Centralized Partnership Audit Regime

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 301

[TD 9844]

RIN 1545-BO03; 1545-BO04

Centralized Partnership Audit Regime

AGENCY:

Internal Revenue Service (IRS), Treasury.

ACTION:

Final regulation.

SUMMARY:

This document contains final regulations implementing the centralized partnership audit regime. These final regulations affect partnerships for taxable years beginning after December 31, 2017 and ending after August 12, 2018, as well as partnerships that make the election to apply the centralized partnership audit regime to partnership taxable years beginning on or after November 2, 2015, and before January 1, 2018.

DATES:

Effective date:

These regulations are effective on February 27, 2019.

Applicability Date:

For dates of applicability, see §§ 301.6221(a)-1(c); 301.6222-1(e); 301.6225-1(i); 301.6225-2(g); 301.6225-3(e); 301.6226-1(g); 301.6226-2(h); 301.6226-3(i); 301.6227-1(h); 301.6227-2(e); 301.6227-3(d); 301.6231-1(h); 301.6232-1(f); 301.6233(a)-1(d); 301.6233(b)-1(e); 301.6234-1(f); 301.6235-1(f); 301.6241-1(b); 301.6241-2(b); 301.6241-3(g); 301.6241-4(b); 301.6241-5(d); 301.6241-6(c).

FOR FURTHER INFORMATION CONTACT:

Concerning the regulations under sections 6221, 6226, 6235, and 6241, Jennifer M. Black of the Office of Associate Chief Counsel (Procedure and Administration), (202) 317-6834; concerning the regulations under sections 6225, 6231, and 6234, Joy E. Gerdy-Zogby of the Office of Associate Chief Counsel (Procedure and Administration), (202) 317-6834; concerning the regulations under sections 6222, 6227, 6232, and 6233, Steven L. Karon of the Office of Associate Chief Counsel (Procedure and Administration), (202) 217-6834; concerning the regulations under section 6225 relating to creditable foreign tax expenditures, Larry R. Pounders, Jr. of the Office of Associate Chief Counsel (International), (202) 317-5465; concerning the regulations relating to chapters 3 and 4 of the Internal Revenue Code (other than section 1446), Subin Seth of the Office of Associate Chief Counsel (International), (202) 317-5003; and concerning the regulations relating to section 1446, Ronald M. Gootzeit of the Office of Associate Chief Counsel (International), (202) 317-4953 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

This document contains final regulations under sections 6221 through 6241 of the Internal Revenue Code (Code) to amend the Procedure and Administration Regulations (26 CFR part 301) to implement the centralized partnership audit regime enacted by section 1101 of the Bipartisan Budget Act of 2015, Public Law 114-74 (BBA), as amended by the Protecting Americans from Tax Hikes Act of 2015, Public Law 114-113, div Q (PATH Act), and sections 201 through 207 of the Tax Technical Corrections Act of 2018, contained in Title II of Division U of the Consolidated Appropriations Act of 2018, Public Law 115-141 (TTCA).

Section 1101(a) of the BBA removed former subchapter C of chapter 63 of the Code effective for partnership taxable years beginning after December 31, 2017. Former subchapter C of chapter 63 of the Code contained the unified partnership audit and litigation rules enacted by the Tax Equity and Fiscal Responsibility Act of 1982, Public Law 97-248 (TEFRA) that were commonly referred to as the TEFRA partnership procedures or simply TEFRA. Section 1101(b) of the BBA also removed subchapter D of chapter 63 of the Code and part IV of subchapter K of chapter 1 of the Code, rules applicable to electing large partnerships, effective for partnership taxable years beginning after December 31, 2017. Section 1101(c) of the BBA replaced the TEFRA partnership procedures and the rules applicable to electing large partnerships with a centralized partnership audit regime that determines adjustments and, in general, determines, assesses, and collects tax at the partnership level. Section 1101(g) of the BBA set forth the effective dates for these statutory amendments, which are effective generally for returns filed for partnership taxable years beginning after December 31, 2017.

On December 18, 2015, section 1101 of the BBA was amended by the PATH Act. 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 June 14, 2017, the Department of the Treasury (Treasury Department) and the IRS published in the

Federal Register

(82 FR 27334) a notice of proposed rulemaking (REG-136118-15) (June 2017 NPRM) proposing rules under section 6221 regarding the scope and election out of the centralized partnership audit regime, section 6222 regarding consistent treatment by partners, section 6223 regarding the partnership representative, section 6225 regarding partnership adjustments made by the IRS and determination of the amount of the partnership's liability (referred to as the imputed underpayment), section 6226 regarding the alternative to payment of the imputed underpayment by the partnership, section 6227 regarding administrative adjustment requests (AARs), and section 6241 regarding definitions and special rules. The Treasury Department and the IRS received written public comments in response to the regulations proposed in the June 2017 NPRM, and a public hearing regarding the proposed regulations was held on September 18, 2017.

On November 30, 2017, the Treasury Department and the IRS published in the

Federal Register

(82 FR 56765) a notice of proposed rulemaking (REG-119337-17) (November 2017 NPRM) proposing rules regarding international provisions under the centralized partnership audit regime, including rules relating to the withholding of tax on foreign persons, the withholding of tax to enforce reporting on certain foreign accounts, and the treatment of creditable foreign tax expenditures of a partnership. No written comments were submitted in response to this NPRM, and no hearing was requested or held.

On December 19, 2017, the Treasury Department and the IRS published in the

Federal Register

(82 FR 60144) a notice of proposed rulemaking (REG-120232-17 and REG-120233-17) (December 2017 NPRM) proposing administrative and procedural rules under the centralized partnership audit regime, including rules addressing assessment and collection, penalties and interest, periods of limitations on making partnership adjustments, and judicial review of partnership adjustments. The regulations proposed in the December 2017 NPRM also provided rules addressing how pass-through partners take into account adjustments under the alternative to payment of the imputed underpayment described in section 6226 and under rules similar to section 6226 when a partnership files an AAR under section 6227. Written comments were received in response to the December 2017 NPRM. However, no hearing was requested or held.

On January 2, 2018, the Treasury Department and the IRS published in

the

Federal Register

(82 FR 28398) final regulations under section 6221(b) providing rules for electing out of the centralized partnership audit regime.

On February 2, 2018, the Treasury Department and the IRS published in the

Federal Register

(83 FR 4868) a notice of proposed rulemaking (REG-118067-17) (February 2018 NPRM) proposing rules for adjusting tax attributes under the centralized partnership audit regime. Written comments were received in response to the February 2018 NPRM. However, no hearing was requested or held.

On March 23, 2018, Congress enacted the TTCA, which made a number of technical corrections to the rules under the centralized partnership audit regime. The amendments under the TTCA 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 9, 2018, the Treasury Department and the IRS published in the

Federal Register

(83 FR 39331) final regulations under section 6223 providing rules relating to partnership representatives and final regulations under § 301.9100-22 providing rules for electing into the centralized partnership audit regime for taxable years beginning on or after November 2, 2015, and before January 1, 2018. Corresponding temporary regulations under § 301.9100-22T were also withdrawn.

On August 17, 2018, the Treasury Department and the IRS published in the

Federal Register

(83 FR 41954) a notice of proposed rulemaking, notice of public hearing, and withdrawal and partial withdrawal of notices of proposed rulemaking (REG-136118-15) (August 2018 NPRM) that withdrew the regulations proposed in the June 2017 NPRM, the November 2017 NPRM, the December 2017 NPRM, and the February 2018 NPRM, and proposed regulations reflecting the technical corrections enacted in the TTCA as well as other changes as discussed in the preamble to the August 2018 NPRM. Written public comments were received in response to the August 2018 NPRM, and a public hearing regarding the proposed regulations was held on October 9, 2018.

In the preambles to the June 2017 NPRM and November 2017 NPRM, comments were requested regarding certain international and tax-exempt aspects of the centralized partnership audit regime. No comments were received in response to these requests, other than a comment regarding fiduciary issues under title I of the Employee Retirement Income Security Act of 1974 (ERISA), which is discussed later in section 3.B.i of the Summary of Comments and Explanation of Revisions. The Treasury Department and IRS will still consider comments on whether any issues related to international rules and tax-exempt partners warrant guidance either under the centralized partnership audit regime provisions or under the relevant provisions of the Code directly related to those areas.

After careful consideration of all written public comments received in response to the June 2017 NPRM, the December 2017 NPRM, and the August 2018 NPRM, as well as statements made during the public hearings for the June 2017 NPRM and the August 2018 NPRM, the portions of the August 2018 NPRM described in this preamble are adopted as amended by this Treasury Decision. Comments received in response to the February 2018 NPRM or that otherwise concern basis and tax attribute rules under § 301.6225-4 or § 301.6226-4 will be addressed in future guidance. For purposes of this preamble, the regulations proposed in the June 2017 NPRM, the November 2017 NPRM, and the December 2017 NPRM are collectively referred to as the “former proposed regulations.” The regulations proposed in the August 2018 NPRM are referred to as the “proposed regulations.”

