Centralized Partnership Audit Regime

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 301

RIN 1545-BN77

[REG-136118-15]

Centralized Partnership Audit Regime

AGENCY:

Internal Revenue Service (IRS), Treasury.

ACTION:

Notice of proposed rulemaking, notice of public hearing, and withdrawal of notice of proposed rulemaking.

SUMMARY:

This document contains proposed regulations regarding implementation of section 1101 of the Bipartisan Budget Act of 2015 (BBA), which was enacted into law on November 2, 2015. Section 1101 of the BBA repeals the current rules governing partnership audits and replaces them with a new centralized partnership audit regime that, in general, assesses and collects tax at the partnership level. These proposed regulations provide rules for partnerships subject to the new regime, including procedures for electing out of the centralized partnership audit regime, filing administrative adjustment requests, and the determination of amounts owed by the partnership or its partners attributable to adjustments that arise out of an examination of a partnership. The proposed regulations also address the scope of the centralized partnership audit regime and provide definitions and special rules that govern its application, including the designation of a partnership representative. The proposed regulations affect partnerships for taxable years beginning after December 31, 2017 and any partnerships that elect application of the centralized partnership audit regime pursuant to § 301.9100-22T for taxable years beginning after November 2, 2015 and before January 1, 2018. This document also provides notice of a public hearing on these proposed regulations. This document also withdraws the notice of proposed rulemaking published in the

Federal Register

on February 13, 2009 (74 FR 7205), regarding the conversion of partnership items related to listed transactions.

DATES:

Written or electronic comments must be received by August 14, 2017. Outlines of topics to be discussed at the public hearing scheduled for September 18, 2017, at 10 a.m. must be received by August 14, 2017.

ADDRESSES:

Send submissions to: CC:PA:LPD:PR (REG-136118-15), Room 5207, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be hand delivered Monday through Friday between the hours of 8:00 a.m. and 4:00 p.m. to CC:PA:LPD:PR (REG-136118-15), Courier's Desk, Internal Revenue Service, 1111 Constitution Avenue NW., Washington, DC 20224. Alternatively, taxpayers may submit comments electronically via the Federal eRulemaking Portal at

www.regulations.gov

(IRS REG-136118-15).

FOR FURTHER INFORMATION CONTACT:

Concerning the proposed regulations, Jennifer Black of the Office of Associate Chief Counsel (Procedure and Administration), (202) 317-6834; concerning the submission of comments and requests for a public hearing, Regina Johnson, (202) 317-6901 (not toll-free numbers).

Background

This document contains proposed regulations to amend the Procedure and Administration Regulations (26 CFR part 301) under Subpart—Tax Treatment of Partnership Items to implement the centralized partnership audit regime enacted by section 1101 of the BBA, Public Law 114-74.

1. In General

The BBA was enacted on November 2, 2015, and was amended by the Protecting Americans from Tax Hikes Act of 2015, Public Law 114-113, div. Q (PATH Act) on December 18, 2015. Section 1101(a) of the BBA removes subchapter C of chapter 63 of the Internal Revenue Code (Code) effective for partnership taxable years beginning after December 31, 2017. Subchapter C of chapter 63 contains the unified partnership audit and litigation rules that were enacted as part of the Tax Equity and Fiscal Responsibility Act of 1982, Public Law 97-248 (TEFRA). These partnership audit and litigation rules are commonly referred to as the TEFRA partnership procedures or simply TEFRA.

Section 1101(b) of the BBA also removes subchapter D of chapter 63 of the Code (subchapter D) and part IV of subchapter K of chapter 1 of the Code (part IV of subchapter K), rules applicable to electing large partnerships, effective for partnership taxable years beginning after December 31, 2017. Subchapter D contains the audit rules for electing large partnerships, and part IV of subchapter K prescribes the income tax treatment for such partnerships.

Section 1101(c) of the BBA replaces the rules to be removed by section 1101(a) and (b) with a centralized partnership audit regime. Section 1101(c) adds a new subchapter C to chapter 63, consisting of sections 6221 through 6241 of the Code. The BBA also makes related and conforming amendments to other provisions of the Code.

Pursuant to section 1101(g)(1) of the BBA, the amendments made by section 1101, which repeal the TEFRA partnership procedures and the rules applicable to electing large partnerships and which create the centralized partnership audit regime, generally apply to returns filed for partnership taxable years beginning after December 31, 2017. Section 1101(g)(2) provides that, in the case of an administrative adjustment request under section 6227 as amended by the BBA, the amendments made by section 1101 apply to requests with respect to returns filed for partnership taxable years beginning after December 31, 2017. Similarly, section 1101(g)(3) provides that, in the case of an election to use the alternative to payment of the imputed underpayment by the partnership under section 6226 as amended by the BBA, the amendments made by section 1101 apply to elections with respect to returns filed for partnership taxable years beginning after December 31, 2017.

Section 1101(g)(4) provides that a partnership may elect (at such time and in such form and manner as the Secretary may prescribe) for the amendments made under section 1101 (other than the election out of the centralized partnership audit regime under section 6221(b) as added by the BBA) to apply to any return of a partnership filed for partnership taxable years beginning after November 2, 2015 (the date of the enactment of the BBA) and before January 1, 2018.

On December 18, 2015, President Obama signed into law the PATH Act. Section 411 of the PATH Act corrects and clarifies certain amendments made by the BBA. The amendments under the PATH Act are effective as if included in section 1101 of the BBA, and therefore, subject to the effective dates in section 1101(g) of the BBA.

On August 5, 2016, the Treasury Department and the IRS published temporary regulations (TD 9780, 81 FR 51795) and a notice of proposed rulemaking (REG-105005-16, 81 FR 51835) in the

Federal Register

. The temporary regulations set forth in § 301.9100-22T provide the time, form, and manner for a partnership to make an election pursuant to section

1101(g)(4) of the BBA to have the centralized partnership audit regime apply to any of its partnership returns filed for a partnership taxable year beginning after November 2, 2015 and before January 1, 2018. Section 301.9100-22T(a) provides the general rule that a partnership may elect at the time and in such form and manner as described in § 301.9100-22T for amendments made by section 1101 of the BBA, except section 6221(b) added by the BBA, to apply to any return of the partnership filed for an eligible taxable year (as defined in § 301.9100-22T(d)).

On December 6, 2016, Congress introduced the Tax Technical Corrections Act of 2016 (H.R. 6439, S. 3506) (Tax Technical Corrections Act) which contains what are described as technical corrections to the centralized partnership audit regime and other corrections to the Bipartisan Budget Act of 2015. The Tax Technical Corrections Act addresses a number of the provisions of the centralized partnership audit regime enacted as part of BBA. The Tax Technical Corrections Act, however, was not enacted by Congress.

2. Specific Provisions

A. Scope of the Centralized Partnership Audit Regime

Section 6221(a), as added by the BBA, provides the scope of items that are subject to adjustment under the centralized partnership audit regime. That section provides that any adjustment to items of income, gain, loss, deduction, or credit of a partnership for a partnership taxable year (and any partner's distributive share thereof) shall be determined, and any tax attributable thereto shall be assessed and collected, at the partnership level. The applicability of any penalty, addition to tax, or additional amount which relates to an adjustment to any such item or share shall also be determined at the partnership level.

Prior to the enactment of TEFRA, any adjustment to an item attributable to a partner's interest in a partnership required the IRS to open an examination for each partner and follow deficiency procedures to adjust items from a partnership and determine the resulting tax. Separate proceedings for each partner often resulted in inconsistent treatment of various partners with respect to the same items from a partnership. In some cases, inconsistent results occurred in the partner-level examinations themselves. In other cases, not all partners allocated the same items from the partnership were subject to an IRS examination because, for instance, the period of limitations on assessment had expired for some, but not all, partners. In addition, each partner could challenge the IRS adjustment in separate partner-level proceedings in different litigation forums and appellate venues, resulting in different outcomes with respect to the same partnership item. Over time, the size and complexity of partnerships increased, multiplying the disparate treatment of partners with respect to the same items from a partnership and increasing the burden on the IRS in examining and assessing tax related to partnership issues at the partner level.

In 1982, in response to these difficulties, Congress enacted the TEFRA partnership procedures to establish unified rules to allow the IRS to make adjustments to “partnership items” at the partnership level in one proceeding. Partnership items are those items that are more appropriately determined at the partnership level than at the partner level, as provided by regulation. Section 6231(a)(3) (prior to amendment by the BBA). The regulations under section 6231 (prior to amendment by the BBA) define partnership items by listing the items that are more appropriately adjusted at the partnership level within the framework of TEFRA. § 301.6231(a)(3)-1. Items on a partner return that are not partnership items are not subject to adjustment at the partnership level by the IRS under TEFRA, but rather are adjusted with respect to each partner at the partner level in a proceeding outside of the TEFRA regime (generally, under deficiency procedures).

Once a TEFRA proceeding is final, the IRS makes corresponding computational adjustments to each partner's return to reflect the proper treatment of partnership items. Section 6230(a)(1) (prior to amendment by the BBA). A computational adjustment may include adjustments to “affected items” of the partner. § 301.6231(a)(6)-1. An “affected item” is any item on a partner's return that is affected by a partnership item. Section 6231(a)(5) (prior to amendment by the BBA). When making a computational adjustment, if partner-level factual determinations are necessary to properly determine the tax, the IRS is required to follow the deficiency procedures at the partner level. Section 6230(a)(2)(A)(i) (prior to amendment by the BBA). Any item on the partner's return that is neither a partnership item nor an affected item is not subject to TEFRA and must be adjusted in a separate deficiency proceeding.

See, e.g.,

Bedrosian

v.

Commissioner,

144 T.C. 152, 159 (2015);

see also

section 6230(a)(2)(B) (prior to amendment by the BBA),

Desmet

v.

Commissioner,

581 F.3d 297, 302 (6th Cir. 2009).

The TEFRA partnership procedures automatically exempt certain partnerships with ten or fewer direct partners. Section 6231(a)(1)(B) (prior to amendment by the BBA). For those small partnerships, the IRS must follow deficiency procedures for each partner, which requires the IRS to adjust items from the partnership on each partner's return and to assess the resulting tax subject to the deficiency procedures in a separate proceeding at the partner level.

Since the enactment of TEFRA, the number and complexity of partnerships have continued to increase. The number of large partnerships, in particular, has increased dramatically. In 1997, Congress recognized some of the difficulties facing the IRS under TEFRA when auditing complex, large partnership structures and in response enacted a streamlined, elective audit regime for certain large partnerships (ELP regime). Sections 6240 through 6255 (prior to amendment by the BBA). The ELP regime allowed certain partnerships with 100 or more partners to elect the application of simplified reporting rules and a centralized audit regime with features similar to the regime enacted under the BBA. The ELP regime was a legislative response to the recognition that:

[a]udit procedures for large partnerships are inefficient and more complex than those for other large entities. The IRS must assess any deficiency arising from a partnership audit against a large number of partners, many of whom cannot easily be located and some of whom are no longer partners. In addition, audit procedures are cumbersome and can be complicated further by the intervention of partners acting individually.

Joint Comm. on Taxation, JCS-23-97,

General Explanation of Tax Legislation Enacted in 1997,

363 (1997).

Since 1997, the number and complexity of partnerships has continued to increase, reflecting a shift in how business entities are structured—toward partnerships and away from C corporations. The ELP regime attempted to address some of the difficulties the IRS faced auditing large partnerships under TEFRA; however, the ELP regime is elective and only a handful of partnerships elected application of the ELP regime.

In 2013, Congress requested that the Government Accountability Office (GAO) investigate partnerships and the IRS's audit rate of partnerships. The GAO report concluded that from 2002 to 2011 “the number of large partnerships

with 100 or more direct and indirect partners as well as $100 million or more in assets more than tripled to 10,099—an increase of 257 percent.” U.S. Gov't Accountability Office, GAO-14-732,

Large Partnerships: With Growing Number of Partnerships, IRS Needs to Improve Audit Efficiency,

13 (2014) (GAO-14-732). And yet, as the number of large partnerships increased, the number of partnership audits did not keep pace. Compared to the audit rate for large corporations, which was 27.1 percent in 2012, the audit rate for large partnerships was much lower at 0.8 percent. (Large partnership is defined for purposes of the GAO report as a partnership with 100 or more direct and indirect partners and $100 million or more in assets.) GAO-14-732, cover page, summary.

When the IRS completes an examination of a large partnership under TEFRA, the IRS must pass the audit adjustments to partnership items on to the ultimate partners, a complex and time-consuming process. This requires the IRS to link potentially thousands of partner returns, including through tiers of partners that are themselves partnerships, to determine the proper share of the adjustments for each ultimate partner flowing from adjustments to partnership items. This process is “paper and labor intensive. When hundreds of partners' returns have to be adjusted, the costs involved limit the number of audits IRS can conduct.” GAO-14-732, cover page, summary. In the meantime, while the IRS is determining these linkages, the period of limitations for the IRS to assess tax with respect to each partner continues to run.

Specifically, the GAO reported that without “legislative action, the IRS's ability [to effectively audit]” partnerships would not improve. GAO-14-732, cover page, summary. At the time of the 2014 GAO report, Congress and the Administration had put forth legislative proposals that “would allow IRS to collect tax at the partnership level instead of having to pass it through to the taxable partners.” GAO-14-732 at 31.

In 2015, Congress enacted the BBA to replace the TEFRA partnership procedures and the ELP regime with the centralized partnership audit regime, which contained many aspects of the legislative proposals referenced in the GAO report. The centralized partnership audit regime, when fully effective for partnership taxable years beginning after December 31, 2017, will be the exclusive method by which the IRS may audit a partnership in one unified proceeding. For those partnerships that will be subject to the centralized partnership audit regime that were previously exempt from TEFRA (for example, a partnership with no more than 10 partners, none of which is a pass-through entity), the centralized partnership audit regime replaces the separate partner-level deficiency proceedings as the sole method for auditing the partnership unless an eligible partnership elects out of the centralized regime.

The centralized partnership audit regime enacted in the BBA addresses many of the shortcomings of TEFRA identified by the GAO and practitioners. For instance, “unlike prior law, distinctions between partnership items and affected items are no longer made” in the centralized partnership audit regime. Joint Comm. on Taxation, JCS-1-16,

General Explanations of Tax Legislation Enacted in 2015,

57 (2016) (JCS-1-16). Instead, section 6221(a) provides that the centralized partnership audit regime applies to any adjustment to items of income, gain, loss, deduction, or credit of a partnership for a partnership taxable year and any partner's distributive share thereof.

Under TEFRA, the statute broadly defines a partnership item as any item more appropriately determined at the partnership level. Section 6231(a)(3) (prior to amendment by the BBA). In keeping with the statute, the regulations under TEFRA broadly define the term partnership item to include all items of income, gain, deduction, loss, or credit, as well as other related items such as expenditures, tax preferences, exempt income, partnership liabilities, guaranteed payments, certain basis adjustments, character and the percentage of partnership interests, and items arising from the determination at the partnership level of partnership assets, investments, transactions and operations, such as investment tax credits and at risk rules. See generally § 301.6231(a)(3)-1.

