibility for their partners in structuring business arrangements. Therefore, it is not surprising that the IRS has noticed a significant uptick in partnership income tax return filings in the last decade.

Congress also noticed. In late 2015, it enacted the Bipartisan Budget Act of 2015 (BBA), which significantly changed the existing partnership audit and collection rules known as TEFRA, the latter of which had been in place since 1982. Generally, the BBA audit rules apply to partnership tax returns for the 2018 and later tax years.

Buried within the BBA audit rules are strict requirements applicable to amending a partnership income tax return—known as making an administrative adjustment request (AAR). Unfortunately, filing an AAR is usually not an easy process. Taxpayers and tax professionals alike must ensure care in filing the proper forms while also taking care to understand the consequences of the AAR filing to the BBA partnership and its partners. Their failure to do so may result in additional IRS scrutiny and unforeseen circumstances, such as an extension of the statute of limitations for assessment of income tax.

The BBA Audit Rules Generally

Under the BBA, all partnerships are subject to the new centralized audit and collection rules unless the partnership, through its partnership representative, makes a timely election out of the rules. To make an election out of the BBA, the partnership must have 100 or fewer partners and all such partners must be “eligible partners,” i.e., individuals, C corporations, S corporations, and estates of a deceased partner. For purposes of the 100-or-fewer-partner rule, the BBA requires S corporation partners to include their shareholders in the computation.

[Note: Because partnership partners and trust partners are ineligible partners, many partnerships may not make an election out of the BBA.]

Partnership Tax Returns

Partnerships report their business activities to the IRS on Form 1065, U.S. Return of Partnership Income. In addition, partnerships must file and provide their partners with Schedules K-1, Partner’s Share of Income, Deductions, Credits, etc. In turn, partners use the Schedules K-1 to report their allocable share of partnership items on their own income tax returns (e.g., Form 1040, U.S. Individual Income Tax Return).

Under the BBA audit rules, the partners of a partnership must generally report the items reported to them on Schedules K-1 consistently and without change. If a partner disagrees with the partnership’s manner of Schedule K-1 reporting, the partner must file a Form 8082, Notice of Inconsistent Treatment or Administrative Adjustment Request (AAR), to notify the IRS of the different reporting position. Partners that fail to file a Form 8082 in these circumstances run the risk of the IRS making a mathematical or clerical adjustment and imposing penalties.

Administrative Adjustment Request

Of course, there are numerous reasons a partnership may want to change a prior year partnership income tax return. For example, the partnership may discover, after the filing, that it erroneously omitted income or failed to claim deductions that it was entitled to claim. Under the BBA audit rules, a partnership cannot simply file an amended partnership income tax return to make these revisions. Rather, the BBA partnership must comply with the filing requirements applicable to making an AAR.

Generally, the AAR-filing mechanism will differ depending on whether the partnership wants to make the AAR electronically or on paper. If the partnership files an AAR electronically, it must file a Form 1065 and Form 8082. In addition, the partnership should check Box G(5) on the Form 1065 to alert the IRS that the filing relates to an “Amended Return.” Conversely, if the BBA partnership files an AAR on paper, it must file a Form 1065-X, Amended Return or Administrative Adjustment Request (AAR).

[Note: In many instances, the partnership may not have the option to file electronically or via paper. Effective January 1, 2024, partnerships must file their partnership income tax returns electronically if the partnership files 10 or more returns of any type during the tax year, including information, income tax, and employment tax returns. The IRS can impose penalties against the partnership if it files on paper where it was otherwise required to file electronically.]

Additional Complexities in Making an Administrative Adjustment Request

In addition to the filing mechanics mentioned above, the partnership must also determine whether the adjustments result in an “imputed underpayment,” a concept new to the BBA audit rules. Very generally, imputed underpayments mean the partnership has requested an AAR adjustment that will result in more income tax (e.g., omitted income). Under the BBA audit rules, the partnership must pay income tax associated with an imputed underpayment unless the partnership makes a timely and valid “push-out” election. With a push-out election, the partners for the year in which the AAR adjustment relates–referred to as the “reviewed-year partners”–must report the flow-through adjustments on their income tax returns and pay the corresponding income tax.

If the partnership files an AAR and wants to make a push-out election, it must file (in addition to the forms mentioned above): (i) Form 8985, Pass-Through Statement – Transmittal/Partnership Adjustment Tracking Report, and (ii) Forms 8986, Partner’s Share of Adjustment(s) to Partnership-Related Items. The partnership must also provide Forms 8986 to its partners.

If some or all of the AAR adjustments do not result in an imputed underpayment, the reviewed-year partners must take into account the adjustments. In these instances, and similar to a push-out election, the partnership must file Forms 8985 and 8986.

Finally, IRS guidance indicates that a partnership filing an AAR must always include a computation of the imputed underpayment, even if the imputed underpayment is zero or the adjustments do not result in an imputed underpayment.

[Note: Partnerships that plan to file an AAR should be cognizant of the preparation time and costs associated with filing the forms, including Forms 8985 and 8986, if applicable. Under IRS guidance, the Forms 8985 and 8986 must be filed with the AAR. Although outside the scope of this article, partnerships with flow-through partners should also be aware that making a push-out election will result in additional preparation time and costs at the flow-through partner level.]

Other Considerations

In addition to the filing mechanics above, there are other considerations partnerships and tax professionals should take into account prior to making an AAR. First, an AAR filing may result in the IRS having additional time to examine the partnership income tax return. Specifically, the applicable BBA statute provides that the IRS may initiate an examination within three years of an AAR filing. In these instances, the IRS may have authority to audit items that were not subject to the AAR.

Second, there are restrictions on AAR filings. For example, a partnership may not file an AAR after the IRS initiates an examination of the partnership. In addition, a partnership has a limited amount of time to file an AAR–that is, by statute, within three years of the later of: (i) the partnership income tax return filing date, or (ii) the partnership income tax return filing deadline (without extensions).

Read the full article here

Share.
Leave A Reply

© 2025 Breaking News Today. All Rights Reserved.