Summary of Comments and Explanation of Revisions

Thirty written comments were received in response to the June 2017 NPRM. Five statements were provided at the public hearing held on September 18, 2017. Four written comments were received in response to the December 2017 NPRM. No public hearing was held. Eight written comments were received in response to the August 2018 NPRM, and one statement was provided at the public hearing held on October 9, 2018. All of these comments (both written and provided orally at the public hearings) have been considered, and revisions to the regulations were made in response to the comments. The written comments received are available for public inspection at

www.regulations.gov

or upon request.

In addition to changes in response to the comments, editorial revisions were also made to correct typographical errors, grammatical mistakes, and erroneous cross-references. Revisions were also made to clarify language in the proposed regulations that was potentially unclear. Unless specifically described in this Summary of Comments and Explanation of Revisions, such revisions were not intended to change the meaning of the language that was revised. All applicability dates were revised to provide that the final regulations will not apply to taxable years that ended before the date the August 2018 NPRM was filed with the

Federal Register

. To the extent comments recommended as a general matter that the regulations take into account the TTCA amendments, those comments were adopted as described in this Summary of Comments and Explanation of Revisions.

1. Scope of the Centralized Partnership Audit Regime

Three comments were received regarding the scope of the centralized partnership audit regime. All of the comments concerned former proposed § 301.6221(a)-1, which was issued before the TTCA was enacted. No comments were received on proposed § 301.6221(a)-1 as revised subsequent to the TTCA in the August 2018 NPRM.

Prior to amendment by the TTCA, section 6221(a) provided that any adjustment to items of income, gain, loss, deduction, or credit of a partnership shall be determined at the partnership level. Former proposed § 301.6221(a)-1(b)(1)(i) had defined the phrase “items of income, gain, loss, deduction, or credit” to mean all items and information required to be shown, or reflected, on a return of the partnership and any information contained in the partnership's books and records for the taxable year. One comment stated the definition under former proposed § 301.6221(a)-1(b)(1)(i) included items on the partnership return or in the partnership's books and records regardless of whether (i) such items or information would affect the income that the partnership reports or (ii) the particular tax characteristics of the separate partners would affect the ultimate tax liability. The comment expressed concern that, by broadly defining the scope of the centralized partnership audit regime, the proposed regulations would expand the number of partnerships and partners that encounter differences between the correct tax they would have paid if they had properly reported, and the amount of the imputed underpayment. No changes to the regulations were made in response to this comment.

The TTCA amended section 6221(a) by replacing the phrase “items of income, gain, deduction, loss or credit of a partnership for a partnership taxable year (and any partner's distributive share thereof)” with the term “partnership-related item.” The TTCA added a definition of “partnership-related item” to section

6241(2). The August 2018 NPRM adopted the TTCA amendments to section 6221(a) and 6241 by moving the majority of the regulation text under former proposed § 301.6221(a)-1 to the definition of “partnership-related item” under proposed § 301.6241-6. Because of these changes, the comment is generally no longer applicable to this section of the regulations.

In addition, the TTCA amendments address the comment's first concern that the scope of former proposed § 301.6221(a)-1(b)(1)(i) was overly broad in that it was delineated without regard to whether items or information adjusted at the partnership level affect the income of the partnership. Section 6241(2)(B) broadly defines a partnership-related item as any item or amount with respect to the partnership which is relevant in determining the tax liability of any person under chapter 1 of the Code and any partner's distributive share thereof. Section 6241(2)(B). Nothing within that definition limits the term partnership-related item to income reported by the partnership. To the contrary, partnership-related items are any items with respect to the partnership that are relevant to determining any person's chapter 1 tax, which could include partnership expenses, credits generated by partnership activity, assets and liabilities of the partnership, and any other items concerning the partnership that are relevant to someone's chapter 1 tax, irrespective of the impact such items have on the partnership's income.

Furthermore, the core feature of the centralized partnership audit regime is to provide a centralized method of examining items of a partnership. Adjusting items on a partnership's return or in the partnership's books and records, regardless of their effect on partnership income, in a centralized partnership proceeding at the partnership level is not only consistent with this centralized approach, but it also results in efficiencies because one proceeding can be conducted that will bind all partners and the partnership. See section 6223(b). Nothing in the statute requires only items that affect the partnership's income, as reported on the partnership's return, to be adjusted at the partnership level.

Regarding the comment's second concern that an imputed underpayment is determined without regard to partners' tax characteristics and that the imputed underpayment amount differs from the amount of tax the partners would have paid had the items been reported correctly, those concerns are addressed in section 3.A. of this Summary of Comments and Explanation of Revisions.

Former proposed § 301.6221(a)-1(b)(1)(i) provided as an example of an “item of income, gain, loss, deduction, or credit” any items related to transactions between a partnership and any person including disguised sales, guaranteed payments, section 704(c) allocations, and transactions to which section 707 applies. Former proposed § 301.6221(a)-1(b)(1)(i)(H). One comment suggested that this provision inappropriately included partner items such as a disguised fee under section 707(a)(2)(A) and the gain or loss a partner may realize from a disguised sale under section 707(a)(2)(B). The comment recommended revising the regulations to refer to “items

of a partnership

related to . . . transactions to which section 707 applies.” Similarly, another comment expressed concern about situations where a partner was not acting in the partner's capacity as a partner, but rather as a counterparty to a transaction with the partnership. The comment suggested that the regulations clarify that a final determination of a transaction between a partnership and a partner following an examination of the partnership is not binding on any third person, including a partner not acting in its capacity as a partner and who was not a party to the examination.

These comments are addressed by the final regulations under § 301.6241-1(a)(6) regarding the definition of partnership-related item. Proposed § 301.6241-6(b)(4) and (5) defined the phrase “item or amount with respect to the partnership” to include an item or amount that relates to a transaction with the partnership by a partner acting in its capacity as a partner or by an indirect partner acting in its capacity as an indirect partner as well as an item or amount relating to a transaction that is described in section 707(a)(2), 707(b), or 707(c). Accordingly, under the proposed regulations if an item or amount related to a transaction that is described in section 707(a)(2), 707(b), or 707(c) and was relevant in determining chapter 1 tax, that item was a partnership-related item and must be determined at the partnership level.

As described more fully in section 1.B., the final regulations clarify that items or amounts relating to transactions of the partnership are items or amounts with respect to the partnership only if those items or amounts are shown, or required to be shown, on the partnership return or are required to be maintained in the partnership's books and records. The final regulations further clarify that items or amounts shown, or required to be shown, on a return of a person other than the partnership (or in that person's books and records) that result after application of the Code to a partnership-related item and that take into account the facts and circumstances specific to that person are not partnership-related items and, therefore, are not determined at the partnership level under the centralized partnership audit regime.

The changes in the final regulations to the definition of partnership-related item address the concerns raised by the comment. First, § 301.6241-1(a)(6) provides that only items or amounts reflected, or required to be reflected on the partnership's return or in its books and records are with respect to the partnership. If such items are relevant to determining chapter 1 tax such items are partnership-related items. This rule applies equally to items or amounts relating to any transaction with, liability of, or basis in the partnership. Second, § 301.6241-1(a)(6) further provides that items reflected, or required to be reflected on the return of a person other than the partnership or in that person's books and records that result after application of the Code to a partnership-related item are not with respect to a partnership and, thus, not partnership-related items. Accordingly, only items of the partnership, as suggested by the comment, are partnership-related items under § 301.6241-1(a)(6).

Proposed § 301.6221(a)-1(a) provided that any consideration necessary to make a determination at the partnership level under the centralized partnership audit regime, including the period of limitations on making partnership adjustments under section 6235 or facts necessary to calculate an imputed underpayment under section 6225 were determined at the partnership level. The final regulations under § 301.6221(a)-1(b) retain this concept, but with revised language. The final regulations provide that any legal or factual determinations underlying any adjustment or determination made under the centralized partnership audit regime are also determined at the partnership level under the centralized partnership audit regime. For instance, such determinations include the period of limitations on making adjustments under the centralized partnership audit regime and any determinations necessary to calculate the imputed underpayment or any modification of the imputed underpayment under section 6225.

After consideration, the Treasury Department and the IRS have concluded that the phrase “legal and factual determinations underlying an

adjustment or determination” instead of the phrase “any consideration necessary to make a determination at the partnership level” more clearly and accurately reflects the rule that facts and legal conclusions that underlie adjustments to partnership-related items, tax, and penalties made at the partnership level are also determined at the partnership level. The revised language more clearly describes the rule and provides taxpayers with more definitive guidance regarding the items determined at the partnership level. Additionally, this language is consistent with language used in proposed § 301.6241-6(b)(8), which was removed as described in section 2 of this Summary of Comments and Explanation of Revisions.

Lastly, the final regulations remove the list of cross-references from the end of proposed § 301.6221(a)-1(a). The TTCA amended section 6221(a) to provide that adjustments to partnership-related items are determined at the partnership level “except to the extent otherwise provided in” subchapter C of chapter 63. Because the statutory language is clear that there are exceptions within subchapter C of chapter 63 to the general rule under section 6221(a) and § 301.6221(a)-1, the list of cross-references from proposed § 301.6221(a)-1(a) was no longer necessary.