Nothing in the text or legislative history of the BBA, or the events leading to enactment of the new regime, indicates that Congress's use of the phrase “income, gain, deduction, loss, or credit” in section 6221(a) was intended to adopt a more limited set of items to be adjusted at the partnership level than the items included in the broad definition of partnership items under the TEFRA regulations. It would be illogical to conclude that Congress intended to limit the scope of what the IRS could adjust at the partnership level under an expanded centralized partnership audit regime. Such a narrow interpretation could mean that rather than increase the ability of the IRS to audit large partnerships in one unified proceeding, BBA would significantly increase the number of issues affecting partnerships that the IRS would be required to audit at the partner level, meaning that in large partnerships with thousands of partners, the IRS would have to audit issues related to the same partnership multiple times, for each partner, rather than just once at the partnership level. Given the GAO's criticism in GAO-14-732 of the low partnership audit rate, it does not follow that Congress enacted a new partnership audit regime that weakens the IRS's ability to conduct audits at the partnership level and forces the IRS to open additional partner-level proceedings to re-audit the same partnership.

The centralized partnership audit regime purposefully avoids the terms partnership items, affected items, computational adjustments, and nonpartnership items that caused so much litigation under TEFRA and does so by adopting the single phrase “income, gain, deduction, loss, or credit” as the scope of the regime. Removing the distinctions between the different types of items and adjustments was an effort to streamline the examination and judicial process to allow centralized collection of the correct amount of tax had the partnership and the partners reported items from the partnership correctly. The centralized partnership audit regime limits the burden on the IRS in both the examination of partnerships and the judicial process—changes that were designed to increase the ability of the IRS to audit large partnerships. IRS received comments in response to Notice 2016-23, 2016-13 I.R.B. 490, that agreed that the use of the term “income, gain, deduction, loss, or credit” in the centralized partnership audit regime was an attempt to reduce the challenges the IRS faced under TEFRA and does not limit the scope of items subject to audit, assessment, and collection at the partnership level.

Under the centralized partnership audit regime, the IRS is no longer required to determine each partner's share of the adjustments made to partnership items followed by a separate computational adjustment for each partner to assess the correct tax due as a result of the partnership audit. Instead, under the default rules of section 6225, the partnership is liable for an imputed underpayment based on the adjustments made at the partnership level. The imputed underpayment calculation may, for some partnerships, overstate the amount of tax due had the

partnership and partners reported the partnership adjustments properly. To correct potential overstatements, the centralized partnership audit regime includes modification procedures and provides additional discretionary authority for the IRS to further modify imputed underpayments to carry out the function of the modification provision. The Joint Committee on Taxation observed that the intent of the modification provision is to “determine the amount of tax due as closely as possible to the tax due if the partnership and partners had correctly reported and paid while at the same time to implement the most efficient and prompt assessment and collection of tax attributable to the income of the partnership and partners.” JCS-1-16 at 65-66.

To reach the correct amount of tax, the IRS makes one set of adjustments at the partnership level and allows the partnership, through modification, to adjust the imputed underpayment amount down to the correct amount of tax. To determine the amount of an imputed underpayment that reflects “tax due as closely as possible to the tax due if the partnership and partners had correctly reported and paid,” the breadth of what the IRS must be able to adjust at the partnership level must be at least as broad as the different type of adjustments made under TEFRA.

Furthermore, under the modification provisions, the partnership (and its partners if they may amend their returns) takes on the burden of further refining the adjustments to reflect the correct amount of tax. Where all partners amend their returns taking all of the adjustments into account, the IRS, the partnership and its partners have effectively mirrored the result of a TEFRA audit, including the final partner-level computational adjustments. This can only be possible if the scope of what the IRS may adjust at the partnership level is sufficiently broad.

As such, the proposed regulations take an expansive view of the scope of the centralized partnership audit regime to cover all items and information related to or derived from the partnership. Accordingly, under proposed § 301.6221(a)-1 all items required to be shown or reflected on the partnership's return and information in the partnership's books and records related to a determination of such items, as well as factors that affect the determination of items of income, gain, loss, deduction, or credit, are subject to determination and adjustment at the partnership level under the centralized partnership audit regime.

B. Election Out of the Centralized Partnership Audit Regime

In general, the centralized partnership audit regime applies to all partnerships with partnership taxable years beginning after December 31, 2017 for any partnership (domestic or foreign) required to file a return under section 6031. Section 6241(1). Section 6221(b), as added by the BBA, allows eligible partnerships to elect out of the centralized partnership audit regime. The fact that all partnerships are covered by the centralized partnership audit regime unless they elect out distinguishes the centralized partnership audit regime from the TEFRA partnership procedures. Under TEFRA, only partnerships with more than 10 partners and partnerships with at least one partner that is not a U.S. individual, a C corporation, or an estate of a deceased partner are automatically covered by the regime. Section 6231(a)(1)(B) (prior to amendment by the BBA). However, partnerships not automatically subject to TEFRA can make an affirmative election into TEFRA. Section 6231(a)(1)(B)(ii) (prior to amendment by the BBA).

Partnerships that elect out of the centralized partnership audit regime are subject to the pre-TEFRA audit procedures under which the IRS must separately assess tax with respect to each partner under the deficiency procedures under subchapter B of chapter 63. As described in section 2.A. of the Background section of this preamble, enactment of TEFRA was a reaction to the complexity and burden of the pre-TEFRA deficiency procedures in the case of partnerships; however, since TEFRA was enacted, the IRS and taxpayers have identified numerous issues with that regime. The centralized partnership audit regime is intended to simplify TEFRA's burdensome processes and to increase the IRS's ability to examine partnerships, particularly large and tiered partnerships, and to make the process of assessing tax resulting from those audits more efficient. The limited opt-out nature of the centralized partnership audit regime, which requires the partnership to take affirmative action to elect out of the regime, increases the likelihood that a partnership will be subject to the more streamlined adjustment, assessment, and collection procedures of the centralized partnership audit regime, thereby increasing the number of partnerships the IRS is able to examine under the centralized partnership audit regime. Limiting the number of partnerships that can elect out of the centralized partnership audit regime to those entities specifically permitted under the statute is necessary to carry out this goal.

There are two conditions that must be met for a partnership to be eligible to elect out of the centralized partnership audit regime. First, a partnership must have 100 or fewer partners. Under the statute, a partnership has 100 or fewer partners when it is required to furnish 100 or fewer statements under section 6031(b), currently Schedule K-1,

Partner's Share of Income, Deductions, Credits, etc.

(Schedules K-1), for the taxable year. Section 6221(b)(1)(B). For partnerships that have an S corporation as a partner (S corporation partner), special rules under section 6221(b)(2)(A) apply for purposes of determining the number of Schedules K-1 furnished by the partnership. Under that rule, the number of statements required to be furnished by the S corporation partner to its own shareholders under section 6037(b) for the taxable year, currently Schedule K-1,

Shareholder's Share of Income, Deductions, Credits, etc.,

are taken into account to determine the number of statements furnished by the partnership for purposes of section 6221(b)(1)(B). Section 6221(b)(2)(A)(ii).

Second, a partnership must only have eligible partners. Under the statute, eligible partners are individuals, C corporations, foreign entities that would be treated as C corporations if they were domestic, S corporations, and estates of deceased partners. Section 6221(b)(1)(C). Under section 6221(b)(1)(D)(i), a partnership may elect out of the centralized partnership audit regime only on a timely filed return for a taxable year (including extensions).

A partnership must include, in the manner prescribed by the Secretary, a disclosure of the name and taxpayer identification number (TIN) of each partner of the partnership. Section 6221(b)(1)(D)(ii). In the case of an election out by a partnership with an S corporation partner, the election also must include, in the manner prescribed by the Secretary, a disclosure of the name and TIN of each person to whom an S corporation partner is required to furnish a statement for the taxable year of the S corporation ending with or within the partnership taxable year that is subject to the election. Section 6221(b)(2)(A)(i). A partnership must notify each partner of the election in the manner prescribed by the Secretary. Section 6221(b)(1)(E).

Section 6221(b)(2)(B) permits the Secretary to prescribe alternative identification procedures for foreign partners. The Secretary may by

regulation or other guidance prescribe rules similar to the rules applicable to S corporations with respect to any partners not described in section 6221(b)(1)(C). Section 6221(b)(2)(C).

C. Consistent Treatment

i. Consistent Treatment Under TEFRA

TEFRA includes a requirement that a partner treat items from the partnership consistent with the partnership's treatment of such items on the partnership's return. Section 6222 (prior to amendment by the BBA). TEFRA permits the partner to notify the IRS of inconsistent treatment of an item by the partner on the partner's return and avoid having a computational adjustment made to the inconsistently treated item without the IRS first completing a proceeding at the partnership level. The IRS could either accept the partner's inconsistent treatment of the item, open up an audit of the partnership to address the item at the partnership level, or open up audit of the partner to address the inconsistent item. If the IRS examined the partnership or the partner, all items for that taxable year would be subject to the examination.

Section 6222, as amended by the BBA, includes a similar requirement of consistency and rules for notification of the inconsistency, but the consequences of failing to treat items consistently are different. Under TEFRA, the consequence of filing inconsistently is that the IRS is not required to conduct a partnership-level proceeding before making computational adjustments at the partner level and assessing any deficiency attributable to the adjustment of an item to make it consistent with the partnership return. Section 6222 now states that any underpayment of tax by a partner resulting from a failure to treat an item consistently shall be assessed and collected as if the underpayment were on account of a mathematical or clerical error appearing on the partner's return, permitting the IRS to immediately assess and collect such tax.

ii. Statutory Provision

Section 6222(a) requires a partner to treat on the partner's return each item of income, gain, loss, deduction or credit attributable to a partnership subject to subchapter C of chapter 63 in a manner that is consistent with the treatment of such item on the partnership return. If the partner fails to comply with the requirements of section 6222(a), any underpayment of tax resulting from that failure may be assessed and collected as if such underpayment were on account of a mathematical or clerical error appearing on the partner's return. Section 6222(b). The procedures under section 6213(b)(2), which permit a taxpayer to request an abatement of a mathematical or clerical error assessment, do not apply in these situations. Section 6222(b).

Section 6222(c) provides an exception for situations in which a partner notifies the IRS of the inconsistent treatment on the partner's return. Under section 6222(c)(1), if the partnership has filed a return and the partner's treatment of an item on the partner's return is (or may be) inconsistent with the treatment of that item on the partnership return, the provisions of section 6222(a) (requiring consistent treatment) and (b) (allowing math error treatment to adjust inconsistent items) will not apply to that item if the partner files with the Secretary a statement identifying the inconsistency. Section 6222(c)(1)(A)(i). The exception also applies if the partnership has not filed a return, and the partner files a statement identifying the inconsistency. Section 6222(c)(1)(A)(ii).

In cases where a partner receives incorrect information in a statement furnished by a partnership, section 6222(c)(2) provides that the partner is treated as having notified the IRS of an inconsistency if the partner satisfactorily demonstrates to the Secretary that the treatment of the item on the partner's return is consistent with the treatment of the item on the statement furnished to that partner by the partnership, and the partner elects to have this provision apply. Under section 6222(d), any final decision with respect to an inconsistent position identified under section 6222(c) in a proceeding to which the partnership is not a party is not binding on the partnership.

D. Partnership Representative and Partners Bound by Actions of the Partnership

Section 6223 provides that each partnership shall designate in the manner prescribed by the Secretary a partner or other person with a substantial presence in the United States as the partnership representative who shall have the sole authority to act on behalf of the partnership. Section 6223(a). In any case in which such designation is not in effect, the statute provides that the Secretary may select any person as the partnership representative. Section 6223(a). A partnership and all partners of such partnership are bound by actions taken under subchapter C of chapter 63 by the partnership and by any final decision in a proceeding brought under subchapter C of chapter 63 with respect to the partnership. Section 6223(b).

Section 6223 and the concept of the partnership representative replace the tax matters partner (TMP) framework that exists under the TEFRA partnership procedures. Under TEFRA, a partnership is required to designate a TMP who acts as a liaison between the partnership and the IRS. That TMP must be a general partner and may be an individual or an entity.

The requirements placed on the designation of the TMP under TEFRA make it difficult in many cases to identify a qualified TMP. First, only general partners of the partnership may be the TMP. Because the TMP has to be a partner, the partnership cannot designate a non-partner, such as a non-partner manager, even if that person is in the best position to understand and have available the partnership's books and records. In some cases, the TMP has to be a particular partner, such as the partner with the highest profits interest, who may not be knowledgeable about the partnership's taxes. See, for example, § 301.6231(a)(7)-1(m)(2).

Even if a qualified TMP is identified, the IRS may be unable to contact the TMP because the TMP is out of the country or simply unreachable. Furthermore, in the case of a TMP that is an entity rather than an individual, the IRS must identify and track down an individual who can act for the entity. As a result, under TEFRA, partnerships and the IRS may spend a significant amount of time determining whether a person designated is even eligible to serve as the TMP before the IRS can proceed with a partnership examination.

Additionally, while the TMP has the authority to bind the partnership, it cannot bind other partners in the partnership. A partner who is not the TMP also has rights during an examination, including certain notification rights and the right to participate in the proceeding. The rights of the partners to intervene in the examination and to contradict the actions taken by the TMP cause confusion during examinations and increase the administrative burden on the IRS.

In contrast, the centralized partnership audit regime introduces the concept of the partnership representative, which is intended to address the shortcomings of the TMP as the representative of the partnership under TEFRA. First, unlike the TMP who must be a partner, a partnership representative can be any person, including a non-partner. This allows the partnership to select the person best

situated to represent the partnership. The only limitation is that the partnership representative must have a substantial presence in the United States. This requirement is intended to ensure that the person selected to represent the partnership will be available to the IRS in the United States when the IRS seeks to communicate or meet with the representative. Like TEFRA, the centralized partnership audit regime does not prescribe whether a partnership representative may be an entity or an individual.

Second, unlike the TMP who could act for the partnership but whose actions did not bind other partners and could be contradicted by those partners, section 6223(b) provides that the partnership representative has the sole authority to bind the partnership, and all partners and the partnership are bound by the actions of the partnership representative and any final decision in a proceeding brought under subchapter C of chapter 63. The centralized partnership audit regime does not include a statutory right to notice of, or to participate in, the partnership-level proceeding for any person other than the partnership and the partnership representative.

E. Imputed Underpayment and Modification of Imputed Underpayment

Section 6225 as amended by the BBA addresses partnership adjustments made by the IRS under the centralized partnership audit regime and the determination of any resulting imputed underpayment. Section 6225(a)(1) provides that in the case of any adjustment by the Secretary in the amount of any item of income, gain, loss, deduction, or credit of the partnership, or any partner's distributive share thereof, the partnership shall pay any imputed underpayment with respect to such adjustment in the adjustment year as provided in section 6232. Any adjustment that does not result in an imputed underpayment must be taken into account by the partnership in the adjustment year. Section 6225(a)(2). Except for an adjustment to an item of credit, which is taken into account as a separately stated item, an adjustment not resulting in an imputed underpayment must be taken into account as a reduction in non-separately stated income or as an increase in non-separately stated loss (whichever is appropriate) in accordance with section 702(a)(8). Section 6225(a)(2)(A)-(B).