A. Penalty Defenses

Five comments were received with respect to former proposed § 301.6221(a)-1(c), which provided that any defense to any penalty, addition to tax, or additional amount must be raised by the partnership in a partnership-level proceeding under the centralized partnership audit regime, regardless of whether the defense relates to facts and circumstances relating to a person other than the partnership. Once the adjustments determined in the partnership-level proceeding became final, no defense to any penalty determined could be raised or taken into account. Former proposed § 301.6221(a)-1(c).

Several comments stated that the rule under former proposed § 301.6221(a)-1(c) was inequitable to partners because, among other reasons, partners had no control over whether the partnership representative would raise a partner-specific defense, especially in the case of indirect partners who are less directly connected to the partnership representative. Some comments recommended the regulations clarify how partner-level defenses would be raised in the partnership-level proceeding and how decisions regarding those penalty defenses would be communicated to partners. Other comments suggested that partners should be able to raise their own partner-level defenses. In response to these comments, former proposed § 301.6221(a)-1(c) was removed from the proposed regulations in the December 2017 NPRM. See section 3 of the preamble to the December 2017 NPRM. The December 2017 NRPM also proposed regulations under sections 6225 and 6226 (former proposed §§ 301.6225-2(d)(2)(viii) and 301.6226-3(i)) which allowed partners to raise their own partner-level defenses at the time partners took into account the partnership adjustments determined at the partnership level (either through the modification process or as part of the election under section 6226). For further discussion of the rules regarding partner-level defenses under sections 6225 and 6226, see sections 3.D. and 4.C.ii.I. of this preamble. See also section 8.A. of this preamble regarding section 6233(a).

B. Partnership-Related Item

Proposed § 301.6241-6(a) defined the term “partnership-related item” as any item or amount with respect to the partnership which is relevant to determining the tax liability of any person under chapter 1 and any partner's distributive share of any such item or amount. Proposed § 301.6241-6(b) provided that an item or amount is with respect to the partnership without regard to whether the item or amount appeared on the partnership return if the item or amount was described in one of eight categories. Two categories described items or amounts that are shown or reflected, or required to be shown or reflected, on a return of the partnership under section 6031 or are in the partnership's books and records. The other categories described items or amounts relating to certain transactions with the partnership, items or amounts relating to liabilities of the partnership provided the item or amount was reported by a partner, and items or amounts relating to basis in the partnership. Imputed underpayments and any legal or factual determinations necessary to make an adjustment to items or amounts described in the other categories were also defined as items or amounts with respect to the partnership. Proposed § 301.6241-6(b)(1) through (8).

After careful consideration, the Treasury Department and the IRS have revised the definition of “item or amount with respect to the partnership.” First, the final regulations remove the language “without regard to whether or not such item or amount appears on the partnership's return” from proposed § 301.6241-6(b). That phrase derived from the parenthetical in section 6241(2)(B)(i) that follows “item or amount with respect to the partnership.” The Treasury Department and the IRS have determined that the parenthetical language describes items or amounts that appear on the partnership return, items or amounts that were required to appear on the return but actually did not, and items or amounts that factor into the determination of items or amounts that do appear on the partnership return. The Treasury Department and the IRS have concluded that this parenthetical does not extend the concept of “with respect to the partnership” to items or amounts that are reported by third parties and that are otherwise not defined as partnership-related items in these final regulations. See § 301.6241-1(a)(6)(vi)(A) and (B).

Second, the final regulations replace the list of eight categories of items or amounts that were with respect to the partnership with a single, streamlined paragraph, § 301.6241-1(a)(6)(iii) that includes all the items and amounts from the prior list, except as described in this section of this preamble. Third, the definition of partnership-related item was moved from proposed § 301.6241-6 and placed under the definition of “partnership adjustment” in § 301.6241-1(a)(6) to more closely track the statutory structure of section 6241(2).

The final regulations under § 301.6241-1(a)(6)(iii) maintain the rule from the proposed regulations that items or amounts shown or reflected, or required to be shown or reflected, on the return of the partnership are items or amounts with respect to the partnership. The final regulations also clarify that items or amounts in the partnership's book or records are items or amounts with respect to the partnership if those items or amounts are “required to be maintained” in the partnership's books and records. The phrase “required to be maintained” is added to account for items that may be maintained in the partnership's books and records on a voluntary basis. For example, a partnership may choose to maintain the outside basis of each of its partners in its books and records, even though the Code does not require this information be maintained by the partnership. The rule make clears that the voluntary recording of an item in the partnership's books is not determinative of the meaning of the phrase “item or amount with respect to the partnership.” A partnership cannot convert an item or amount that is not with respect to the

partnership into an item or amount that is with respect to the partnership merely by including that item or amount in the partnership's books and records. This rule provides consistency among partnerships and more certainty regarding what items in the books and records of a partnership constitute items or amounts with respect to the partnership.

The final regulations do not retain the separate categories of items relating to transactions with, liabilities of, and basis in the partnership. Instead, the final regulations adopt a streamlined approach and provide that those items are only with respect to the partnership if those items are reflected, or required to be reflected, on the partnership's return or required to be maintained in its books and records. The separate treatment under the proposed regulations for these types of items and amounts was duplicative. Items or amounts relating to transactions with, liabilities of, and basis in the partnership are items or amounts shown or reflected, or would be required to be shown or reflected, on the partnership return or required to be maintained in the partnership's books and records. Accordingly, describing separate categories for such items was unnecessary and potentially confusing.

Under § 301.6241-1(a)(6)(iii), an item or amount is with respect to the partnership only if the item or amount is shown or reflected, or required to be shown or reflected, on the partnership return or required to be maintained in the partnership's books and records. Consistent with that interpretation, the final regulations provide an item or amount relating to transactions with, liabilities of, and basis in the partnership is with respect to the partnership only if the item or amount is reported, or required to be reported, on the partnership return or is required to be maintained in the partnership's books and records.

The term partnership-related item includes a partner's distributive share of items or amounts that are with respect to the partnership which are relevant in determining the chapter 1 tax of any person. Section 6241(2)(B)(ii). In taking into account the partner's distributive share of partnership-related items, a partner must apply the provisions of the Code to each partnership-related item to compute the partner's ultimate tax liability. The application of the Code to the partner's share of partnership-related items requires taking into account facts and circumstances that are unique to a particular partner. Generally speaking, those facts and circumstances are known only by the partner, are not known by the partnership, and are based on information only within the partner's control and outside of the partnership's control.

In an examination of items on a partner's return, the IRS generally needs information pertaining to the partner's specific facts and circumstances to determine the correctness of the items. The partner whose items are at issue is normally the best source for that type of information. While a partnership may possess some information about a particular partner's facts and circumstances, obtaining information from the partnership is generally not as efficient as obtaining information from the partner. Obtaining such information from the partner also preserves the privacy interests of the partner. Therefore, from both a taxpayer and tax administration standpoint, an examination of items for which application of the Code depends on a partner's particular facts and circumstances is, in general, best performed at the partner level, rather than the partnership level.

Under the TEFRA procedures, these types of items were considered affected items and adjustments to those items were computational adjustments. The centralized partnership audit regime is intended to have a scope sufficient to address those items that would have been considered partnership items, affected items, and computational adjustments under TEFRA, including the regulations. Joint Comm. on Taxation, JCX-6-18, Technical Explanation of the Revenue Provisions of the House Amendment to the Senate Amendment to H.R. 1625 (Rules Committee Print 115-66), 37 (2018) (JCX-6-18). One way to achieve a sufficiently broad scope is to attempt to define the term “partnership-related item” to include those items that would have been partnership items, affected items, and computational adjustments under TEFRA. For the following reasons, however, this approach was not adopted.

The centralized partnership audit regime is a fundamentally distinct system from TEFRA. While under both sets of rules adjustments are made at the partnership level and those adjustments are binding on partners, the framework for assessing and collecting tax resulting from those adjustments is significantly different. Under TEFRA, tax attributable to partnership items determined at the partnership level and tax attributable to affected items was assessed against the partners of the partnership through computational adjustments made by the IRS with respect to the partner. Computational adjustments were made either by mailing a notice of deficiency to the partner if factual determinations were necessary at the partner level or by directly assessing tax against the partner. The tax was assessed with respect to the year that was audited by the IRS, and assessments were required to be made within one year of the completion of the partnership-level proceeding.

Under the centralized partnership audit regime, adjustments to partnership-related items are similarly determined at the partnership level. In stark contrast to the TEFRA procedures, however, the tax attributable to those adjustments is also assessed and collected at the partnership level in the form of an imputed underpayment determined pursuant to section 6225. An imputed underpayment is assessed as if it were a tax imposed for the adjustment year, generally the year in which the adjustments are finally determined, instead of the year that was subject to examination. Section 6225(d). The partnership, not the partners, is liable for the imputed underpayment. A partnership may elect the alternative to payment of the imputed underpayment under section 6226 and “push out” the adjustments determined at the partnership level, in which case the tax attributable to the adjustments is assessed and collected from the partnership's partners. Unlike the TEFRA procedures, however, under the push out process, assessment and collection is initiated by the partner, rather than by the IRS, by the partner taking into account the partnership adjustments and self-reporting any tax due on the partner's next filed return, alleviating both the administrative and timing issues that arose in TEFRA. See section 2.A of the preamble to the June 2017 NPRM.

When calculating an imputed underpayment based on adjustments determined at the partnership level, taxpayer favorable adjustments are generally disregarded and the highest rate of tax is applied. This formula may produce an amount that is larger than the cumulative amount of tax the partners would have paid had the partners taken the adjustments into account separately, but it also relieves the IRS of the obligation to account for specific partner facts and circumstances when initially determining the imputed underpayment amount. During the modification phase, a partnership may, at its option, request that the imputed underpayment be modified to take into account partner tax attributes and facts and circumstances. See section 3.B. for further discussion.

When taking into account adjustments under section 6226, a partner determines the increase or decrease in tax that would have occurred if the adjustments were taken into account for the partner's tax year correlating to the year that was audited. For intervening years, any year between the audited year and the current year, the partner must determine the effect on tax attributes of the adjustments and the resulting increase or decrease that would have occurred for those years as well. The partner then adjusts her tax for the current year by the aggregate tax that would have resulted had the adjustments been properly taken into account. Under TEFRA, it was the IRS's burden to determine tax at the partner level. The centralized partnership audit regime, under section 6226, shifts that burden from the IRS to the partner. As a result, it is neither necessary nor efficient for the IRS to determine at the partnership level the facts and circumstances specific to a partner in order for that partner to determine the proper amount of tax in the case of a push out.

The rules for calculating an imputed underpayment under section 6225 and the computation rules under section 6226 are sufficiently broad to ensure that the tax attributable to items that would have been partnership items, affected items, and computational adjustments under the TEFRA is collected under the centralized partnership audit regime. When the partnership pays an imputed underpayment, the application of limitations and restrictions is assumed and favorable adjustments are disregarded unless a partnership demonstrates that partner tax attributes should override those assumptions. In this way, the imputed underpayment determination, including any modifications, sufficiently accounts for those types of items that would have been affected items or computational adjustments under TEFRA. Similarly, in the case of an election under section 6226, the re-computation process necessarily involves the application of items that would have been affected items or computational adjustments.

Because both the imputed underpayment rules and the section 6226 rules sufficiently address items that would have been partnership items, affected items, and computational adjustments, it is both unnecessary and over-inclusive to define partnership-related item to encompass all of those items. Accordingly, the final regulations clarify that the term partnership-related item does not include items or amounts that would have been TEFRA affected items or computational adjustments. The final regulations do this by defining “with respect to the partnership” to exclude items or amounts shown, or required to be shown, on a return of a person other than the partnership (or in that person's books and records) that result after application of the Code to a partnership-related item and that take into account the facts and circumstances specific to that person. Because these items and amounts are not with respect to the partnership, they are not partnership-related items the IRS must adjust at the partnership level. Two examples were added to the final regulations under § 301.6241-1(a)(6)(vi) to illustrate this rule.

The definition of “with respect to the partnership,” and by extension partnership-related item, under the final regulations preserves the centralized nature of the proceeding with respect to the partnership. During the partnership level proceeding under the centralized partnership audit regime, the IRS adjusts items that are germane to the partnership as an entity—that is, items reported by the partnership on its return or items in its books and records generally used for purposes of completing the return. The partnership has access to this information, and it is therefore, in general, most efficient to obtain this information from the partnership in the partnership level proceeding.

This rule also protects the tax and privacy interest of partners. Under section 6223, partners are bound by actions taken by the partnership in the partnership proceeding and by any final decision in the partnership proceeding. Unlike under TEFRA, individual partners do not have a right to participate in the partnership level administrative or judicial proceeding. If items based on the application of the Code to a particular partner based on that partner's facts and circumstances were items required to be determined at the partnership level, the partner may be unable to dispute adjustments to those items. And even if the partner were able to dispute adjustments to those items, the partner would need to divulge private information in a proceeding in which the partnership was the party, not the partner itself.

In addition, a rule that would require that such items and amounts be determined at the partnership level raises significant administrative concerns for the IRS. In general, the partnership would in most cases lack the facts necessary to determine items or amounts that depend on the facts and circumstances of the partners. By necessity, the IRS would be required to involve the partners in the examination to the extent the partner's items and amounts were at issue. Requiring the IRS to involve potentially the many partners in the entity level examination of the partnership would undermine the efficiencies of the centralized partnership audit regime's concept of the partnership representative and the binding nature of the partnership representative on the outcome of the entity level examination. Further, if the IRS did not examine all of the various items or amounts on the partners' returns during the partnership level proceeding, the IRS would, for each of the partners' items and amount that were also partnership-related items, be precluded from adjusting those items at the partner level outside of the centralized partnership audit regime. This would lead to an unnecessary expansion of partnership-level proceedings to encompass what could more simply and efficiently be resolved at the partner level for one or a small group of partners.

i. Comments Concerning Partnership-Related Item

One comment recommended that all partners should be audited as a group, but only about their financial involvement within the scope of the partnership. According to the comment, outside interests and income should not be determined at the partnership level. Although it is not entirely clear what the comment includes in the phrases “financial involvement within the scope of the partnership” and “outside interests and income”, the Treasury Department and the IRS understand this comment to be a request to limit the scope of the items that are “with respect to the partnership” for purposes of this section. Another comment suggested that the scope of the term “partnership-related item” should not be unreasonably broad, particularly with respect to partner-level items where the underlying issue is primarily of interest to the partner and not the partnership. The comment expressed concern that the partnership could have little interest in disputing a proposed adjustment that would have little impact to the partnership but could have a dramatic effect on a particular partner.

These comments were adopted as reflected in the changes to the definition of “with respect to the partnership” described in this section of this preamble. Under the final regulations, outside interests and income and partner-level items are not “with respect to the partnership” to the extent those are not items or amounts reflected, or required to be reflected, on the

partnership return or required to be maintained in the partnership's books and records. In addition, the items or amounts that are “with respect to the partnership” as defined in § 301.6241-1(a)(6)(iii) are generally items concerning the partners' financial involvement within the scope of the partnership. Accordingly, adjustments to items concerning the partners' financial involvement within the scope of the partnership would generally be determined at the partnership level, and adjustments to items involving outside interests and income or partner-level items that result after application of the Code to a partnership-related item and that take into account facts and circumstances specific to the partner, to the extent provided for in this section, are not determined at the partnership level under the centralized partnership audit regime.

In addition to the revisions described earlier in this section of this preamble, the term imputed underpayment was moved from the definition of “item or amount is with respect to the partnership” to the definition of partnership-related item under § 301.6241-1(a)(6)(ii). This change clarifies that an imputed underpayment is always a partnership-related item. First, an imputed underpayment is a creation of the centralized partnership audit regime and can only arise under the centralized partnership audit regime. See sections 6225, 6226, and 6227. Second, the statute expressly defines an imputed underpayment as an item or amount that is with respect to the partnership. Section 6241(2)(B)(i). Third, an imputed underpayment is relevant in determining the liability of any person under chapter 1, as defined in § 301.6241-1(a)(6)(iv), because payment of the imputed underpayment by the partnership relieves the partners of any chapter 1 liability attributable to the reviewed year partnership adjustments.

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

Five comments were received concerning section 6222, regarding the requirement that a partner's return be consistent with the partnership return. The comments covered the following topics: Inconsistent treatment in the case of an amended return, an administrative adjustment request, or where no partnership return is filed; the form and method for identifying inconsistent treatment; proceedings to adjust identified, inconsistently reported items; and the election regarding consistent treatment with a schedule furnished to the partner by the partnership. In addition to responding to these comments, this section of the preamble describes changes to the language of § 301.6222-1(a)(2) regarding partners that are partnerships with an election in effect under section 6221(b).

A. Inconsistent Treatment on an Amended Return and Definition of Partner's Return for Purposes of § 301.6222-1

One comment recommended that the regulations clarify that a partner may file an amended return in order to take a position inconsistent with the filed partnership return as long as such amended return includes a statement identifying the inconsistent treatment. Under section 6222(a), a partner shall, on the partner's return, treat each partnership-related item in a manner that is consistent with the treatment of such item on the partnership return. Proposed § 301.6222-1(a) provided that the treatment of partnership-related items on a partner's return must be consistent with the treatment of such items on the partnership return in all respects, including the amount, timing, and characterization of such items. The term “partner's return” is not defined in either section 6222(a) or proposed § 301.6222-1(a).

Section 6222(a) and § 301.6222-1(a) are designed to ensure consistent treatment of partnership-related items on partners' returns and the partnership return filed with the IRS, except for cases where the partner notifies the IRS of the inconsistency. The requirement to be consistent with the partnership return extends to each return filed by the partner that reflects, or is required to reflect, partnership-related items. This includes both original and amended returns. Any other application of this requirement would render the requirement of consistency meaningless. For example, a partner could file a return on April 15 taking a consistent position, only to turn around on April 16 and file an amended return taking an inconsistent position.

To clarify that the consistency requirement under section 6222(a) and proposed § 301.6222-1(a) applies to each return of the partner, the final regulations provide that the term “partner's return” for purposes of § 301.6222-1 includes any return, statement, schedule, or list, and any amendment or supplement thereto, filed by the partner with respect to any tax imposed by the Internal Revenue Code. Accordingly, pursuant to § 301.6222-1(a), a partner on either an original or an amended return must treat partnership-related items consistently with how those items were treated on the partnership return filed with the IRS.