An imputed underpayment with respect to a partnership adjustment for the partnership's reviewed year is determined in accordance with section 6225(b). Under that section, adjustments to similar items of income, gain, loss, or deduction are netted with each other, treating any net increase or decrease in loss as a decrease or increase, respectively, in income. Section 6225(b)(1)(A)-(B). The net amount is then multiplied by the highest rate of tax in effect for the reviewed year under section 1 (individual rates) or section 11 (corporate rates). Section 6225(b)(1)(A). The product is then increased or decreased, as the case may be, by any adjustments to items of credit. Section 6225(c).

Section 6225(b)(2) provides that in the case of an adjustment that reallocates the distributive share of an item from one partner to another, such adjustment shall be taken into account when determining the imputed underpayment by disregarding any decrease in any item of income or gain and any increase in an item of deduction, loss, or credit.

Under section 6225(c), a partnership may modify an imputed underpayment under procedures established by the Secretary. Anything required to be submitted to the Secretary under the procedures for modification of the imputed underpayment must be submitted within 270 days following the date the notice of proposed partnership adjustment (NOPPA) is mailed under section 6231 by the IRS, unless that period is extended with the consent of the Secretary. Section 6225(c)(7). Any modification of the imputed underpayment amount shall be made only upon approval of the requested modification by the Secretary. Section 6225(c)(8).

Under section 6225(c)(2), modification procedures shall provide that if one or more partners files amended returns (notwithstanding section 6511) for the taxable year of the partners that includes the end of the reviewed year of the partnership, such returns take into account all adjustments made by the Secretary that are properly allocable to such partners (and for any other taxable year with respect to which a tax attribute is affected by reason of the adjustments made by the Secretary), and payment of any tax due is included with the amended returns, the imputed underpayment shall be determined without regard to the portion of the adjustments taken into account in the amended returns. In the case of any adjustment that reallocates the distributive share of any item from one partner to another, a modification described in section 6225(c)(2) shall apply only if amended returns are filed by all partners affected by such adjustment.

Under section 6225(c)(3), modification procedures shall provide for determining the imputed underpayment without regard to the portion thereof that the partnership demonstrates is allocable to a partner that would not owe tax by reason of its status as a tax-exempt entity (as defined in section 168(h)(2)).

Under section 6225(c)(4), modification procedures shall provide for taking into account a rate of tax lower than the rate of tax described in section 6225(b)(1)(A) (that is, the highest rate under section 1 or section 11) with respect to any portion of an imputed underpayment that the partnership demonstrates is allocable to a partner that is a C corporation or, in the case of a capital gain or qualified dividend, is an individual. In no event shall the lower rate determined under section 6225(c)(4) be lower than the highest rate in effect for the reviewed year with respect to the type of income and taxpayer (that is, a C corporation or an individual). For the purposes of the lower rate for capital gains and qualified dividends, an S corporation shall be treated as an individual. Section 6225(c)(4)(A). The portion of an imputed underpayment to which the lower rate applies with respect to a partner shall be determined by reference to the partner's distributive share of the items to which the imputed underpayment relates. Section 6225(c)(4)(B)(i). If an imputed underpayment is attributable to the adjustment of more than one item, and any partner's distributive share of such items is not the same with respect to all such items, the portion of the imputed underpayment to which the lower rate applies with respect to a partner shall be determined by reference to the amount which would have been the partner's distributive share of net gain or loss if the partnership had sold all of its assets at their fair market value as of the close of the reviewed year of the partnership. Section 6225(c)(4)(B)(ii).

Section 6225(c)(5) provides that, in the case of a publicly traded partnership (as defined in section 469(k)(2)), the modification procedures shall provide for determining the imputed underpayment without regard to the portion thereof that the partnership demonstrates is attributable to a net decrease in a specified passive activity loss that is allocable to a specified partner and for the partnership to take such net decrease into account as an adjustment in the adjustment year with respect to the specified partners to which such net decrease relates. Section 6225(c)(5)(A). For purposes of section 6225(c)(5), the term “specified passive

activity loss” means, with respect to any specified partner of such publicly traded partnership, the lesser of the passive activity loss of such partner which is separately determined with respect to such partnership under section 469(k) with respect to such partner's taxable year in which or with which the reviewed year of such partnership ends, or such passive activity loss so determined with respect to such partner's taxable year in which or with which the adjustment year of such partnership ends. Section 6225(c)(5)(B). For purposes of section 6225(c)(5), the term “specified partner” means any person if such person with respect to each taxable year of such person which is during the period beginning with the taxable year of such person in which or with which the reviewed year of such publicly traded partnership ends and ending with the taxable year of such person in which or with which the adjustment year of such publicly traded partnership ends is (1) a partner of such publicly traded partnership; (2) is described in section 469(a)(2); and (3) has a specified passive activity loss with respect to such publicly traded partnership. Section 6225(c)(5)(C).

Section 6225(c)(6) provides that the Secretary may by regulations or guidance provide for additional procedures to modify imputed underpayment amounts on the basis of such other factors as the Secretary determines are necessary or appropriate to carry out the purposes of section 6225(c).

F. Election for the Alternative to Payment of the Imputed Underpayment

Section 6226 provides an alternative to the general rule under section 6225(a)(1) that the partnership must pay the imputed underpayment. Under section 6226, the partnership may elect to have its reviewed year partners take into account the adjustments made by the IRS and pay any tax due as a result of those adjustments. In this case, the reviewed year partners must pay any tax resulting from taking into account the adjustments and the partnership is not required to pay the imputed underpayment.

In order to elect application of section 6226, a partnership must take two steps with respect to an imputed underpayment. First, the partnership must make an election in the manner provided by the Secretary no later than 45 days after the date the FPA is mailed by the IRS under section 6231. Section 6226(a)(1). Second, the partnership must furnish, at such time and in such manner as provided by the Secretary, a statement of each partner's share of any adjustment as determined in the FPA to its reviewed year partners. Section 6226(a)(2). If the partnership takes these two steps in the time and manner prescribed by the statute and by the Secretary, section 6225 does not apply with respect to the imputed underpayment, and each partner must take its share of the adjustments into account as provided in section 6226(b). Section 6226(a) (flush language). An election under section 6226 is revocable only with the consent of the Secretary.

Id.

Section 6226(b) describes how the adjustments subject to the section 6226 election are taken into account by the reviewed year partners. Under section 6226(b)(1), each partner's tax imposed by chapter 1 of subtitle A of the Code (chapter 1 tax) is increased by the aggregate of the adjustment amounts as determined under section 6226(b)(2). This increase in chapter 1 tax is reported on the return for the partner's taxable year that includes the date the statement described under section 6226(a) is furnished to the partner by the partnership (reporting year).

The adjustment amounts determined under section 6226(b)(2) fall into two categories. In the case of the taxable year of the partner that includes the end of the partnership's reviewed year (first affected year), the adjustment amount is the amount by which the partner's chapter 1 tax would increase for the partner's first affected year if the partner's share of the adjustments were taken into account in that year. Section 6226(b)(2)(A). In the case of any taxable year after the first affected year, and before the reporting year (that is, the intervening years), the adjustment amount is the amount by which the partner's chapter 1 tax would increase by reason of the adjustment to tax attributes determined under section 6226(b)(3) in each of the intervening years. Section 6226(b)(2)(B). The adjustment amounts determined under section 6226(b)(2)(A) and (B) are added together to determine the aggregate of the adjustment amounts for purposes of determining the increase to the partner's chapter 1 tax in accordance with section 6226(b)(1).

Section 6226(b)(3) provides two rules regarding adjustments to tax attributes that would have been affected if the partner's share of adjustments were taken into account in the first affected year. First, in the case of an intervening year, any tax attribute must be appropriately adjusted for purposes of determining the adjustment amount for that intervening year in accordance with section 6226(b)(2)(B). Section 6226(b)(3)(A). Second, in the case of any subsequent taxable year (that is, a year, including the reporting year, that is subsequent to the intervening years referenced in 6226(b)(3)(A)), any tax attribute must be appropriately adjusted. Section 6226(b)(3)(B).

Section 6226(c) provides rules for the treatment of penalties and interest determined under section 6221 at the partnership level when an election is made under section 6226. Notwithstanding the provisions of section 6226(a) and (b) (regarding the requirements for making an election and how partners take into account adjustments), any penalties, additions to tax, or additional amounts are determined under section 6221 at the partnership level, and the reviewed year partners of the partnership are liable for any such penalty, addition to tax, or additional amount. Section 6226(c)(1).

In contrast, section 6226(c)(2) provides that interest is determined at the partner level. Section 6226(c)(2)(A). Interest is calculated from the due date of the partner's return for the taxable year to which the increase in tax is attributable taking into account any increases attributable to a change in tax attributes for an intervening year as determined under section 6226(b)(2). Section 6226(c)(2)(B). The interest is computed at the underpayment rate under section 6621(a)(2), substituting five percentage points for three percentage points for purposes of section 6621(a)(2)(B) (the sum of the federal short-term rate plus five percentage points instead of three percentage points).

G. Administrative Adjustment Requests

Section 6227 provides a mechanism for a partnership to file an administrative adjustment request (AAR) to correct errors on a partnership return for a prior year. A partnership may file a request for administrative adjustment in the amount of one or more items of income, gain, loss, deduction, or credit of the partnership for any partnership taxable year. Section 6227(a). Any adjustment requested in an AAR is taken into account for the partnership taxable year in which the AAR is made. Section 6227(b). Under section 6227, only a partnership may file an AAR. Therefore, a partner who is not also the partnership representative acting on behalf of the partnership may not file an AAR.

Under section 6227(c), a partnership has three years from the later of the filing of the partnership return or the due date of the partnership return (excluding extensions) to file an AAR for that taxable year. However, a

partnership may not file an AAR for a partnership taxable year after the IRS has mailed a notice of an administrative proceeding under section 6231 with respect to that taxable year.

Under section 6227(b), if an adjustment results in an imputed underpayment, the adjustment may be determined and taken into account in one of two ways. The partnership may determine and take the adjustment into account for the partnership taxable year in which the AAR is filed under rules similar to the rules under section 6225, relating to payment of the imputed underpayment by the partnership, except that the provisions under section 6225 pertaining to modification of the imputed underpayment based on amended returns by partners, the time for submitting information to the Secretary for purposes of modification, and approval by the Secretary of any modification do not apply. Section 6227(b)(1). Alternatively, the partnership and the partners may determine and take the adjustment into account under rules similar to the rules under section 6226 relating to the alternative to the partnership payment of the imputed underpayment, except that the additional 2 percentage points of interest imposed under section 6226 does not apply. Section 6227(b)(2).

In the case of an adjustment that would not result in an imputed underpayment, section 6227(b) requires that the partnership and the reviewed year partners must determine and take the adjustment into account under rules similar to the rules under section 6226 with appropriate adjustments. This provision ensures that the partners for the year to which the adjustments relate benefit from any refund that may result from such adjustments.

H. Definitions and Special Rules

i. Definitions

Section 6241(1) defines the term “partnership” for purposes of subchapter C of chapter 63 as any partnership required to file a return under section 6031(a). Section 6241(2) defines the term “partnership adjustment” as any adjustment in the amount of any item of income, gain, loss, deduction, or credit of a partnership, or any partner's distributive share thereof. Section 6241(3) defines the term “return due date” as the due date prescribed for filing the partnership return for such taxable year (determined without regard to extensions).

Section 6225(d)(1) defines the term “reviewed year” as the partnership taxable year to which the item being adjusted relates. Section 6225(d)(2) defines the term “adjustment year” to mean, in the case of an adjustment pursuant to the decision of a court in a proceeding brought under section 6234, the taxable year in which such decision becomes final; in the case of an administrative adjustment request under section 6227, the taxable year in which such administrative adjustment request is made; and, in any other case, the taxable year in which a notice of the final partnership adjustment (FPA) is mailed under section 6231.

ii. Bankruptcy

Section 6241(6)(A) provides that, in a case under Title 11 of the United States Code (Title 11 case), the running of any period of limitations provided in subchapter C of chapter 63 for making a partnership adjustment (or provided in section 6501 or 6502 for the assessment or collection of any imputed underpayment determined under subchapter C of chapter 63) is suspended for the period during which the Secretary is prohibited by reason of the Title 11 case from making the partnership adjustment or assessing or collecting any amounts due under subchapter C of chapter 63. Section 6241(6)(A)(i) provides that in the case of the period of limitations for making adjustments or making an assessment, the suspension period includes an additional 60 days. Section 6241(6)(A)(ii) provides that in the case of the period of limitations on collection, the suspension period includes an additional six months.

Section 6241(6)(A) provides that a rule similar to the rule of section 6213(f)(2) applies for purposes of section 6232(b), the limitation on assessments under subchapter C of chapter 63. Section 6213(f) clarifies that the limitation on assessment under section 6213(a) with respect to deficiencies does not prohibit the Secretary from filing of a proof of claim in a bankruptcy case. Thus, the limitation on assessment under section 6232(b) similarly does not prohibit the filing of a proof of claim in bankruptcy.

Under section 6241(6)(B), the running of the 90-day period to file a petition for readjustment under section 6234 is suspended during the period during which the partnership is prohibited by reason of a bankruptcy case from filing the petition for readjustment and for an additional 60 days.

iii. Other Rules

Section 6241(4) provides that any payments required to be made under subchapter C of chapter 63 are nondeductible under subtitle A.

Section 6241(5) provides the general rule that, for purposes of section 6234 (regarding judicial review of partnership adjustments), a principal place of business located outside the United States is treated as located in the District of Columbia.

Section 6241(7) provides that, where a partnership ceases to exist before a partnership adjustment under subchapter C of chapter 63 takes effect, the partnership adjustment shall be taken into account by the former partners of the partnership pursuant to regulations prescribed by the Secretary.

Section 6241(8) provides that, to the extent provided by regulations, the provisions of subchapter C of chapter 63 shall extend to the taxable year of an entity for which a partnership return is filed by the entity (even if it is determined that the entity is not a partnership or that there is no entity for such taxable year), to the items of such entity, and to any person holding an interest in such entity.

I. Withdrawal of Proposed Regulations Under Section 6231(c)

On February 13, 2009, a notice of proposed rulemaking (REG-138326-07) regarding the conversion of partnership items related to listed transactions was published in the

Federal Register

(74 FR 7205). The proposed regulations were issued under section 6231(c) (prior to amendment by the BBA), which permitted the IRS to issue regulations that address special enforcement areas, that is, areas where the application of the TEFRA partnership procedures would interfere with the effective and efficient enforcement of the internal revenue laws. Written or electronic comments responding to the notice of proposed rulemaking were received, but no public hearing was requested or held. After consideration of all the comments, the Treasury Department and the IRS have decided to withdraw the proposed regulations.