The clarification of the term “partner's return” also addresses the comment's suggestion that the regulations permit inconsistent treatment on an amended return provided the IRS is notified of that inconsistent treatment. Under § 301.6222-1(c)(1), the requirement that a partner treat a partnership-related item consistently with the partnership's treatment of that item, and the effect of inconsistent treatment, do not apply to partnership-related items identified as inconsistent (or that may be inconsistent) in a statement attached to the partner's return on which the partnership-related item is treated inconsistently. As clarified in these final regulations, the term partner's return for purposes of § 301.6222-1 includes any amendment to the partner's original return. Accordingly, so long as a partner notifies the IRS of an inconsistent treatment, in the form and manner prescribed by the IRS, by attaching a statement to the partner's return—including an amended return—on which the partnership-related item is treated inconsistently, the consistency requirement under § 301.6222-1(a), and the effect of inconsistent treatment under § 301.6222-1(b), do not apply to that partnership-related item.

i. Limitations on Filing Amended Returns Reporting Inconsistent Positions

When a partner on an amended return treats a partnership-related item inconsistently with how the item was treated on the partnership return, the partner is making a request for an administrative adjustment of that partnership-related item. Accordingly, the rule under proposed § 301.6227-1(a) that provided a partner may not request an administrative adjustment of a partnership-related item was revised to account for situations in which on an amended return a partner treats a partnership-related item inconsistently with the partnership return pursuant to § 301.6222-1(c)(1).

Section 6227(c) provides that in no event may a partnership file an AAR after a notice of an administrative proceeding with respect to the taxable year is mailed under section 6231. Consistent with section 6227(c), proposed § 301.6227-1(b) provided that no AAR may be filed after a NAP has been mailed by the IRS, except as provided in § 301.6231-1(f) (regarding withdrawal of a NAP). To give effect to this rule in the context of inconsistent treatment, the final regulations under § 301.6222-1(c)(5) provide that a partner

may not notify the IRS that the partner is treating an item inconsistently with the partnership return for a taxable year after a NAP with respect to such partnership taxable year has been mailed by the IRS under section 6231. This rule clarifies that once the IRS initiates an administrative proceeding with respect to a partnership taxable year, any adjustment to a partnership-related item for that year must be determined exclusively within that partnership-level proceeding in accordance with section 6221(a). Neither the partnership, through filing an AAR, nor a partner, by taking an inconsistent position, may adjust a partnership-related item outside of that proceeding. Any actions taken by the partnership and any final decision in the proceeding are binding on the partnership and all its partners. Section 6223(b).

B. Inconsistent Treatment in the Case of an Administrative Adjustment Request

Proposed § 301.6222-1(c)(2) provided that the notification procedures under § 301.6222-1(c) do not apply to a partnership-related item the treatment of which is binding on the partner because of actions taken by the partnership, or because of any final decision in a proceeding with respect to the partnership, under the centralized partnership audit regime. Accordingly, under proposed § 301.6222-1(c)(2), the provisions of § 301.6222-1(c) did not apply with respect to the partner's treatment of a partnership-related item reflected on an AAR. This meant that a partner could not treat an item inconsistently with how such item was treated on an AAR. One comment recommended that the regulations under § 301.6222-1(c)(2) be revised to permit a partner to notify the IRS of an inconsistent position taken with respect to an item reported on an AAR. This comment was adopted.

Under section 6223(b), all partners are bound by actions taken by the partnership and by any final decision with respect to the partnership under the centralized partnership audit regime. In the case of an AAR, section 6223(b) binds each partner to the partnership's making of the request itself and the mechanism by which the adjustments requested are taken into account, including any election by the partnership to have the partners take into account the adjustments. Accordingly, if the partnership takes into account the adjustments by paying an imputed underpayment, the partners must follow the rules under section 6225. If there is no imputed underpayment or if the partnership elects to have the partners take into account the adjustments, the partners must follow the procedures under § 301.6227-3.

When taking into account AAR adjustments under § 301.6227-3, partners must adhere to the consistency requirements under section 6222(a). See § 301.6222-1(a)(4) (providing consistency requirement applies to the treatment of a partnership-related item on an AAR). Nothing in sections 6222, 6223(b), or 6227, however, precludes a partner from notifying the IRS the partner is taking an adjustment into account inconsistently with how the adjusted item was treated in an AAR. While section 6227 imposes certain requirements with respect to AARs, none of those requirements contradict section 6222(c)'s exception to the consistency requirement. Accordingly, the final regulations under § 301.6222-1(c)(2) remove the language stating that the provisions of § 301.6222-1(c)(1) do not apply with respect to a partner's treatment of a partnership-related item reflected on an AAR. In addition, the final regulations under § 301.6227-1 remove the rule under proposed § 301.6227-1(f) regarding the binding nature of an AAR. As a result of these changes, a partner may notify the IRS it is treating an AAR-adjusted item inconsistently in accordance with the provisions of § 301.6222-1(c).

The final regulations under § 301.6222-1(c)(2) maintain the language stating that the provisions of § 301.6222-1(c)(1) do not apply to a partner's treatment of an item reflected on a statement under section 6226 filed by the partnership with the IRS. A cross-reference to § 301.6226-1(e) was also added. In addition, the final regulations clarify that the provisions of § 301.6222-1(c)(1) do not apply to any item the treatment of which is binding on the partner because of an action taken by the partnership or because of a final decision in a proceeding under the centralized partnership audit regime with respect to the partnership. Section 6223(b). Items reflected on a statement under section 6226 filed with the IRS are an example of such items.

C. Inconsistent Treatment When No Partnership Return is Filed

Proposed § 301.6222-1(a)(3) provided that a partner's treatment of a partnership-related item attributable to a partnership that does not file a return is per se inconsistent, unless the partner files a notice of inconsistent treatment in accordance with proposed § 301.6222-1(c). One comment recommended that the regulations include an example to illustrate the outcome of the application of the rule under proposed § 301.6222-1(a)(3). The comment observed that without a return filed by the partnership, there would not be a return with which to make the partner's return consistent. To illustrate the application of § 301.6222-1(a)(3), Example 7 was added under § 301.6222-1(a)(5).

In light of the comment, the final regulations under § 301.6222-1(b)(1) include the clarification that where a partnership has failed to file a return, any treatment of a partnership-related item on a partner's return may be removed, and the IRS may determine any underpayment of tax resulting from such adjustment.

Lastly, the final regulations eliminate the phrase “unless the partner files a notice of inconsistent treatment in accordance with proposed § 301.6222-1(c)” from proposed § 301.6222-1(a)(3). This change clarifies that a partner's treatment of an item attributable to a partnership that has not filed a return is per se inconsistent, even if the partner notifies the IRS of the inconsistent treatment. The notification under § 301.6222-1(c) turns off the consistency requirement, but it does not change, as a factual matter, that the partner reported inconsistently.

D. Form and Method for Identifying Inconsistent Treatment of a Partnership-Related Item

Under proposed § 301.6222-1(c)(1), in addition to the requirement that a statement identifying an inconsistent treatment must be attached to the partner's return on which the item is treated inconsistently, the statement must be provided to the IRS according to the forms, instructions, and other guidance prescribed by the IRS. One comment asked about the form and method for providing the IRS with the statement described in proposed § 301.6222-1(c)(1) and suggested specific format guidance in the regulations would assist the public in reporting an inconsistent treatment. This comment was not adopted.

The final regulations maintain the rule that a partner must provide the statement described in § 301.6222-1(c)(1) in accordance with forms, instructions, and other guidance prescribed by the IRS. Prescribing the form and method for notifying the IRS of inconsistent treatment through forms, instructions, and other sub-regulatory guidance allows the IRS the flexibility to update its procedures for identifying an inconsistency as appropriate and necessary without the IRS having to amend the regulations. This flexibility preserves government resources and

also expedites the guidance process for taxpayers to be aware of changes in IRS procedures. Accordingly, the final regulations do not provide a specific form or method for identifying inconsistent treatment.

The same comment asked whether a statement identifying inconsistent treatment can only be filed contemporaneously with the partner's tax return. Proposed § 301.6222-1(c) provided that a statement does not identify an inconsistency unless it is attached to the partner's return on which the partnership-related item is treated inconsistently. Because the plain language of proposed § 301.6222-1(c) made clear that the statement identifying inconsistent treatment must be attached to a return, no change was made in response to this comment.

E. Proceeding To Adjust an Identified, Inconsistently Reported Item

If a partner fails to satisfy the requirements of § 301.6222-1(a), the IRS may adjust the inconsistently reported partnership-related item on the partner's return to make it consistent with the treatment of such item on the partnership return, unless the partner provides notice of the inconsistent treatment in accordance with § 301.6222-1(c). See § 301.6222-1(b). Under proposed § 301.6222-1(c)(4)(i), if a partner notifies the IRS of an inconsistent treatment of a partnership-related item in accordance with proposed § 301.6222-1(c)(1) and the IRS disagrees with that inconsistent treatment, the IRS may adjust the identified, inconsistently reported item in a proceeding with respect to the partner. Nothing in proposed § 301.6222-1(c)(4)(i) precluded the IRS, however, from also conducting a proceeding with respect to the partnership.

One comment recommended that § 301.6222-1(c)(4)(i) provide that if the IRS does conduct a proceeding with respect to the partnership to adjust an identified, inconsistently reported item, the IRS may include within that proceeding the partner who provided notice of inconsistent treatment. The comment was concerned that the regulations provided partners who identified inconsistent treatment an automatic right to contest the IRS's adjustment through deficiency proceedings, which would result in more partner-level proceedings and which would be contrary to the intent of the centralized system. According to the comment, the recommended rule would allow the IRS to avoid conducting separate partnership and partner proceedings by allowing the IRS to include notifying partners in the partnership-level proceeding, rather than engaging such partners through deficiency procedures.

Proposed § 301.6222-1(c)(4)(i) provided that the IRS may adjust an identified, inconsistently reported item in a proceeding with respect to the partner. The IRS is not required to make that adjustment. The IRS may instead choose to make the adjustment in a proceeding with respect to the partnership. To the extent the comment was suggesting the IRS must adjust an identified, inconsistently reported item in a proceeding with respect to the partner, the comment was not correct.

If the IRS conducts a proceeding with respect to the partnership, that proceeding will include only the IRS, the partnership, and the partnership representative who is acting on behalf of the partnership. No partner, except a partner that is the partnership representative, or any other person may participate in the partnership proceeding without permission of the IRS. See § 301.6223-2(d)(1). Accordingly, while a partner is not generally included in a proceeding with respect to the partnership under the centralized partnership audit regime, the IRS has the authority under § 301.6223-2(d)(1) to allow any other person, including a partner who notified the IRS of inconsistent treatment, to participate in a partnership-level proceeding. Because that authority exists under § 301.6223-2, a separate rule within § 301.6222-1 to allow notifying partners to be included in a partnership-level proceeding is unnecessary. Therefore, the revision to proposed § 301.6222-1(c)(4) as recommended by the comment was not adopted.

All partners, including partners that have filed a notice of inconsistent treatment, are bound by the actions of the partnership and any final decision in a proceeding with respect to the partnership under the centralized partnership audit regime. See section 6223(b). To clarify the application of this rule in the case of a partnership-level proceeding to adjust an identified, inconsistently reported item, proposed § 301.6222-1(c)(4) was revised to provide that where the IRS conducts a proceeding with respect to the partnership, and there is no proceeding with respect to the partner regarding an identified, inconsistently reported partnership-related item, the partner is bound to actions by the partnership and any final decision in the partnership proceeding.

Another comment suggested that the regulations clarify what happens when the IRS conducts a proceeding with respect to the partnership under § 301.6222-1(c)(4)(i) and at the conclusion of that proceeding, the IRS accepts the partnership return as filed. The comment suggested the regulations address what procedures apply for collection of an imputed underpayment in that scenario or for collection of tax from the partner that filed inconsistently. This comment was not adopted.

First, because there is no partnership adjustment in the scenario described, there is also no imputed underpayment to collect from the partnership. Additionally, because there is no imputed underpayment, the partnership cannot make a push out election. See section 4.A.iii of this preamble. With respect to collection of tax from the partner, nothing in the regulations prevents the IRS, when it conducts a proceeding with respect to the partnership under § 301.6222-1(c)(4)(i), from also conducting a proceeding with respect to the partner to adjust an identified, inconsistently reported item. Accordingly, no changes were made in response to this comment.

F. Consistent Treatment With Schedule Furnished to the Partner by the Partnership

Under proposed § 301.6222-1(d)(1), a partner is treated as having notified the IRS of treating a partnership-related item inconsistently if the partner demonstrates that the treatment of such item on the partner's return is consistent with the treatment of that item on the statement, schedule, or other form prescribed by the IRS and furnished to the partner by the partnership, and the partner makes a valid election under proposed § 301.6222-1(d)(2). This election must be filed no later than 60 days after the date of such notice. Proposed § 301.6222-1(d)(2). One comment recommended that the regulations provide that this 60-day period may be extended with approval by the IRS. This comment was not adopted.

The IRS may assess and collect any underpayment of tax resulting from an adjustment to conform an inconsistent position in the same manner as if the underpayment were on account of a mathematical or clerical error appearing on the partner's return, except that the procedures under section 6213(b)(2) for requesting abatement of an assessment do not apply. The 60-day period under § 301.6222-1(d)(2) is designed to allow a partner to demonstrate consistency with the information furnished to the partner by the partnership and corresponds to the 60-day period the

partner would have had to request abatement if section 6213(b)(2) were applicable. Notably, section 6213(b)(2) does not provide for any extensions of time. Accordingly, the 60-day period under § 301.6222-1(d)(2) affords the partner an opportunity to contest the IRS's conforming adjustment the partner would not have otherwise had.

Additionally, the 60-day period is a reasonable amount of time for the partner to demonstrate consistency with the information it has received from the partnership. At the time the partner is notified by the IRS of the inconsistent treatment, the partner should be in possession of any statements, schedules, or forms furnished to the partner by the partnership. If the partner were permitted to request abatement, the partner would likewise only have 60 days. Furthermore, if the partnership is made aware by the partner that an item was treated incorrectly on the partnership return or the schedules furnished by the partnership, the partnership has the ability to file an AAR with respect to the partnership-related item.

Another comment suggested guidance is needed as to how the election under proposed § 301.6222-1(d)(2) is made. Proposed § 301.6222-1(d)(2)(i) provided that the election must be filed in writing with the IRS office set forth in the notice that notified the partner of the inconsistency. Proposed § 301.6222-1(d)(2)(ii) provided the election must be clearly identified as an election under section 6222(c)(2)(B); signed by the partner making the election; accompanied by a copy of the incorrect statement and IRS notice that notified the partner of the inconsistency; and include any other information required in forms, instructions, or other guidance prescribed by the IRS.

The comment did not suggest what further guidance should be provided in the regulations. Deferring further guidance to forms, instructions, and other sub-regulatory guidance allows the IRS the flexibility to update its procedures as appropriate and necessary without the IRS having to amend the regulations. As discussed earlier in this section of this preamble, this flexibility preserves government resources and also expedites the guidance process for taxpayers to be aware of changes in IRS procedures. Accordingly, proposed § 301.6222-1(d)(2) was not revised in response to this comment.

G. Effect of Inconsistent Treatment When Partner is a Partnership

Proposed § 301.6222-1(a)(2) provided that the rules of § 301.6222-1 apply to a partnership-partner regardless of whether the partnership-partner has made an election under section 6221(b) to elect out of the provisions of the centralized partnership audit regime. The final regulations clarify that the rules of § 301.6222-1 apply to all partners including partnership-partners that have elected out of the centralized partnership audit regime and revise the language referring to such partners to better conform to similar references in other regulation sections.

Proposed § 301.6222-1(b)(3) provided a rule regarding the effect of inconsistent treatment where the partner is itself a partnership and also provided a cross-reference to the rules under section 6232(d)(1)(B) and § 301.6232-1(d). To better conform the two sets of rules and to reduce any potential confusion between the provisions, the final regulations eliminate the rule under § 301.6222-1(b)(3) in favor of providing only a cross-reference to the rules under section 6232(d)(1)(B) and § 301.6232-1(d).

3. Determination of an Imputed Underpayment, Modification of an Imputed Underpayment, and Adjustments That Do Not Result in an Imputed Underpayment

Twenty comments were received concerning section 6225 and the rules regarding imputed underpayments. This section 3 addresses the comments concerning the determination of an imputed underpayment under proposed § 301.6225-1; modification of an imputed underpayment under proposed § 301.6225-2; and the rules regarding how adjustments that do not result in an imputed underpayment are taken into account in accordance with proposed § 301.6225-3. As discussed in the Background, comments concerning the rules regarding basis and tax attributes under proposed § 301.6225-4 will be addressed in future guidance.

A. Determination of an Imputed Underpayment

Section 6225(b)(1)(B) provides that the determination of any imputed underpayment is made by “applying the highest rate of tax in effect for the reviewed year under section 1 or 11.” Consistent with section 6225(b)(1)(B), proposed § 301.6225-1 provided that an imputed underpayment is determined by multiplying the total netted partnership adjustment by the highest rate of federal income tax in effect for the reviewed year under section 1 or 11 and increasing or decreasing that product by certain adjustments to credits and creditable expenditures.

One comment stated that the statute's use of the highest marginal tax rate to calculate the imputed underpayment is unfair to taxpayers who may not be taxed at the highest marginal rate, particularly with respect to adjustments for qualified dividends or capital gains, where a partner is subject to the alternative minimum tax, or where a partner is a tax-exempt entity. To the extent the comment was suggesting that the regulations use a rate different than the rate prescribed in the statute to compute an imputed underpayment, the comment was not adopted. Section 6225(b)(1)(B)'s mandate to “apply the highest rate of tax in effect for the reviewed year under section 1 or 11” is unambiguous, and there is no exception from application of the highest rate for any particular partnership or for any specific type of partner, such as an exception that takes into account unique circumstances of specific partners. Because application of the highest rate is established by statute, the regulations also apply the highest rate of tax to determine an imputed underpayment under section 6225(b).