Explanation of Provisions

1. Scope of the Centralized Partnership Audit Regime

Proposed § 301.6221(a)-1(a) provides that all adjustments and items relating to a partnership are determined at the partnership level under the centralized partnership audit regime. Accordingly, the proposed regulations provide that the centralized partnership audit regime covers any adjustment to items of income, gain, loss, deduction, or credit of a partnership and any partner's distributive share of those adjusted items. Further, the proposed regulations provide that any chapter 1 tax resulting

from an adjustment to items under the centralized partnership audit regime is assessed and collected at the partnership level. Under the proposed regulations, the applicability of any penalty, addition to tax, or additional amount which relates to an adjustment to any such item or share is also determined at the partnership level.

Proposed § 301.6221(a)-1(b)(1) defines the phrase “income, gain, loss, deduction, or credit” for purposes of the centralized partnership audit regime broadly so that the phrase includes: The character, timing, source, and amount of items; the character, timing, and source of the partnership's activities; contributions to and distributions from the partnership; the partnership's basis in its assets and the value of those assets; the amount and character of partnership liabilities; the separate category (for purposes of the foreign tax credit limitation), timing, and amount of the partnership's creditable foreign tax expenditures; elections made by the partnership; items related to transactions between a partnership and any partner (including disguised sales and guaranteed payments); any items related to terminations of a partnership; and partners' capital accounts. Proposed § 301.6221(a)-1(b)(2) defines the phrase “a partner's distributive share” to include any partner's share of any item determined at the partnership level; the nature and amount of the partner's interest in the partnership; whether any special allocations apply to any partner; the character and timing of any item or activity required to be taken into account by the partner which is related to any item adjusted at the partnership level under subchapter C of chapter 63; and any amount required to be taken into account by the partner if the partnership makes an election under section 6226.

Proposed § 301.6221(a)-1(b)(3) defines the term “tax” for purposes of § 301.6221(a)-1 to mean tax imposed by chapter 1 of subtitle A of the Code. Accordingly, for purposes of assessment and collection at the partnership level, taxes imposed by other chapters of the Code are not included in the term “tax.” Those taxes that are not covered by the centralized partnership audit regime include taxes imposed by chapter 2 (Tax on Self-Employment Income), chapter 2A (Unearned Income Medicare Contribution), chapter 3 (Withholding of Tax on Nonresident Aliens and Foreign Corporations), chapter 4 (Taxes to Enforce Reporting on Certain Foreign Accounts), and chapter 6 (Consolidated Returns). In addition, taxes imposed by other subtitles of the Code, such as subtitle C (Employment Taxes), are not included within the scope of the centralized partnership audit regime. Accordingly, the IRS may separately examine the partnership or its partners outside the centralized partnership audit regime for purposes of determining and assessing these types of taxes.

In some circumstances, adjustments made under the centralized partnership audit regime may have an effect on the determination of taxes imposed by provisions of the Code outside of chapter 1. For example, if it is determined in a proceeding under the centralized partnership audit regime that a partnership has additional unreported ordinary income, that determination could form the basis for a separate determination that one or more of the partners in that partnership owe additional self-employment tax under chapter 2 of the Code. Additionally, as clarified in proposed § 301.6221(a)-1(d), determinations regarding items covered by the centralized partnership audit regime may be relied upon by the IRS when making determinations of taxes not covered by chapter 1 to the extent they are relevant in making such determinations. For instance, if the IRS determines as part of the centralized partnership audit regime that an individual who is treated as a partner in the partnership has received additional unreported ordinary income from the partnership, the IRS is not precluded from separately examining the partnership or that individual for purposes of determining whether that individual is an employee and not a partner of the partnership for purposes of imposing subtitle C employment taxes with regard to that income or examining the individual for purposes of determining whether the individual owes additional self-employment tax on the income. Any such determinations made in a separate examination outside the centralized partnership audit regime will be solely for purposes of the taxes not covered by chapter 1, will not constitute determinations for purposes of chapter 1, and will not constitute an administrative proceeding with respect to the partnership for purposes of subchapter C of chapter 63. The IRS may use all procedures available, such as obtaining the books and records of the partnership, to make determinations of items covered by the centralized partnership audit regime solely for purposes of taxes not covered by chapter 1. Any determinations for taxes other than chapter 1 taxes are not covered by the centralized partnership audit regime under subchapter C of chapter 63.

Proposed § 301.6221(a)-1(a) provides that the applicability of any penalty, addition to tax, or additional amount that relates to an adjustment under subchapter C of chapter 63 is determined at the partnership level. Proposed § 301.6221(a)-1(c) provides that any defenses to any penalty, addition to tax, or additional amount under subchapter C of chapter 63 may only be raised or considered in a partnership proceeding initiated under subchapter C of chapter 63. The partnership representative (as defined in section 6223 and the regulations thereunder) is the sole representative of the partnership. Accordingly, only the partnership representative may raise defenses to penalties, additions to tax, or additional amounts, including the partnership's defenses and defenses that relate to any partner. For example, if the partnership believes it has a viable reasonable cause defense, the partnership representative must raise this defense as part of the partnership proceeding. Any defense, whether it relies on facts and circumstances relating to the partnership or one or more partners or any other person, that is not raised by the partnership before a final determination under subchapter C of chapter 63 is waived and will not be considered if raised by any other person, including a partner that receives a section 6226 statement as a result of the partnership making an election under section 6226.

2. Election Out of the Centralized Partnership Audit Regime

A. Eligibility To Make the Election

Proposed § 301.6221(b)-1(b) provides that only an eligible partnership may elect out of the centralized partnership audit regime. Under that section, a partnership is an eligible partnership if it has 100 or fewer partners during the year and, if at all times during the taxable year, all partners are eligible partners, as defined in proposed § 301.6221(b)-1(b)(3).

i. 100 or Fewer Partners

Under proposed § 301.6221(b)-1(b)(2), a partnership has 100 or fewer partners during the year if it is required to furnish 100 or fewer statements under section 6031(b) during the taxable year for which the partnership makes the election. When determining whether a partnership is required to furnish 100 or fewer statements under section 6031(b) during the taxable year, only statements required to be furnished by the partnership under section 6031(b) for

the taxable year are taken into account, regardless of the number of statements actually furnished by the partnership. Accordingly, if contrary to the instructions to the Schedule K-1 the partnership furnishes more statements than are required under section 6031(b), any statements that are not required to be issued under section 6031(b) are not taken into account. For instance, if contrary to the instructions to the Schedule K-1 a partnership furnishes two Schedules K-1 to a partner (one for the partner's general interest in the partnership and one for the partner's limited interest in the partnership), the partnership is treated as furnishing only one Schedule K-1 for purposes of proposed § 301.6221(b)-1(b)(2) because the partnership is only required to furnish one statement to that partner under section 6031(b).

The proposed regulations include a special rule for partnerships that have S corporation partners. As described in proposed § 301.6221(b)-1(b)(2)(ii), any statements required to be furnished by the S corporation partner under section 6037(b) for the taxable year of the S corporation ending with or within the partnership's taxable year are taken into account for purposes of determining whether the partnership is required to furnish 100 or fewer statements for the taxable year. For instance, if an S corporation with 50 shareholders is a partner in a partnership, in addition to the statement the partnership is required to furnish to the S corporation, the 50 statements that the S corporation is required to furnish to its shareholders under section 6037(b) are taken into account for purposes of determining whether the partnership is required to issue 100 or fewer statements. As illustrated in Example 5 of proposed § 301.6221(b)-1(b)(2)(iii), the special rule under proposed § 301.6221(b)-1(b)(2)(ii) does not apply to partners that are not S corporations.

Pursuant to section 6221(b), the determination of whether the partnership has 100 or fewer partners is made by counting the number of statements required to be furnished under section 6031(b). Under TEFRA, section 6231(a)(1)(B) (prior to amendment by the BBA) specifically states that a husband and wife were treated as a single partner for purposes of determining whether the partnership had 10 or fewer partners (the TEFRA small partnership exception). Section 6221(b) contains no similar language. Accordingly, the principles of section 6031(b), which do not treat a husband and wife as a single partner, apply for purposes of determining whether the partnership has 100 or fewer partners. Examples 1 and 2 in proposed § 301.6221(b)-1(b)(2)(iii) illustrate this point.

ii. Eligible Partners

Proposed § 301.6221(b)-1(b)(3)(i) defines the term “eligible partner” as any person who is an individual, C corporation, eligible foreign entity, S corporation, or an estate of a deceased partner. Under this proposed rule, a C corporation is an entity defined in section 1361(a)(2), including a regulated investment company (RIC) under section 851 and a real estate investment trust (REIT) under section 856. The Treasury Department and the IRS intend to continue to treat an organization that is determined to be, or claims to be, exempt from tax under section 501(a) and is classified as a corporation under section 7701(a)(3) as a C corporation for purposes of proposed § 301.6221(b)-1(b)(3), consistent with Revenue Ruling 2003-69, 2003-1 C.B. 1118 (treating tax-exempt corporations as C corporations for purposes of the TEFRA small partnership exception). This treatment does not extend to an organization that is determined to be, or claims to be, exempt from tax under section 501(a) that is not classified as a corporation under section 7701(a)(3) as a C corporation, such as trusts.

An “eligible foreign entity” is defined in proposed § 301.6221(b)-1(b)(3)(iii) as any foreign entity that is classified as a per se corporation under § 301.7701-2(b)(1), (3)-(8), is classified by default as an association taxable as a corporation under § 301.7701-3(b)(2)(i)(B), or is classified as an association taxable as a corporation in accordance with an election under the provisions of § 301.7701-3(c).

Proposed § 301.6221(b)-1(b)(3)(ii) clarifies that the term “eligible partner” does not include partnerships, trusts, foreign entities that are not eligible foreign entities, disregarded entities, nominees, other similar persons that hold an interest on behalf of another person, and estates that are not estates of a deceased partner.

A number of comments received in response to Notice 2016-23 suggested that the Treasury Department and the IRS should exercise the regulatory authority provided in section 6221(b)(2)(C) to expand the types of entities that are eligible partners for purposes of the election out. Specifically, commenters requested that entities such as disregarded entities, trusts, partnerships, and partners who use nominees should be considered eligible partners for purposes of the election out rules. The commenters also suggest that there may be certain partnership structures that could be efficiently examined at the ultimate taxpayer level even if a partner is not one of the eligible partners listed in section 6221(b). The Treasury Department and the IRS considered these comments, but have declined in these proposed regulations to exercise the authority under section 6221(b)(2)(C) to expand the types of entities that are eligible partners for purposes of the election out rules or to create separate election out provisions for specific partnership structures. When a partnership elects out of the centralized partnership audit regime, the IRS must examine and assess tax with respect to each ultimate partner under the deficiency procedures under subchapter B of chapter 63. Enactment of TEFRA was a reaction to the complexity and burden of these deficiency procedures with respect to partnerships. The increasing number and complexity of partnerships since TEFRA was enacted revealed that the TEFRA procedures were inadequate for the IRS to effectively audit partnerships. The centralized partnership audit regime is intended to enhance the IRS's ability to examine partnerships, particularly large and highly tiered partnerships. If the proposed regulations broaden the scope of the election out provisions to include additional types of partners or partnership structures, the IRS will face additional administrative burden in examining those structures and partners under the deficiency rules. Comments on any potential expansion of the election out rules are particularly helpful if they address the additional burdens any such expansion would impose on the IRS and not just the decreased burden on taxpayers resulting from the suggested change.

B. Making the Election Out

Proposed § 301.6221(b)-1(c) provides the time, form, and manner for the partnership to make an election out of the centralized partnership audit regime, and unless all of these requirements are satisfied an election will not be valid. The requirements under proposed § 301.6221(b)-1(c) are described below.

First, under proposed § 301.6221(b)-1(c)(1), a partnership may make the election only on a timely filed partnership return (including extensions) (that is, Form 1065,

U.S. Return of Partnership Income

) for the partnership taxable year to which the election relates. Therefore, a partnership may not make the election on a return that is filed after the due date (including extensions) for the taxable year. An election out made by a partnership may

only be revoked with the consent of the IRS. Proposed § 301.6221(b)-1(c)(1).

In response to Notice 2016-23, some commenters requested that the election out rules should not penalize a partnership that does not timely file a return. Section 6221(b) specifically prescribes that the election must be made on a timely filed return. Accordingly, the proposed regulations conform with the statute and require the election under section 6221(b) to be made on a timely filed return.

Second, proposed § 301.6221(b)-1(c)(2) provides that a partnership must disclose to the IRS the names, correct TINs, and federal tax classifications of all partners of the partnership and, if there is an S corporation partner, the names, correct TINs, and federal tax classifications of all persons to whom an S corporation partner is required to furnish statements during the S corporation partner's taxable year ending with or within the partnership's taxable year at issue, and any other information regarding those partners (and shareholders) as required by the IRS in forms and instructions. The Treasury Department and the IRS recognize that section 6221(b)(2)(B) grants authority to the Secretary to provide for alternative identification of any foreign partners. However, in most cases, partners (including foreign partners) in partnerships that file a Form 1065,

U.S. Return of Partnership Income,

are required to have taxpayer identification numbers, and, as a result, alternative identification procedures for foreign partners may be unnecessary. The Treasury Department and the IRS request comments describing situations in which a foreign partner in a partnership subject to the centralized partnership audit regime may not otherwise be required to have a taxpayer identification number except for purposes of making an election out under section 6221(b), as well as recommendations for alternative identification procedures that could be used in such cases.

Finally, proposed § 301.6221(b)-1(c)(3) provides that a partnership that elects out of the centralized partnership audit regime must notify each of its partners that the partnership made the election. This notification must be made within 30 days of making the election. The proposed regulations do not mandate the form of the notice that the partnership must provide to its partners. Accordingly, the notice may be in writing, electronic, or other form chosen by the partnership.

Proposed § 301.6221(b)-1(d) clarifies that any election out of the centralized partnership audit regime by an eligible partnership that is a partnership-partner (as defined in proposed § 301.6241-1(a)(7)) has no effect on the application of the centralized partnership audit regime to that partnership-partner in its capacity as a partner in another partnership. The Treasury Department and the IRS intend this provision to make clear that the effect of adjustments on a partnership-partner that is a partner in a partnership that is subject to the centralized partnership audit regime are determined under the centralized partnership audit regime even if that partnership-partner has made a valid election under section 6221(b). The examples in proposed § 301.6221(b)-1(d)(2) illustrate these principles.

Proposed § 301.6221(b)-1(e) provides that, if a partnership makes an election under this section, the IRS may rely on that election for all purposes unless and until the IRS determines that the election is invalid. The Treasury Department and the IRS intend proposed § 301.6221-1(e) to provide certainty to partnerships and the IRS because whether an election out is valid will determine whether the IRS must conduct a proceeding with respect to the partnership under the centralized partnership audit regime or whether the IRS will follow deficiency procedures with respect to the direct or indirect partners of the partnership to examine items that, absent a valid election, would be subject to the centralized partnership audit regime. Proposed § 301.6221-1(e) provides that an election that is not fully compliant with all the applicable rules, including an election by a partnership not eligible to make the election, may still be relied upon by the partnership unless challenged by the IRS, and the IRS may also rely upon an election in determining whether a partnership is subject to the centralized partnership audit regime. As a result, it will be clear to partnerships, direct and indirect partners, and the IRS which examination and adjustment regime should apply to the items otherwise subject to the centralized partnership audit regime.