A partnership and its partners may be able to reduce the rate used in computing an imputed underpayment by requesting modification under section 6225(c). For example, the partnership may request modification under § 301.6225-2(d)(3) with respect to partnership adjustments that are allocable to a tax-exempt entity or modification under § 301.6225-2(d)(4) with respect to adjustments to capital gains or qualified dividends that are attributable to an individual. The partnership may also make a push out election under section 6226, allowing partners to take into account the adjustments and pay tax using their respective marginal tax rates, including taking into account the effect of the alternative minimum tax.

Proposed § 301.6225-1(a)(1) provided that each imputed underpayment determined under § 301.6225-1 is based solely on partnership adjustments with respect to a single taxable year. One comment recommended that the regulations allow adjustments that move income or expense from one year to another to be netted for purposes of computing the imputed underpayment amount. This comment was not adopted.

The comment described an example in which the IRS determines that the partnership should have reported income in year 1 that was originally reported in year 2. The increase in income for year 1 results in an imputed underpayment. The decrease in income in year 2 is an adjustment that does not

result in an imputed underpayment pursuant to § 301.6225-1(f)(1)(i), and the partnership and its partners take into account the decrease in income in the adjustment year pursuant to § 301.6225-3. One partner in the comment's example reports income from other sources in the adjustment year; the other partner does not report income from other sources.

Section 6225(b) sets forth the rules for determining an imputed underpayment. The statutory structure of section 6225(b) is premised on the concept that an imputed underpayment is determined with respect to a reviewed year and that adjustments with respect to the reviewed year result in such imputed underpayment or are adjustments that do not result in an imputed underpayment. Section 6225(a). Section 6225(b)(1)(A) expressly provides that “any imputed underpayment

with respect to any reviewed year

shall be determined by the Secretary by appropriately netting all adjustments

with respect to such reviewed year

. . . .” (emphasis added). The statute does not reference adjustments with respect to any year other than the reviewed year. Accordingly, a rule that allows for the netting of adjustments across tax years is not consistent with the statutory language of section 6225(b)(1)(A).

In addition, netting across multiple tax years would not constitute “appropriately netting” within the meaning of section 6225(b)(1)(A). A fundamental federal income tax principle is that each taxable year stands alone.

Commissioner

v.

Sunnen,

333 U.S. 591 (1948) (“Income taxes are levied on an annual basis. Each year is the origin of a new liability and of a separate cause of action.”). A rule that provides for netting across tax years ignores this fundamental principle. For netting to be appropriate, it must take into account general principles of federal income tax laws as well as the provisions of the Code. Allowing an adjustment from one taxable year to offset or net with an adjustment from another taxable year when determining an imputed underpayment contravenes both the general tax principle that each year stands alone and is not supported by the plain language of section 6225. These principles are particularly significant in the context of partnerships given that partners' interests and the identity of partners can vary from year to year. Because adjustments relating to multiple years may affect items that are allocable to different partners or in different amounts, it would be particularly inappropriate to offset those types of adjustments against each other when determining the imputed underpayment.

Furthermore, a timing adjustment, such as the one described in the comment's example, often has effects that must be reflected in each taxable year's return. Allowing such adjustments to net against each other could inappropriately negate those effects. For instance, an adjustment that shifts a depreciation deduction from one year to another year might have the effect of changing a taxpayer's status from being in a loss posture to being in a gain posture for the year from which the loss is being shifted. Although in some cases a gain in one year might effectively offset a loss in another year, such a result cannot be known without an analysis of each of the partners' specific circumstances. As discussed later in section 3.A.i. of this preamble, requiring the IRS to review each partner's specific circumstance in order to determine the imputed underpayment is the type of inquiry that the centralized partnership audit regime was designed to avoid.

A rule that allows for automatic netting of adjustments across tax years also ignores the limitation in section 6225(b)(4) and would create significant administrative burdens for the IRS. Section 6225(b)(4) provides that if any adjustment would result in a decrease in the amount of the imputed underpayment and could be subject to any additional limitation under the Code if taken into account by any person, such adjustment should not be taken into account in the netting process described in section 6225(b)(1)(A). This provision codifies the presumption that, except as otherwise provided, taxpayer favorable adjustments subject to any possible limitation under the Code if taken into account by any person are disregarded when determining an imputed underpayment. The statute does not require the IRS to determine whether taxpayer favorable adjustments are in fact subject to such limitations. A rule allowing for netting across tax years would, however, require the IRS to make such determinations. This would have the effect of inappropriately expanding the number of tax years and partnership adjustments potentially at issue in the partnership-level proceeding. Not only would that result undermine the limitation under section 6225(b)(4), it would also unnecessarily complicate the partnership examination, creating potential burdens for both the IRS and the partnership.

A rule allowing adjustments to offset across years would also create administrative burdens for both the IRS and for taxpayers because it would require determining the identity of the partners affected by the adjustment. While in some cases a lack of partner turnover may make that determination less burdensome, in other cases where there is a high turnover of partners or where special allocations are involved, the determination becomes more difficult. Establishing a rule that allows netting of adjustments across tax years as a general matter fails to take into account the differing make-up of partnerships and their partners. For instance, assume a case where there is a high turnover of partners, adjustments are determined across multiple reviewed years, and the rules allow netting of those adjustments to form a single imputed underpayment. If the partnership requested to modify that imputed underpayment, it would be unclear which partners would be required to participate in modification and if the partnership made a push out election with respect to the imputed underpayment, it would be unclear which partners would be furnished statements under § 301.6226-2.

Lastly, as a practical matter, the IRS may not examine each relevant partnership taxable year. If an adjustment results in moving a partnership-related item from one taxable year to another, the IRS may examine the other taxable year, but the IRS is not required to. Providing a rule requiring the IRS to take into account other taxable years when netting adjustments would effectively require the IRS to examine all of the partnership's open taxable years, which would result in a significant administrative burden to the IRS and the partnership subject to the administrative proceeding. If netting across tax years was allowed, but the IRS did not examine all relevant years, different partnerships would receive different, and potentially distorted, netting results. For instance, a partnership under examination for multiple taxable years could potentially benefit from netting across those taxable years, but a partnership under examination for only one taxable year would not receive the same benefit. The determination of an imputed underpayment amount for any one year should not be dependent on the number of partnership taxable years the IRS examines.

Accordingly, a rule that allows adjustments to net across taxable years is inconsistent with the statutory language of section 6225(b)(1)(A), contravenes general tax principles, creates administrative burdens for the IRS, and inappropriately affects the timing and netting of certain

partnership-related items. Therefore, the final regulations under § 301.6225-1(a)(1) maintain the requirement that an imputed underpayment be based solely on partnership adjustments with respect to a single taxable year.

i. Grouping, Subgrouping, and Netting of Partnership Adjustments

Several comments provided recommendations regarding the grouping, subgrouping, and netting rules under proposed § 301.6225-1(c), (d), and (e). In order to determine an imputed underpayment, each partnership adjustment determined by the IRS is first placed into one of four groupings pursuant to § 301.6225-1(c) according to the type of partnership-related item being adjusted: The reallocation grouping, the credit grouping, the creditable expenditure grouping, or the residual grouping. Adjustments are then subgrouped, if appropriate, and netted to produce the total netted partnership adjustment. Proposed § 301.6225-1(b)(2), (d) and (e).

One comment stated that the grouping and netting procedures are broad, vague, and generally err on the side of maximizing tax revenue resulting from an audit without regard to generally applicable provisions of the Code. The design of section 6225(a) and (b) and the grouping and netting rules under § 301.6225-1 is to create an imputed underpayment amount that is based on the highest rate of tax and that disregards any taxpayer favorable adjustments which would otherwise reduce the imputed underpayment. Given this formula, an imputed underpayment determined under § 301.6225-1 will likely reflect an amount that is larger than the cumulative amount of tax the partners would have paid if the partners took the partnership adjustments into account separately.

This formula is a feature of section 6225(a) and (b). The statute expressly disregards certain adjustments that may be subject to limitations and that would otherwise reduce the imputed underpayment and mandates the application of the highest applicable tax rate. Section 6225(b)(1)(B), (2) and (4). The proposed regulations followed these statutory mandates. By removing the obligation on the IRS to consider partners' facts and circumstances, such as whether adjustments that would otherwise reduce the imputed underpayment might be allowed at the partner level or whether adjustments might be taken into account by partners at a rate lower than the highest rate, section 6225(b) shifts the burden from the IRS during this phase of a partnership examination. Because the imputed underpayment determined at this phase in the examination is not required to reflect the facts and circumstances of the ultimate partners, modifications may be necessary to more closely reflect the proper tax treatment.

After the preliminary determination of the imputed underpayment amount under § 301.6225-1, the burden is shifted to the partnership to utilize the modification procedures under § 301.6225-2 if the partnership so chooses. Modification is designed to allow the partnership and its partners to arrive at an imputed underpayment amount that is closer to the correct amount of tax while maintaining the assessment and collection efficiencies of a centralized audit process. See Joint Comm. on Taxation, JCS-1-16, General Explanations of Tax Legislation Enacted in 2015, 65-66 (2016) (JCS-1-16). As an alternative to modification and paying an imputed underpayment, the partnership can elect under section 6226 to push out the adjustments to its partners. Both modification and the push out election provide the opportunity to establish that the correct amount of tax is collected from the partnership and its partners. Accordingly, the final regulations under § 301.6225-1 were not revised in response to the comment's concern about maximizing revenue.