C. Effect of Election Out

As discussed in the Background, the centralized partnership audit regime is designed to make it easier for the IRS to examine partnerships and collect any resulting underpayments through one centralized proceeding. For partnerships that elect out, the IRS will be required to open deficiency proceedings at the partner level to adjust items associated with the partnership, resolve issues, and assess and collect any tax that may result from the adjustments. Each partner-level deficiency proceeding is subject to its own statute of limitations and venue, which often results in separate partner-by-partner determinations with respect to the same item. Nevertheless, the IRS intends to increase the number of partnership audits for both partnerships that are subject to the centralized partnership audit regime and partnerships that have elected out of the partnership audit regime.

In addition, to ensure that the election out rules are not used solely to frustrate IRS compliance efforts, the IRS intends to carefully review a partnership's decision to elect out of the centralized partnership audit regime. This review will include analyzing whether the partnership has correctly identified all of its partners for federal income tax purposes notwithstanding who the partnership reports as its partners. For instance, the IRS will be reviewing the partnership's partners to confirm that the partners are not nominees or agents for the beneficial owner.

In addition, the IRS intends to carefully scrutinize whether two or more partnerships that have elected out should be recast under existing judicial doctrines and general federal tax principles as having formed one or more constructive or de facto partnerships for federal income tax purposes. The types of arrangements that the IRS will carefully review include those where the profits or losses of partners are determined in whole or in part by the profits or losses of partners in another partnership, and those that purport to be something other than a partnership, such as the co-ownership of property. If it is determined that two or more partnerships that have elected out of the centralized partnership audit regime have formed a constructive or de facto partnership for a particular partnership taxable year and are recast as such by the IRS, that constructive or de facto partnership will be subject to the centralized partnership audit regime because that constructive or de facto partnership will not have filed a partnership return and, therefore, will not have made a timely election out as required under section 6221(b)(1)(D)(i) and these proposed regulations. The constructive or de facto partnership may also have more than 100 partners or an ineligible partner, making it ineligible to elect out.

3. Partner's Return Must Be Consistent With Partnership Return

A. Requirement of Consistency

Proposed § 301.6222-1(a)(1) provides that a partner's treatment of each item of income, gain, loss, deduction, or credit attributable to a partnership must be consistent with the treatment of those items on the partnership return, including treatment with respect to the amount, timing, and characterization of those items. Additionally, proposed § 301.6222-1(a)(1) clarifies that the determination of whether a partner treats an item consistently with the partnership return is determined with reference to the treatment of that item on the partnership return filed with the IRS, and not with reference to any schedule or other information provided or furnished by the partnership to the partner, for example, a schedule K-1 furnished to the partner by the partnership, unless the election under proposed § 301.6222-1(d), regarding incorrect statements or information, applies.

Proposed § 301.6222-1(a)(2) provides that a partnership-partner is subject to section 6222 and the regulations thereunder regardless of whether the partnership-partner has made an election out of the centralized partnership audit regime under section 6221(b). Proposed § 301.6222-1(a)(3) provides that a partner's return is considered automatically inconsistent if the partnership does not file a return, unless the partner notifies the IRS of this inconsistency in accordance with proposed § 301.6222-1(c).

For purposes of these proposed regulations, the term “treatment of items on a partnership return” is defined under proposed § 301.6222-1(a)(4) to take into account treatment of all items reported by the partnership, regardless of the form that the reporting of the partnership return position with respect to that item takes (that is, regardless of whether the return position with respect to an item is reflected on an original return or reflected on a statement issued as a result of a partnership-initiated adjustment or an IRS-initiated adjustment). Accordingly, the term treatment of items on a partnership return includes not only the treatment of an item on the partnership's return filed with the IRS under section 6031(a), but also includes any amendment or supplement to such return, such as an administrative adjustment request filed under section 6227 and the regulations thereunder, as well as the treatment of an item on any statement, schedule or list, and any amendment or supplement thereto, filed by the partnership with the IRS, including statements filed pursuant to section 6226. Proposed § 301.6222-1(a)(5) provides examples illustrating the rules requiring consistent reporting by partners.

B. Mathematical or Clerical Error Adjustments

Section 6222(b) provides that when a partner fails to treat items attributable to a partnership consistently with the treatment of those items on the partnership return, the IRS may assess and collect any underpayment of tax that results from that inconsistency as if it were on account of a mathematical or clerical error appearing on the partner's return; however the ability to request an abatement of the assessment under section 6213(b)(2) does not apply. Section 6213(b) provides the general rules for assessments of amounts of tax arising out of mathematical or clerical errors. In general, section 6213(b)(1), permits the IRS to immediately assess and collect tax that arises on account of a mathematical or clerical error appearing on a taxpayer's return, notwithstanding the general restrictions on assessment and collection of deficiencies under section 6213(a). Section 6213(b)(2) gives the taxpayer 60 days to request an abatement of that assessment.

Section 6222(b) specifically states that the IRS may assess an underpayment of tax as if it were on account of a mathematical or clerical error on the partner's return. Section 6222(b), however, does not define the term underpayment for these purposes, and the term underpayment is not defined elsewhere under subchapter C of chapter 63. The term underpayment is defined in section 6664(a); however, that definition is expressly limited to part I of subchapter A of chapter 68 of the Code. Section 6213(b)(1), which discusses assessments arising out of mathematical or clerical errors, refers to the amount of tax due in excess of that shown on the return on account of the error. Because section 6222(b) refers explicitly to mathematical or clerical error and other provisions under 6213(b), proposed § 301.6222-1(a) provides that the underpayment of tax described under 6222(b) is the amount of tax due that results from adjusting the item on the partner's return to make the treatment of the item consistent with the treatment of such item on the partnership return.

Accordingly, proposed § 301.6222-1(b) provides that the IRS may assess and collect any underpayment of tax that results from adjusting a partner's inconsistently reported item to conform that item with the treatment on the partnership return as if the resulting underpayment of tax were on account of a mathematical or clerical error appearing on the partner's return. A partner may not request an abatement of that assessment. See proposed § 301.6222-1(b)(2).

In instances where the partner is itself a partnership, section 6232(d)(1)(B) provides for the use of rules similar to the rules of section 6213(b). Accordingly, proposed § 301.6222-1(b) states that if the partner is itself a partnership, any adjustment on account of such partnership's failure to treat an item consistently will be treated as an adjustment on account of a mathematical or clerical error. Also, in accordance with section 6232(d)(2), proposed § 301.6222-1(b) states that the procedures under section 6213(b)(2) for requesting abatements do not apply.

C. Notice of Inconsistency

Proposed § 301.6222-1(c) states that the provisions of proposed § 301.6222-1(a) (consistent reporting requirement) and proposed § 301.6222-1(b) (math error treatment) do not apply to items that the partner properly identifies as being treated inconsistently with the partnership return. In order to properly identify an item, the proposed regulations provide that the partner must attach a statement identifying the inconsistency to the partner's return on which the item is treated inconsistently. Proposed § 301.6222-1(c)(1).

Proposed § 301.6222-1(c)(2) coordinates the rules regarding notice of inconsistent treatment under proposed § 301.6222-1(c)(1) with situations where a partner is bound to the treatment of an item under section 6223 as result of actions taken by the partnership under subchapter C of chapter 63 or by any final decision in a proceeding brought under subchapter C of chapter 63 with respect to the partnership. For instance, as noted in the proposed regulations under section 6226, the election under section 6226 and the filing and furnishing of statements under that section are actions of the partnership under section 6223. See proposed § 301.6226-1(d). Because the partner is bound by the treatment of an item reflected in a statement filed by the partnership under section 6226, the partner is precluded from treating that item inconsistently under section 6222. The fact that the partner files a notice of inconsistent treatment does not change the fact that the partner is bound by the treatment of the items in the section 6226 statement. Any other result would undermine the purpose of section 6223, which provides certainty and finality with respect to actions

taken by the partnership during the centralized partnership audit regime. Accordingly proposed § 301.6222-1(c)(2) provides that if a partner's treatment of the item is not consistent with the treatment to which the partner is bound under section 6223 with respect to such item, such as the partnership treatment of items in an administrative adjustment request or in a section 6226 statement, the provisions of proposed § 301.6222-1(a) (consistent reporting requirement) and proposed § 301.6222-1(b) (math error treatment) apply to that item, and any underpayment of tax resulting from the failure to treat the item consistently with the treatment to which the partner is bound may be assessed and collected in the same manner as if such underpayment were on account of a mathematical or clerical error.

Situations may arise in which a partner treats several items inconsistently from how the partnership treated those same items, but the partner notifies the IRS only of some, but not all, of the inconsistencies. Proposed § 301.6222-1(c)(3) clarifies that the exception to the consistent reporting requirement and math error treatment applies only to the inconsistent positions that are specifically identified to the IRS in a proper notification.

Under section 6223(b), a final decision in an administrative or judicial proceeding with respect to a partnership under the centralized partnership audit regime is binding on the partnership and all partners of the partnership. In contrast, under section 6222(d), a final determination in an administrative or judicial proceeding with respect to a partner's identified inconsistent position is not binding on the partnership if the partnership is not a party to the proceeding. Accordingly, section 6222(d) provides that the IRS may conduct a proceeding with respect to the partner, that is, a proceeding that does not involve the partnership, where the partner notified the IRS of an inconsistent position under 6222(c). Section 6222(d) does not, however, preclude the IRS from conducting a proceeding with respect to the partnership.

In some cases, the IRS may determine that conducting a partnership proceeding under the centralized partnership audit regime under subchapter C of chapter 63 is appropriate, for instance when the IRS disagrees with both the partner's and the partnership's treatment of the item or when multiple partners treat an item inconsistently from the treatment by the partnership. In other cases, the IRS may determine that a partner proceeding, which generally would be under deficiency procedures in subchapter B of chapter 63, is appropriate, for instance when the IRS determines that the partner's inconsistent treatment is incorrect. Accordingly, proposed § 301.6222-1(c)(4)(i) clarifies that in the case of an identified inconsistency, the IRS may conduct both a proceeding with respect to the partner (a proceeding in which the partnership would not be involved) and a proceeding with respect to the partnership. Proposed § 301.6222-1(c)(4)(ii) provides that any final decision with respect to an inconsistent position identified in a notice to the IRS under section 6222(c) in a proceeding to which the partnership is not a party is not binding on the partnership.

Proposed § 301.6222-1(c)(4)(ii) also provides that if the IRS conducts a separate proceeding with respect to a partner, the IRS is not required to conform items on the partner's return to make those items consistent with the treatment of the items on the partnership return. Rather, if the IRS disagrees with the partner's treatment of an inconsistent item, the IRS may adjust the item to conform to the proper treatment of such item under federal tax law. Proposed § 301.6222-1(c)(5) provides examples illustrating the provisions under proposed § 301.6222-1(c).

Proposed § 301.6222-1(d) provides that a partner has provided notice to the IRS of an inconsistency if the partner treats an item consistently with incorrect information that the partnership furnished to the partner and makes an election to allow such treatment. The proposed regulations provide that the partner makes the election after being notified by the IRS of an adjustment due to treatment of an item on the partner's return inconsistent with the treatment of that item on the partnership's return. As part of the election, the proposed regulations require the partner to demonstrate that the treatment of the item on the partner's return is consistent with the treatment of that item on the incorrect schedule or information furnished to the partner by the partnership. Proposed § 301.6222-1(d)(2) provides that this election must be made within 60 days from the date of the notice informing the partner of the inconsistent treatment. The election must be clearly identified as an election under section 6222(c)(2)(B), signed by the partner making the election, and must be accompanied by copies of the schedule or other information furnished to the partner by the partnership as well as the notice mailed by the IRS informing the partner of the conforming adjustment. If it is not clear that the partner's treatment of the item on the partner's return is consistent with the information provided by the partnership, the election must include an explanation of how the partner's treatment is consistent. Proposed § 301.6222-1(d)(3) provides examples illustrating the provisions under proposed § 301.6222-1(d).

One comment in response to Notice 2016-23 suggested that when a partner notifies the IRS of an inconsistency, the notification of inconsistent treatment should be included with the partner's return for the tax year in which the partner took the inconsistent position, rather than create a separate notification process. The Treasury Department and the IRS agree with this comment. Accordingly, the proposed regulations require a partner to attach a notification of inconsistent treatment to the partner's return on which the item is treated inconsistently. A separate notification process is necessary, however, when a partner receives an incorrect statement, schedule, or other information from the partnership because the partner generally will not know about the inconsistency.

4. Partnership Representative

Proposed § 301.6223-1 provides rules requiring a partnership to designate a partnership representative (proposed § 301.6223-1(a)), rules describing the eligibility requirements for a partnership representative (proposed § 301.6223-1(b)), rules describing designation of the partnership representative (proposed § 301.6223-1(c)-(f)), and rules describing the termination of a designation of a partnership representative (proposed § 301.6223-1(d)-(f)).

A. Eligibility To Serve as the Partnership Representative

Proposed § 301.6223-1(b)(1) provides that a partnership may designate any person as defined in section 7701(a)(1), including an entity, that meets the requirements of proposed § 301.6223-1(b)(2), (b)(3), and (b)(4), to be the partnership representative. The partnership representative must have a substantial presence in the United States and must have the capacity to act. If an entity is designated as the partnership representative, the partnership must identify and appoint an individual to act on the entity's behalf. The appointed individual must also have a substantial presence in the United States and the capacity to act. Accordingly, provided the person is otherwise eligible, the partnership may

appoint a partner or a non-partner, including the partnership's management company, as the partnership representative.

Proposed § 301.6223-1(b)(2) provides that the partnership representative must have a substantial presence in the United States. Proposed § 301.6223-1(b)(2)(i) provides that a person has a substantial presence in the United States for the purposes of section 6223 if three criteria are met. First, the person must be able to meet in person with the IRS in the United States at a reasonable time and place as is necessary and appropriate as determined by the IRS. Second, the partnership representative must have a street address in the United States and a telephone number with a United States area code where the partnership representative can be reached by United States mail and telephone during normal business hours in the United States. Third, the partnership representative must have a U.S. TIN.

The proposed regulations do not use the substantial presence test as described in section 7701(b)(3) (substantial presence test) because the purpose of the substantial presence test is to determine whether an alien individual should be treated as a resident alien for U.S. tax purposes. In contrast, the purpose of requiring that the partnership representative have a substantial presence in the United States is to ensure ease of communication so the audit process can proceed smoothly. As a result, proposed § 301.6223-1(b)(2) does not adopt the substantial presence test in section 7701(b)(3).

Communication between the IRS and the partnership representative is fundamental to an efficient administrative proceeding, both for the IRS and the partnership. As a result, if the partnership designates an entity as the partnership representative (an entity partnership representative), proposed § 301.6223-1(b)(3) requires the partnership to appoint an individual (designated individual) as the sole individual to act on behalf of the entity partnership representative. Like the partnership representative itself, the designated individual must meet the substantial presence requirements of proposed § 301.6223-1(b)(2). If the partnership does not appoint a designated individual, the IRS may determine the partnership representative designation is not in effect. See proposed § 301.6223-1(f).

In addition, a person must have the capacity to act as the partnership representative or the designated individual. Proposed § 301.6223-1(b)(4) describes specific events that cause a person to lose the capacity to act and includes a catch-all provision for unforeseen circumstances in which the IRS reasonably determines that the partnership representative or designated individual may no longer have the capacity to act.

The proposed regulations provide that a person designated by the partnership as the partnership representative is deemed to satisfy the substantial presence requirements and have capacity to act unless and until the IRS determines the person is ineligible. See proposed § 301.6223-1(b)(1). If a partnership representative never met, or no longer meets, the requirements of proposed § 301.6223-1(b), the designation of the partnership representative is valid and remains in effect until the partnership, the partnership representative, or the IRS takes an affirmative action to terminate that designation. This can happen in one of three ways. The partnership representative may resign pursuant to proposed § 301.6223-1(d), the partnership may revoke the designation pursuant to proposed § 301.6223-1(e), or the IRS may determine a designation is not in effect under proposed § 301.6223-1(f). Until one of those events occurs, the designation is valid and remains in effect. For the validity of actions taken by the partnership representative during the period when the designation was in effect, see proposed § 301.6223-2(b).

B. Designating the Partnership Representative

Proposed § 301.6223-1(c) describes the manner in which a partnership designates the partnership representative. A partnership must designate the partnership representative on the partnership's return filed for the partnership taxable year. A partnership must designate a partnership representative separately for each taxable year. A designation for one taxable year is not effective for any other taxable year. A designation for a partnership taxable year remains in effect until the designation is terminated under proposed § 301.6223-1(d) (resignation), proposed § 301.6223-1(e) (revocation), or proposed § 301.6223-1(f) (determination that the designation is not in effect).

Under the TEFRA partnership procedures, a TMP may be designated, including through a resignation or revocation, at any time after the filing of the initial partnership return by submitting a new designation to the IRS. The IRS processes each of these subsequent designations regardless of whether the partnership is examined, creating unnecessary work for the IRS because very often the TMP is not required to take any action on behalf of the partnership or the partners.

The partnership representative rules are intended to be an improvement over the TMP rules. As a result, the partnership representative rules have been crafted to avoid the resource drain created by processing unnecessary resignations, revocations, and subsequent designations of TMPs. Accordingly, the proposed regulations provide that a partnership representative designation may not be changed (either by resignation or revocation) until the IRS issues a notice of administrative proceeding to the partnership, except when the partnership files a valid administrative adjustment request (AAR) in accordance with section 6227 and proposed § 301.6227-1.

The proposed regulations provide that the partnership or the partnership representative may change the initial designation of the partnership representative simultaneously with filing an AAR, but the form used for filing an AAR may not be used solely for the purpose of changing the partnership representative. The Treasury Department and the IRS understand that there may be other circumstances that warrant allowing a partnership or partnership representative to change the partnership representative designation and request comments regarding such other circumstances.

Specifically, proposed § 301.6223-1(d) allows a partnership representative to resign by notifying the partnership and the IRS in writing. The partnership representative may not resign prior to the issuance of a notice of administrative proceeding (except in conjunction with the filing of an AAR), but the partnership representative may resign at any time after the issuance of the notice of an administrative proceeding. The partnership representative may resign regardless of whether that person was designated by the partnership or the IRS. The resigning partnership representative may, but is not required to, designate a successor partnership representative. If the resigning partnership representative does not designate a successor, the IRS will determine that the designation is not in effect under proposed § 301.6223-1(f) and provide the partnership with an opportunity to designate a new partnership representative. If the partnership fails to designate a new partnership representative, the IRS will designate a new partnership representative

pursuant to proposed § 301.6223-1(f)(5). A resignation is effective 30 days after the date the notice of resignation is sent to the IRS. See proposed § 301.6223-1(d)(1). Similar rules apply to designated individuals, allowing the designated individual to resign and appoint a successor. See proposed § 301.6223-1(d)(3).

Proposed § 301.6223-1(e) describes the rules which allow the partnership to revoke the partnership representative designation and designate a successor. This revocation provision is an exception to the general rule that the partnership representative has the sole authority to act on behalf of the partnership. In general, a change in the partnership representative or designated individual should only occur when the partnership representative resigns and appoints a successor under proposed § 301.6223-1(d). However, there may be circumstances where the partnership would like to change the designation, and the partnership representative or designated individual will not resign. Proposed § 301.6223-1(e) provides flexibility to the partnership in these circumstances, allowing the partnership, through its partners, to revoke a prior designation.

In the case of a revocation, the partnership must notify the IRS in writing and must also notify the partnership representative whose designation is being revoked of the revocation. Like resignations under proposed § 301.6223-1(d), the partnership may not revoke the partnership representative designation prior to the issuance of a notice of an administrative proceeding except in conjunction with the filing of a valid AAR. A revocation is effective 30 days after the date the notice of revocation is sent to the IRS. See proposed § 301.6223-1(e)(1). Upon the receipt of a valid revocation, the IRS will notify the partnership and any partnership representative whose designation is being revoked of the acceptance of the revocation.

Proposed § 301.6223-1(e)(3) provides the rules for who may sign a revocation. In general, the partnership representative is the sole representative of the partnership. The revocation provision provides a limited exception to this rule and allows, solely for purposes of revocation, other partners to act on behalf of the partnership. Under the proposed regulations, a general partner as shown on the partnership return at the close of the taxable year for which the partnership representative was designated must sign the revocation. If no general partner has the capacity to act on behalf of the partnership (as described in proposed § 301.6223-1(b)(4)(i)-(v)), proposed § 301.6223-1(e)(3)(i) provides that any reviewed year partner in the partnership may sign the revocation. Proposed § 301.6223-1(e)(3)(ii) provides definitions with respect to limited liability companies (LLCs) and rules for which members of an LLC may sign a revocation. For purposes of which partners may sign a revocation, member-managers are treated as general partners, and other members are treated as a partner other than a general partner. If there is no member-manager, the proposed regulations provide that each member is treated as a member-manager for purposes of this section.

Additionally, proposed § 301.6223-1(e) provides that any revocation must include a statement signed under penalties of perjury that the partner signing the revocation is authorized by the partnership to revoke the designation and has provided a copy of the revocation to the partnership and partnership representative.

The combination of requiring the partner making the revocation to attest under penalties of perjury that the partner is authorized to act for the partnership and requiring the partner to notify the partnership and partnership representative helps ensure that any partnership representative revocation is consistent with the wishes of the partnership. The notification that the revocation has been accepted that the partnership and the partnership representative receive from the IRS provides further notice to the partnership and allows for the partnership to take action against unauthorized revocations and designations.

There may be circumstances in which more than one general partner in the partnership makes a revocation within a short period of time. In that circumstance, the IRS may not be able to readily determine the identity of the proper partnership representative. To allow the IRS to identify the correct partnership representative, proposed § 301.6223-1(e)(5) provides if the IRS receives multiple revocations or subsequent designations within a 90-day period, the IRS may determine that a designation is not in effect due to multiple revocations and follow the procedures under proposed § 301.6223-1(f) to designate a new partnership representative. These rules do not require that the IRS designate a person designated in any of the revocations received. If the IRS designates a partnership representative under proposed § 301.6223-1(f), proposed § 301.6223-1(e)(4) provides that the partnership must receive the IRS's permission to later revoke the designation.

C. Determination That a Designation Is Not in Effect

Proposed § 301.6223-1(f) provides the rules regarding how the IRS makes a determination that a designation of a partnership representative is not in effect, as well as how the IRS will designate a partnership representative if a designation is not in effect.

Proposed § 301.6223-1(f) provides that when the IRS determines a designation is not in effect, the IRS will notify the partnership and the last partnership representative, if there was one, of the IRS's determination. The designation is terminated as of the day the IRS notifies the partnership that no designation is in effect. Proposed § 301.6223-1(f)(4) provides that except in cases where the partnership designation is not in effect because there were multiple revocations, the partnership will have 30 days to designate a successor partnership representative before the IRS will designate a new partnership representative. If the IRS has already received multiple revocations from different partners and determined it is unable to ascertain which partnership representative the partnership wants to designate, proposed § 301.6223-1(f)(4) provides that the IRS will notify the partnership that the designation is not in effect and designate a new partnership representative pursuant to proposed § 301.6223-1(f)(5) without providing the partnership with an opportunity to designate a partnership representative. This rule avoids creating further confusion between the partnership and the IRS, which would delay the designation and the administrative proceeding.

D. Designation of the Partnership Representative by the IRS

Proposed § 301.6223-1(f)(1) provides that if there is no designation of a partnership representative in effect, the IRS may select any person to serve as partnership representative. There is no distinction between the authority of a partnership representative designated by the partnership and one selected by the IRS. For that reason, the proposed regulations refer to the IRS's

selection

of a partnership representative as a

designation.

Under proposed § 301.6223-1(f)(5), the IRS will notify the partnership of its designation by providing the partnership with the name, address, and telephone number of the new partnership representative. Under

proposed § 301.6223-1(f)(5) the designation by the IRS of a new partnership representative is effective on the day the IRS mails the notification to the partnership of the designation. Proposed § 301.6223-1(f)(5) also requires the IRS to mail a copy of the notification to the new partnership representative.

Proposed § 301.6223-1(f)(5)(ii) provides that the IRS may designate any person as the partnership representative. In designating a person as the partnership representative, the IRS will consider whether the person is a partner in the partnership, either in the reviewed year or at the time the designation is made. In addition, the IRS may consider the other remaining factors listed in proposed § 301.6223-1(f)(5)(ii).

Once the IRS has designated a partnership representative, the partnership may not revoke that designation without the consent of the IRS. See proposed § 301.6223-1(f)(3)(iii). The examples under proposed § 301.6223-1(f)(6) illustrate the operation of the rules described above.

E. Authority of the Partnership Representative

Proposed § 301.6223-2 describes the binding nature of actions taken by the partnership representative on behalf of the partnership under subchapter C of chapter 63 and of the partnership with respect to its partners. Under proposed § 301.6223-2, the partnership and all partners are bound by the actions of the partnership and the partnership representative and by any final decision in a proceeding brought under subchapter C of chapter 63. The partnership representative binds the partnership and its partners by the partnership representative's actions, including: Agreeing to settlements, agreeing to a notice of final partnership adjustment, making an election under section 6226, and agreeing to an extension of the period for adjustments under section 6235. In addition, all persons whose tax liability is determined, in whole or in part, by taking into account, directly or indirectly (such as indirect partners), adjustments to any item within the scope of the centralized partnership audit regime under section 6221(a), by the IRS in a notice of final partnership adjustment in a proceeding brought under subchapter C of chapter 63, or in a final decision of a court under subchapter C of chapter 63 are similarly bound. This binding authority extends to all partners, including those partners who have elected out of the centralized partnership audit regime under section 6221(b).

Proposed § 301.6223-2(c)(1) provides that the partnership representative has the sole authority to act on behalf of the partnership in any examination or other proceeding under subchapter C of chapter 63. Similarly, proposed § 301.6223-2(c)(2)(ii) provides that a designated individual has the sole authority to act on behalf of the partnership representative and the partnership. Except for a partner that is also the partnership representative or a designated individual, proposed § 301.6223-2(c)(1) provides that partners may not participate in or contest the results of an examination or other proceeding involving a partnership without permission of the IRS. Proposed § 301.6223-2(c)(1) also provides that no other person, regardless of whether that person's tax liability is affected by the actions of the partnership, may participate in the partnership proceeding under subchapter C of chapter 63.

Proposed § 301.6223-2(c)(1) states that the broad authority of the partnership representative may not be limited by state law, partnership agreement, or any other document or agreement. Any action taken by the partnership representative with respect to the centralized partnership audit regime under the Code and federal tax regulations is valid and binding on the partnership for purposes of tax law regardless of any other provision of state law, partnership agreement, or any other document or agreement.

Proposed § 301.6223-2(c)(2)(i) provides that the partnership representative, by virtue of being designated, has the authority to bind the partnership for purposes of the centralized partnership audit regime. Similarly, under proposed § 301.6223-2(c)(2)(ii), the designated individual's authority to bind the partnership representative and the partnership is derived by virtue of the appointment of that designated individual.

The examples under proposed § 301.6223-2(d) illustrate the operation of the rules described above.

F. Notice 2016-23 Comments Regarding the Partnership Representative

A number of comments made specific suggestions about whom the IRS should designate as the partnership representative when no partnership representative designation is in effect. The suggestions ranged from designating the partner with the largest profits interest or the greatest percentage ownership interest to designating any partner that can sign the partnership return. Commenters suggested that partners with small investments, nominal profits interests, or other minor roles in the partnership would not be suitable to adequately represent the partnership during an administrative proceeding. The proposed regulations, however, establish rules to provide more flexibility for the IRS to designate a partnership representative to avoid some of the shortcomings of TEFRA, including the complexity and difficulty of locating a qualified TMP.

Accordingly, the proposed regulations allow the IRS to designate any person after first considering partners from the reviewed year or at the time the designation is made, but it also provides several factors that the IRS may consider in determining whom to select. This rule balances the needs of the government and the partnership.

Other suggestions included requiring that the IRS select a partnership representative that has authority to bind the partnership under state law. The proposed regulations do not limit whom the IRS may designate based on state law. The sole authority to bind the partnership for all purposes is derived from the Code and applies for purposes of the internal revenue laws. Therefore, proposed regulations are drafted so that federal, rather than state law, controls with respect to the rules regarding the partnership representative for purposes of the centralized partnership audit regime.

Some commenters requested that there be no restrictions on whom the partnership can designate as the partnership representative other than the requirement of substantial presence in the United States. These suggestions included allowing entities, even entities with no employees, to be appointed as the partnership representative. The proposed regulations adopt these suggestions by allowing the partnership to designate any person, including an entity, to be the partnership representative provided, in the case of an entity designated as partnership representative, the partnership also identify a designated individual to act on behalf of the entity partnership representative. The proposed regulations require that both an entity partnership representative and the designated individual have substantial presence in the United States. Provided an entity with no employees otherwise meets the requirements of proposed § 301.6223-1, the proposed regulations would allow that entity to be the partnership representative.

Some commenters suggested that the proposed rules require the partnership representative to provide notice to all

partners of significant developments in an administrative proceeding and to allow partners other than the partnership representative to participate in the administrative proceeding. The proposed regulations do not adopt these suggestions. The centralized partnership audit statutory regime does not include any notice requirements, which relieves both the IRS and the TMP of the cumbersome TEFRA notice requirements. Whether and how the partnership representative communicates with the partners in the partnership is best left to the partnership to determine. Likewise, it is more efficient for the IRS to interact solely with the partnership representative during an administrative proceeding.

5. Imputed Underpayment and Modification of Imputed Underpayment

A. General Rules Regarding the Imputed Underpayment

Proposed § 301.6225-1(a) provides the general rule that if a partnership adjustment results in an imputed underpayment, the partnership must pay the imputed underpayment in the adjustment year. As described in proposed § 301.6225-1(a)(3), the partnership adjustments and any imputed underpayment resulting from such adjustments are set forth in a NOPPA mailed to the partnership and partnership representative. The partnership may request modification with respect to an imputed underpayment set forth in the NOPPA under the procedures described in proposed § 301.6225-2.

The IRS and taxpayers both have an interest in resolving the issues raised by the IRS under the centralized partnership audit regime in the most efficient manner. An administrative proceeding under the centralized partnership audit regime is conducted under the same principles applicable to examinations generally. For instance, after providing the partnership and partnership representative with a notice of administrative proceeding, consistent with IRS general examination procedures, the IRS will endeavor to work with the partnership representative to set a schedule for information document requests (IDRs) and partnership responses to the IDRs. In general, the IRS informs the partnership representative about potential items and transactions that raise issues and provides information about adjustments that will be included in the NOPPA.

As part of this process, the IRS may agree to review certain information prior to the issuance of the NOPPA in an effort to resolve issues in an expedited fashion and eliminate the need to make certain adjustments. In addition, the modification process may move faster if relevant information is provided to the IRS employees conducting the administrative proceeding prior to issuance of the NOPPA. However, once the NOPPA is issued, the modification procedures under proposed § 301.6225-2 are the partnership's only formal route to request changes to an imputed underpayment set forth in the NOPPA.

Proposed § 301.6225-1(a)(2) provides that unless the IRS determines otherwise, all applicable preferences, restrictions, limitations, and conventions will be taken into account as if the adjusted item was originally taken into account by the partnership or the partners in the manner most beneficial to the partnership or partners. Therefore, the IRS calculates an imputed underpayment by taking into account the applicable internal revenue laws, including provisions that may limit or restrict the ability of a partner to reduce income or take advantage of tax benefits flowing from the partnership. For instance, if the adjustment is a reduction of qualified research expenses, the IRS may determine the amount of the adjustment as if all partners claimed a credit with respect to their allocable portion of such expenses under section 41, rather than a deduction under section 174. To the extent supported by the facts, the partnership may take steps through the modification procedures set forth in proposed § 301.6225-2 to provide the IRS with information about specific partners and how those partners took items from the partnership into account.

The modification process, discussed later in this preamble, is the method for the partnership to request that the IRS modify an imputed underpayment to more closely reflect the tax consequences that would have resulted if the partners had taken the adjusted items into account correctly on their original returns for the year that includes the reviewed year of the partnership.

B. Calculation of the Imputed Underpayment

Proposed § 301.6225-1(c) provides rules for the calculation of an imputed underpayment. Proposed § 301.6225-1(c)(1) provides that the imputed underpayment is calculated by multiplying the total netted partnership adjustment by the highest rate of federal income tax in effect for the reviewed year (as defined in proposed § 301.6241-1(a)(8)) under section 1 or 11. The product of that amount is then increased or decreased by any adjustment made to the partnership's credits. If the result of this summation is a net positive adjustment, the resulting amount is the imputed underpayment, and, if it results in a net non-positive amount, the result is an adjustment that does not result in an imputed underpayment. See proposed § 301.6225-1(c)(2).

Proposed § 301.6225-1(c)(3) defines the

total netted partnership adjustment

for purposes of calculating the imputed underpayment in proposed § 301.6225-1(c)(1) as the sum of all net positive adjustments in the residual grouping as determined in accordance with paragraph (d)(2)(v) of this section, plus the sum of all net positive adjustments in the reallocation grouping as determined in accordance with paragraph (d)(2)(ii) of this section.

i. Grouping and Netting of Adjustments

Under proposed § 301.6225-1(d), adjustments are grouped together, which provides a framework for the netting of adjustments appropriately. Within each grouping, adjusted items may be further divided into subgroupings depending on their character or to account for preferences, sources, categories, limitations, or other restrictions under Title 26 (for example, adjustments to short-term capital gain will generally be in a different subgrouping from adjustments to long-term capital gain). See proposed § 301.6225-1(d)(1). The groupings and subgroupings provide the IRS with the ability to net adjustments according to applicable limitations and restrictions, but the Treasury Department and the IRS seek comments on any specific items that may require special rules or special subgroupings.

Proposed § 301.6225-1(d)(2)(i) provides that there are three types of groupings, and that the adjustments are divided in order into those groupings. First, adjustments that reallocate items among the partners (reallocation grouping) are grouped together. Second, adjustments to the partnership's credits (credit grouping) are grouped together. Third, all remaining adjustments (residual grouping) are grouped together according to the character, preferences, restrictions, and other limitations of the item adjusted. Within each grouping, there might be more than one subgrouping based on a partnership's particular adjustments. For instance, within the residual grouping, there might be an ordinary subgrouping as well as a capital subgrouping. Adjustments that generally affect, or that are affected by, the application of

any rules related to preferences, limitations, restrictions, or conventions, will generally be taken into account within their own respective grouping or subgrouping.

Proposed § 301.6225-1(d)(2)(ii) describes the reallocation grouping. Any adjustment that reallocates an item from one or more partners to one or more other partners is treated as two adjustments. The first adjustment is a decrease in the amount of the items allocated by the partnership on its return to one or more partners. The second adjustment is an increase in the amount of the items allocated by the IRS to the other partner(s). Each adjustment is grouped in its own reallocation subgrouping to prevent the two adjustments from netting to zero. After application of the netting rules under proposed § 301.6225-1(d)(3), any net non-positive adjustment is disregarded in the calculation of the imputed underpayment under proposed § 301.6225-1(d)(3)(ii)(A). An adjustment that results in a net non-positive adjustment is an adjustment that does not result in an imputed underpayment because the reallocation of an item among partners is one of the circumstances described in proposed § 301.6225-1(c)(2).

The credit grouping described in proposed § 301.6225-1(d)(2)(iii) includes all adjustments to items that the partnership claimed or could have claimed as a credit on the partnership's return. The Treasury Department and the IRS seek comments on whether additional rules should be proposed regarding how the credits are grouped together, or whether such credits should be applied in a particular order, similar to the order required for general business credits as reported on Form 3800,

General Business Credit.

A paragraph is reserved in proposed § 301.6225-1(d)(2)(iv) for special rules relating to the treatment of certain creditable expenditures. This paragraph is reserved to provide rules applicable with respect to adjustments to items that are, or could be, reported by the partnership as expenditures that may be treated as a credit when taken into account by a partner. The Treasury Department and the IRS also seek comments on the appropriate treatment of items reported by the partnership as expenditures that may be treated as a credit when taken into account by a partner.

The third grouping is the residual grouping, which is described in proposed § 301.6225-1(d)(2)(v). The residual grouping includes all other adjustments, which are grouped according to character (for instance, ordinary or capital) and other limitations under the Code. The adjustments of a particular partnership may warrant further subgroupings for other items (for instance, long-term capital versus short-term capital). An adjustment that recharacterizes the character of an item is treated as two separate adjustments, one adjustment decreasing the amount of the item as reported by the partnership and a second adjustment increasing the amount of the item as recharacterized by the IRS. Each adjustment is grouped separately with similar items.

Proposed § 301.6225-1(d)(3) describes the rules for netting items after separating the items into their groupings and subgroupings. First, proposed § 301.6225-2(d)(3)(i) provides that the IRS will net items within the same grouping or subgrouping. For instance, all ordinary adjustments (assuming no other restrictions under the Code) are netted against each other, regardless of whether such adjustments were part of related transactions or whether they were increases or decreases to income, but none of the ordinary adjustments are netted against the adjustments in the capital subgrouping. Adjustments in the capital subgrouping are netted against each other within that subgrouping. Adjustments from one taxable year may not be netted against adjustments from another taxable year, even if they would otherwise be part of the same subgrouping. See proposed § 301.62251-1(c)(4).

Once adjustments within each subgrouping have been netted, each grouping or subgrouping will have either a net positive adjustment (as defined in proposed § 301.6225-1(d)(3)(ii)(B)) or a net non-positive adjustment (as defined in proposed § 301.6225-1(d)(3)(ii)(C)). Any netted amount that is a net non-positive adjustment in the reallocation grouping or the residual grouping is an adjustment that does not result in an imputed underpayment under proposed § 301.6225-1(c)(2), and the rules described in proposed § 301.6225-3 apply regarding the treatment of the partnership adjustments that were netted giving rise to that net non-positive adjustment. Any such net non-positive adjustment is disregarded for the remaining purpose of calculating the imputed underpayment. See proposed § 301.6225-1(c)(2) (which lists this netting step as another circumstance in which net non-positive adjustments are adjustments that do not result in an imputed underpayment) and § 301.6225-1(d)(3)(ii)(A).

The exception to this rule under proposed § 301.6225-1(d)(3)(ii)(A) (regarding disregarding net non-positive adjustments) is with respect to the credit grouping because adjustments to credits are applied to the total netted partnership adjustment after the rate is applied as described in proposed § 301.6225-1(c)(1). If the net credits reduce the amount calculated under proposed § 301.6225-1(c)(1) to zero or less than zero, the partnership adjustments resulting in the total netted partnership adjustment and the adjustments to credits taken into account in calculating the zero or less than zero amount are all partnership adjustments that do not result in an imputed underpayment under proposed § 301.6225-1(c)(2).

Proposed § 301.6225-1(d)(3)(iii) describes how adjustments are treated within each particular grouping or subgrouping (other than the credit grouping) for purposes of netting. Increased gain is treated as increased income, decreased gain is treated as decreased income, increased loss is treated as decreased income, and decreased loss is treated as increased income. The credit grouping is excluded from this treatment because any adjustment to a credit does not result in an increase or decrease of income but rather in an adjustment to the amount of tax owed after the tax rate is applied under proposed § 301.6225-1(c)(1).

ii. Multiple Imputed Underpayments

Proposed § 301.6225-1(e) provides rules for multiple imputed underpayments. Each administrative proceeding that ends with the determination by the IRS of an imputed underpayment will result in a general imputed underpayment. The IRS may determine, in its discretion, a specific imputed underpayment on the basis of certain adjustments allocated to one partner or a group of partners based on the items or adjustments having the same or similar characteristics, based on the group of partners sharing similar characteristics, or based on the partners having participated in the same or similar transactions. There may be multiple specific imputed underpayments depending on the adjustments. For instance, some transactions may not involve all partners, and there may be a reason to place certain adjustments or even entire groupings into a specific imputed underpayment (described in proposed § 301.6225-1(e)(2)(iii)), while other adjustments remain in a general imputed underpayment (described in proposed § 301.6225-1(e)(2)(ii)).

For example, if a partnership intends to elect the alternative to payment of an imputed underpayment under section

6226 and the regulations thereunder, and, based on the appropriate allocable shares, a particular adjustment should be allocated to one partner or group of partners, the IRS could separate that adjustment into a separate imputed underpayment, called a specific imputed underpayment. The partnership could then elect to apply the rules under section 6226 to the specific imputed underpayment for which a single partner or group of partners would be responsible and the partnership could pay the general imputed underpayment at the partnership level.

The option to create multiple imputed underpayments provides flexibility for the partnership, the partners, and the IRS to address fact-specific issues that may arise as part of the administrative proceeding at the partnership level. If the partnership would like to change the number or composition of the imputed underpayments that are listed on the NOPPA, the partnership may request modification under proposed § 301.6225-2(d)(6).

The examples in proposed § 301.6225-1(f) demonstrate the rules of this section.

C. Modification of an Imputed Underpayment

Proposed § 301.6225-2(a) provides general rules for modification of an imputed underpayment. A partnership that has received a NOPPA may request modification of a proposed imputed underpayment. The effect of modification on the proposed imputed underpayment is described in proposed § 301.6225-2(b). Only the partnership representative may request modification of an imputed underpayment.

With respect to adjustments that do not result in an imputed underpayment, modification is only permissible if the partnership also has an imputed underpayment that is eligible to be modified under proposed § 301.6225-2. Section 6225(c) refers to modification of the imputed underpayment and does not address modification with respect to adjustments that do not result in an imputed underpayment. Section 6225(c)(2)(B), however, requires a partner whose allocable share of a reallocation adjustment does not result in an imputed underpayment to file an amended return and take into account the partner's share in order for the partnership to receive modification of the imputed underpayment. As a result, section 6225 clearly contemplates the possibility of requesting modification with respect to an adjustment that does not result in an imputed underpayment. Accordingly, proposed § 301.6225-2(a) allows for such modifications provided the partnership has an imputed underpayment that is set forth in the NOPPA. If the NOPPA does not set forth an imputed underpayment, the partnership may not request a modification with respect to adjustments that do not result in an imputed underpayment under proposed § 301.6225-2.

i. Effect of Modification

Proposed § 301.6225-2(b) provides the rules describing the effect of modification on the calculation of the imputed underpayment. Some modifications may result in excluding certain adjustments, or portions thereof, from the calculation of the imputed underpayment, such as modification under proposed § 301.6225-2(d)(2), (d)(3), (d)(5), (d)(7), (d)(8), and, if applicable, (d)(9). When the IRS approves one of those types of modification, the portion of the partnership adjustment attributable to that partner (or indirect partner) is removed from the calculation of the netted grouping amounts under proposed § 301.6225-1, resulting in a reduction of the total netted partnership adjustments underlying the calculation of the imputed underpayment. This reduction in the total netted partnership adjustments does not, however, affect the amount of the partnership adjustment itself, only whether the adjustment is included in the calculation of the imputed underpayment. For instance, assume the IRS makes an adjustment by increasing the valuation of an asset from $100 to $1100 (a $1000 adjustment). One partner files an amended return to take into account that partner's 50 percent share of the adjustment. The result is that only $500 worth of adjustments are included in the imputed underpayment calculation. The value of the asset remains $1100 as determined by the IRS, and the adjustment remains $1000, notwithstanding the amended return that is filed by the partner.

Proposed § 301.6225-2(b)(3) provides that modification with respect to a partnership with partners for which rate modification under section 6225(c)(4) and proposed § 301.6225-2(d)(4) is approved affects the taxable rate applied to the total netted partnership adjustment and does not affect the extent to which partnership adjustments factor into the calculation of the imputed underpayment. This rule may also apply in appropriate circumstances to modifications under proposed § 301.6225-2(d)(8) and proposed § 301.6225-2(d)(9). Proposed § 301.6225-2(b)(3) provides the method for calculating the partnership's “rate-modified netted partnership adjustment” and imputed underpayment when rate modification under proposed § 301.6225-2(d)(4) is approved.

A specific rule applies to rate modification with respect to special allocations that requires each partner's distributive share to be determined based on the amount of net gain or loss to the partner that would result if the partnership had sold all of its assets at their fair market value as of the close of the reviewed year of the partnership. See proposed § 301.6225-2(b)(3)(iv). If a partnership requests more than one type of modification, proposed § 301.6225-2(b)(1) provides an ordering rule that states that rate modification is applied after the other types of modification specified in proposed § 301.6225-2(d).

Proposed § 301.6225-2(b)(4) provides that the IRS may prescribe other guidance regarding the effect of other modifications referenced in proposed § 301.6225-2(d)(9), and the Treasury Department and the IRS seek comments on other appropriate modifications and their effect on the calculation of an imputed underpayment. In particular, the Treasury Department and the IRS request comments on modifications that may be considered appropriate where a partner is a foreign person and thus may be subject to gross basis taxation under section 871(a) or 881(a), or where a partner, indirect partner, or the partnership is entitled to a modified rate under the Code or as a resident of a country that has in effect an income tax treaty with the United States.

ii. Time, Form, and Manner for Requesting Modification

Proposed § 301.6225-2(c) provides time, form, and manner rules for when a partnership may request modification. Modification must be requested in the form and manner prescribed by the IRS within the 270-day period described in proposed § 301.6225-2(c)(3)(i). The Treasury Department and the IRS request comments on the coordination of these rules with the mutual agreement procedures available under income tax treaties that a partnership, partner, or indirect partner may invoke in order to determine eligibility for treaty benefits that may affect the calculation of the imputed underpayment.

Proposed § 301.6225-2(c)(1) provides that a determination with respect to a modification request does not preclude the IRS under section 7605(b) from initiating an administrative proceeding with respect to a partner, even if the IRS approves modification based on the

partner's actions or status. The IRS may rely on the facts provided to the IRS by the partnership representative to determine whether a modification request is proper and is not required to conduct an examination of the partners that form the basis of any modification request. Any determination by the IRS with respect to a modification request is a determination as part of the administrative proceeding with respect to the partnership. The IRS may approve modification based on an adjustment in an amended return filed for modification purposes and also examine the amended return in a separate proceeding with respect to that partner.

Similarly, if the IRS approves a modification based on the tax-exempt status of a partner, the IRS is not precluded from examining whether the partner was in fact tax-exempt for the same year in a separate proceeding. A review of or request for any information or documents provided as part of modification does not constitute an examination, inspection, or administrative proceeding with respect to any person other than the partnership. Accordingly, even in the case of an election under section 6226, and where certain modifications may affect what adjustments a partner take into account under proposed § 301.6226-3, nothing in these proposed regulations prohibits the IRS from examining that partner's return and re-determining items that were affected by a previously approved modification.

A partnership requesting modification must substantiate the facts supporting a request for modification to the satisfaction of the IRS. The particular documents and other information that may be required are based on the type of modification requested. The IRS may, in forms, instructions, or other guidance, require particular documents or other information to substantiate a particular type of modification or impose other information-reporting or recordkeeping requirements on partnerships requesting modification.

For all requests, the partnership representative must furnish to the IRS upon request, a detailed description of the structure, allocations, ownership, and ownership changes of the partnership, its partners, and, if relevant, any indirect partners for each taxable year relevant to the request, as well as all partnership agreements (including side agreements) for each relevant taxable year with respect to each modification request. In the case of a modification requested by the partnership with respect to an indirect partner, the IRS may require certain information related to the pass-through partner(s) through which the indirect partner holds its interest in the partnership subject to the administrative proceeding. For instance, in the case of amended return modification by an indirect partner, the IRS may require the partnership to provide any information necessary to determine whether the indirect partner has taken the correct amount of the adjustments into account. Such information may include information similar to amended returns for any partnership-partner through which the adjustments are flowed before being taken into account by the indirect partner. The IRS will deny modification if a partnership fails timely to provide information the IRS determines is necessary to support and substantiate a request for modification.

Proposed § 301.6225-2(c)(3)(ii) provides that the partnership may request an extension of the 270-day period described in proposed § 301.6225-2(c)(3)(i), and proposed § 301.6225-2(c)(3)(iii) provides that the 270-day period described in proposed § 301.6225-2(c)(3)(i) closes early when the partnership representative and the IRS agree, in writing, to waive the 270-day delay between the mailing of the NOPPA and when the IRS may first issue an FPA described in section 6231(a) (flush language). The waiver of the 270-day period would prevent the partnership from providing modification-related information after the date the waiver was executed, and it would also allow the IRS to issue an FPA earlier than normal. This may be desirable for a partnership if the partnership does not intend to seek modification, but the partnership does want to litigate the adjustments or make an election under section 6226. This could also occur in conjunction with the partnership's waiver of the requirement that the IRS issue an FPA before making a partnership adjustment, for example, if the partnership agrees to the adjustments. Proposed § 301.6225-2(c)(4) describes the method by which the IRS will approve modification requests.

D. Types of Modification

Proposed § 301.6225-2(d) provides seven enumerated types of modifications the IRS will consider if requested by the partnership. Additionally, the IRS may consider alternative forms of modification under proposed § 301.6225-2(d)(9). Unless otherwise stated in proposed § 301.6225-2(d), a partnership may request any or all of the types of modification described in that paragraph. See proposed § 301.6225-2(d)(1).

i. Amended Returns

A partnership may request modification of an imputed underpayment if a reviewed year partner (or indirect partner) of a partnership files one or more amended returns that take into account a partnership adjustment or a portion of a partnership adjustment. See proposed § 301.6225-2(d)(2)(i). The reviewed year partner (or indirect partner) filing the amended return(s) must take into account the appropriate adjustments (or portion thereof) and also address the effects of such adjustments on any tax attributes (as defined in proposed § 301.6241-1(a)(10)) that must be adjusted because the partnership adjustments were taken into account. For the partnership to receive modification as a result of a partner's amended returns, the partner must file amended returns for all years with respect to which any tax attribute is affected by reason of the partnership adjustment(s) taken into account and include any payment due. The Treasury Department and the IRS seek comments on how best to streamline this process for ease of administering the amended return modification process.

The partners' amended returns must be filed with the IRS in accordance with the applicable forms and instructions prescribed by the IRS, and the partnership representative must provide affidavits from each partner for which modification is sought that the partner did in fact file amended returns and make appropriate payments. See proposed § 301.6225-2(d)(2)(iii). Any payment due as a result of adjustments taken into account on an amended return is due at the time the partner's amended return is filed. See proposed § 301.6225-2(d)(2)(ii).

Any partner that files an amended return for modification purposes and is required to make a payment of any kind with that amended return must do so prior to the expiration of the period of limitations under section 6501 for the modification year(s). See proposed § 301.6225-3(d)(2)(v). Section 6225(c)(2) provides that partners may file amended returns “notwithstanding section 6511,” and consequently, a partner may file an amended return that seeks a refund (such as in the case of a reallocation of a distributive share as described in proposed § 301.6225-2(d)(2)(vi)) at any time. A request for refund filed as part of an amended return filed for modification purposes outside the period set forth in 6511 may only request a refund for adjustments related to the partnership proceeding and relevant correlative adjustments. A

partner may not request a refund through the amended return modification procedures outside the period set forth in section 6511 for adjustments that are not a direct result of the partnership adjustments determined in the partnership-level proceeding. See proposed § 301.6225-2(d)(2)(v)(B).

If, however, the IRS must make an assessment to collect a payment due with respect to an amended return filed during modification, the partner's period of limitations under section 6501 must not have expired at the time the amended return is filed. Nothing in the proposed regulations prevents partners from signing an extension of the period of limitations for partnership adjustments at the time the IRS initiates the partnership administrative proceeding or at any other time prior to the expiration of the period of limitations under section 6501. The IRS recognizes that securing such extensions may not be possible in all cases, but doing so may be an option for certain partners and partnerships. Alternatively, there may be other modification alternatives for a partner whose assessment period under section 6501 with respect to the modification years (as defined in proposed § 301.6225-2(d)(2)(iv)) has expired. A partner may, for example, be able to enter into a closing agreement that allows for treatment similar to an amended return and to make a payment on behalf of the partnership's liability in recognition of what the partner would have filed and paid if the partner's assessment period had not already expired.

In general, there is no requirement that all reviewed year partners of a partnership file amended returns for the partnership to request amended return modification. However, in the case of a reallocation adjustment, in general, in order for the IRS to approve the modification, all partners affected by the reallocation adjustment must file amended returns related to the reallocation adjustment. See proposed § 301.6225-2(d)(2)(vi). In certain cases, a partnership may be able to demonstrate that a partner subject to a reallocation adjustment has taken into account that partner's relevant adjustment via some other type of modification that may not require an amended return. For instance, if one partner is a tax-exempt entity for which the partnership may request modification based on that partner's tax-exempt status (as described in proposed § 301.6225-2(d)(3)), and that partner is subject to a reallocation adjustment, it may be unnecessary for the tax-exempt partner to file an amended return in order for the partnership to request modification in accordance with the requirements of proposed § 301.6225-2(d)(2)(vi). Such determinations will depend on the facts and circumstances related to the particular modification and are within the discretion of the IRS.

The Treasury Department and the IRS propose a specific rule that addresses pass-through partners in proposed § 301.6225-2(d)(2)(vii). A pass-through partner (as defined in proposed § 301.6241-1(a)(5)) may, for modification purposes only, file an amended return and take into account its allocable share of the adjustments. A pass-through partner that does so must pay an amount calculated in the same manner as the safe harbor amount under proposed § 301.6226-2(g) on the pass-through partner's share of the partnership adjustment except that, for purposes of calculating the payment amount, instead of using the tax rate under section 6225(b)(1)(A), the tax rate is the rate determined by substituting the total net income of the pass-through partner for the taxable year (as adjusted) for taxable income in section 1(c) of the Code (determined without regard to section 1(h)).

An amended return filed by a pass-through partner without a payment (when required based on the adjustments) will not result in modification for the partnership. See proposed § 301.6225-2(d)(2)(vii). An amended return filed by a pass-through partner is not an administrative adjustment request as defined in section 6227 and the regulations thereunder, but rather is a stand-alone document that is filed solely for modification purposes.

Regardless of the number of pass-through partners or tiers involved in a partnership structure, all amended returns filed by a pass-through partner and its owners must be filed with the IRS and any tax, penalties, additions to tax, and interest due with respect to such amended returns must be paid within the 270-day modification period described in proposed § 301.6225-2(c)(3)(i). Modification is allowed to the extent amended returns are filed and any necessary payments are made within the 270-day time period.

Because amended return modification requires a partner to fully take into account all adjustments allocable to that partner, a partnership may not request additional modification with respect to a partner who files and takes into account adjustments on an amended return. See proposed § 301.6225-2(d)(2)(i). This restriction exists because a partner that files an amended return has fully accounted for the adjustment and allowing, for example, a further rate reduction would produce a double benefit at the partnership level.

If a partner files an amended return for modification purposes which leads to a reduction in the imputed underpayment based on the IRS's approval of that modification request, the partner waives its ability to file further amended returns for the modification years with respect to items related to the partnership adjustments and the imputed underpayment unless the partner receives permission from the IRS to do so. See proposed § 301.6225-2(d)(2)(vii)(B). The intent of this provision is to prevent a partner from filing an amended return for modification purposes, paying some additional amount due and then, after the partnership receives modification, filing another amended return claiming a refund for the same amount on which the partnership relied as part of its modification request.

In addition, partners filing amended returns under section 6225 do so as part of the proceeding under subchapter C of chapter 63, which means that they are bound by the partnership representative's actions pursuant to section 6223. If the partnership representative agrees to an imputed underpayment that was modified due to a partner filing an amended return, the partner is bound to that modification through section 6223 and may not change the partner's position related to the partnership adjustments that were taken into account in a way that is inconsistent with the partnership representative's actions. Nonetheless, the IRS understands that situations may arise in which a partner needs to file a further amended return for an unrelated reason, and the partner may request permission from the IRS to do so if necessary. The Treasury Department and the IRS seek comments on the most efficient ways that taxpayers may request permission from the IRS to file a subsequent amended return.

In addition, a partner can only file an amended return with respect to items stemming from a partnership under the procedures set forth in subchapter C of chapter 63, that is, the amended return modification procedures. See proposed § 301.6225-2(d)(2)(vii)(A).

ii. Tax-Exempt Partners

A partnership may request modification based on the status of its tax-exempt partners. If the IRS approves that modification, the imputed underpayment is calculated without regard to the portion of the partnership adjustment that is allocable to the tax-

exempt partner and with respect to which the partner would not be subject to tax for the reviewed year by reason of its status as a tax-exempt entity. The modification request is based on the tax-exempt status of the partner during the reviewed year. See proposed § 301.6225-2(d)(3)(i).

For the purposes of modification, section 6225(c)(3) provides that a tax-exempt entity is defined pursuant to section 168(h)(2). Proposed § 301.6225-2(d)(3)(ii) further provides that status as a tax-exempt entity for purposes of modification is determined in accordance with the definitions provided under section 168(h)(2)(A), (C), and (D) without reference to section 168(h)(2)(B) and (E). Section 168(h)(2)(B) and (E) do not define categories of entities that are treated as tax-exempt entities, but rather impose limits on the extent to which certain property leased to tax-exempt entities is entitled to special treatment as “tax-exempt use property” with respect to depreciation deductions available to a lessor. As such, those provisions are inapplicable to the determination of tax-exempt status for purposes of the modification process.

Some tax-exempt entities may receive income for which they are subject to tax. For example, section 511 imposes a tax on unrelated business taxable income received by certain tax-exempt entities. Additionally, section 871, section 881, and section 882 impose tax on certain income received by foreign persons. A partnership may request modification based on an adjustment allocable to a tax-exempt partner only to the extent that the partnership demonstrates to the satisfaction of the IRS that the tax-exempt partner would not have been subject to tax with respect to the adjustment allocable to the partner for the reviewed year. See proposed § 301.6225-2(d)(3)(iii).

A partnership's decision either to request or not to request modification in the course of an audit under these proposed regulations may raise issues concerning whether and to what extent any benefit that might result from its request or failure to request modification could be considered to have been provided to any person in lieu of to a tax-exempt partner (whether a current or former partner, and at any “tier” of the partnership). For example, such a transfer of benefit may raise issues for one or more partners with respect to: (1) The status of a tax-exempt partner because of private inurement or private benefit under section 501(c); (2) excise taxes under chapter 42 of subtitle D of the Code or under sections 4975, 4976, or 4980; or (3) requirements under title I of the Employee Retirement Income Security Act of 1974, Public Law 93-406 (88 Stat. 829 (1974)) as amended (ERISA), such as the fiduciary responsibility rules under part 4 thereof. Some of these issues may be addressed by including appropriate provisions in the partnership agreement. However, the Treasury Department and the IRS request comments from the public on whether guidance is needed to address these potential issues and, if so, on possible ways to resolve such issues. Any such comments related to title I of ERISA will be shared with the Department of Labor.

iii. Rate Modification

Section 6225(c)(4) provides the opportunity for a partnership to request to modify an imputed underpayment by changing the tax rate applied to the portion of the total netted partnership adjustment allocable to a C corporation or an individual with respect to capital gains and qualified dividends. If the partnership has partners that are C corporations or individuals, the partnership may request that a lower rate apply to those portions, but that lower rate will be the highest rate in effect with respect to the type of income and partner for whom modification is requested. See proposed § 301.6225-2(d)(4).

iv. Certain Passive Losses of Publicly Traded Partnerships (PTPs)

Section 6225(c)(5) provides an opportunity for publicly traded partnerships (as defined in section 469(k)(2)) to request to modify an imputed underpayment in the case of a net decrease in a specified passive activity loss for specified partners. Proposed § 301.6225-2(d)(5)(ii) defines specified passive activity losses, and proposed § 301.6225-2(d)(5)(iii) defines specified partners. This modification is available both to partnerships that are publicly traded partnerships and with respect to partners (and indirect partners) that are publicly traded partnership

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