With respect to the comment's concerns that the grouping and netting procedures are broad and vague and disregard generally applicable tax laws, to the extent those concerns related to the scope of the centralized partnership audit regime and what determinations and adjustments are made at the partnership level, see section 1 of this preamble. To the extent the comment's concerns related to the fact that the regulations do not address every possible grouping and netting scenario, the regulations do so intentionally. The Treasury Department and the IRS have determined it is not reasonable to identify within the regulations all possible permutations of adjustments and partnership facts and circumstances that might affect how an imputed underpayment is calculated. Accordingly, the regulations provide general rules that apply to various scenarios that could arise in the examination process. The general nature of the grouping, subgrouping, and netting rules also allow for the regulations to adapt to future changes to the Code.

Notwithstanding the rules' flexible nature, they are rooted in provisions of the Code and regulations that are generally applicable to partnerships and partners. The regulations require that adjustments be placed into groupings and subgroupings based on how the adjusted items are treated pursuant to the Code, the regulations, forms, instructions, and other guidance and do not generally permit the netting of adjustments that might otherwise be subject to limitations or restrictions under the tax laws. Accordingly, the grouping and netting rules are designed with regard to generally applicable provisions of the Code. For further discussion of the comment's concerns regarding the grouping and netting rules and the interaction with generally applicable tax laws, see section 3.A.ii. of this preamble.

One comment suggested that the regulations should allow partners to supply information to the partnership and require that the partnership and the IRS apply this information in calculating the imputed underpayment. The comment also suggested there be a procedure for partners who are passive investors with respect to the partnership to have an opportunity to claim passive losses for net partnership adjustments on audits that increase income and cause the partnership to pay tax on their behalf.

As discussed earlier in this section of this preamble, the tax attributes of the partnership's partners generally do not factor into the preliminary determination of the imputed underpayment. Rather, the imputed underpayment determined under § 301.6225-1 is computed without regard to the partners' tax circumstances, for example whether a partner would be able to offset additional partnership income with additional deductions or whether a partner's tax attributes would reduce the amount of tax due as a result of the adjustments. See section 6225(b)(1)(B), (2) and (4). Modification as described under section 6225(c) and § 301.6225-2 is the more appropriate stage of the examination for the IRS to take into account specific partner tax attributes. Requiring the IRS to review the tax attributes of each partner within the context of the first phase of the partnership examination would undermine the centralized nature of the examination process. The comment's' recommendation to allow partners to present information during the partnership audit and require the IRS to incorporate that information into the imputed underpayment calculation would require the IRS to review and evaluate partner tax attributes in a way that would significantly impede upon the exam and create numerous

administrative burdens for the government.

Notwithstanding these challenges, proposed § 301.6225-1(c)(1) and (d)(1) provided that the IRS may, in its discretion, place adjustments in groupings and subgroupings in a manner different from that described in the proposed regulations to appropriately reflect the facts and circumstances of each examination. This rule is intended to allow the partnership to provide information to the IRS to demonstrate that certain partner tax attributes should be taken into account when grouping and subgrouping to achieve a more appropriate netting of the adjustments.

The regulations give the IRS the discretion to decide whether or not to use this information in the initial examination phase, that is, prior to modification. This discretion is necessary because the partnership and the IRS may not agree as to whether the groupings and subgroupings requested by the partnership are appropriate. Requiring the IRS and the partnership to resolve such disagreements within the context of the first phase of the partnership proceeding would take time and resources away from the audit and thereby recreate the same problems associated with introducing partner tax attributes into the partnership level exam. If the partnership and the IRS do not agree on the groupings and subgroupings recommended by the partnership during the exam, the partnership is not without recourse. The partnership may request during modification that the IRS include one or more partnership adjustments in a particular grouping or subgrouping or request that certain partnership adjustments be treated as if no limitations or restrictions apply with the result those adjustments may be subgrouped with other adjustments. See § 301.6225-2(d)(6).

Accordingly, modification is generally the appropriate point in the administrative phase at which partner tax attributes may be raised by the partnership and considered by the IRS. For example, the partnership and its partners can utilize the amended return procedure or the alternative procedure to filing amended returns, which require partners to take the adjustments into account in light of their individual tax attributes. Those procedures would potentially allow partners to offset passive income with any passive losses, consistent with the procedure recommended by the comment. In the alternative, the partnership may elect to push out the adjustments under section 6226, and the partners would be required to take into account the adjustments and any effects on the partners' tax attributes. At that stage, the partners could use passive losses to the extent permitted by the rules under § 301.6226-3 (regarding how partners take into account pushed out adjustments).

Although the IRS is permitted to consider partner tax attributes during the first phase of the partnership exam, the statute and the regulations provide clear guidance on the modification process and specifically how a partnership may request that partners' tax attributes be taken into account to reduce the imputed underpayment. Limiting the requirement that the IRS consider such information to the modification stage is efficient for both the IRS and the partnership because it ensures that the first phase of the exam is focused on the substance of what adjustments must be made at the partnership level, rather than on specific partner attributes.

For these reasons, the comment suggesting a rule that permits partners, as a matter of right, to present information regarding their tax attributes during the partnership audit is not adopted. However, a partnership may request that the IRS take into account facts and circumstances relating to its partners pursuant to the rules under § 301.6225-1(d)(1) and (e)(1), which may allow for more appropriate grouping and subgroupings of adjustments. The comment's recommendation that the IRS be required to apply such information during the netting process was not adopted. The partnership may, however, request during modification to reduce the amount of the imputed underpayment based on the partners' specific tax attributes.

Another comment stated the proposed regulations create a divergence between the imputed underpayment amount and the cumulative amount that the reviewed year partners would have to pay if the adjustments were allocated to them. The comment described two situations to illustrate this concern. In the first situation, one adjustment increases ordinary income, and another adjustment decreases capital gain. The comment concludes that because the proposed regulations do not allow the decrease in capital gain to be netted against the increase in ordinary income, the partners may have overpaid tax with respect to the capital gain. In the second situation, one adjustment increases capital gain, and another adjustment decreases ordinary income. The comment concludes that because the proposed regulations do not allow the decrease in ordinary income to be netted against the increase in capital gain, the partners may have overpaid tax with respect to the ordinary income. The comment suggested that the Treasury Department and the IRS should ensure that the government does not seek an increase in tax collections solely because the partnership bears the burden for the tax. This comment was not adopted because its conclusions are based on assumptions that may not apply in all situations and section 6225(b)(1)(A) requires that adjustments are “appropriately netted” taking into consideration the further limitation of section 6225(b)(4) which does not permit the netting of adjustments that would reduce the imputed underpayment with other adjustments. The comment's suggestion presents the same issues described earlier in this section of the preamble regarding the introduction of partner tax information in the partnership level proceeding.

The comment's conclusions that the partners may have overpaid tax with respect to the decreased capital gain or the decreased ordinary income may be true in some cases. Without a review of the partners' accounts or some affirmation from the partners that they did pay tax, the IRS cannot be certain this is true in all cases or any one particular case. For example, a partner may have been in an overall loss position for the taxable year, may not have originally reported the decreased item, or may not have filed a return. As discussed earlier in this section of this preamble, the initial phase of the examination is not designed for the IRS to consider the specific circumstances of any partners. A rule requiring the IRS to consider specific partner circumstances would require the IRS to review each partner's account and prior returns to ensure that the partner previously took an item into account and paid tax on that item. Such a rule would create significant burden on the IRS during the initial exam phase and undermine a core aspect of the centralized partnership audit regime's shifting of the burden from the IRS to the partnership and its partners. As discussed earlier in this section of this preamble, a partnership may request that tax attributes are accounted for by using the modification procedures or the partnership may make the election under section 6226.

The comment also appears to conclude that if all partnership adjustments were netted, the imputed underpayment would result in some number closer to the amount the reviewed year partners would have to pay if the adjustments were allocated to

them. While this may be true in some cases, it would not occur in all situations. For instance, assume the partner in the first situation described by the comment had not reported and paid tax with respect to the capital gain that was then decreased on examination. If the regulations permitted the decreased capital gain to be fully netted against the increased ordinary income, the result may lead to little or no imputed underpayment, even though the partner had not paid tax on the capital gain that was reduced. In that case, no tax was paid by the partner on the capital gain (as originally allocated to the partner) and no tax was paid by the partnership with respect to the increased ordinary income, even though the partnership had additional ordinary income that should have been allocation to the partner. While the comment stated that the netting process under proposed § 301.6225-1 eliminated situations that would benefit the taxpayer, the comment did not acknowledge that the statutory structure of section 6225 mandates this result. The comment also does not acknowledge that the netting process as enacted in the statute and implemented in the regulations also protects the IRS, for instance in cases where the partner did not pay tax on an adjusted item. During the initial phase of determining the imputed underpayment, the rules should not require the IRS to take steps to ameliorate a potential discrepancy in payment amounts based on facts applicable in one situation if the rule would result in distortions for taxpayers with different facts.

As discussed earlier in this section of this preamble, “appropriately netting” within the meaning of section 6225(b)(1)(A) means, as a general matter, that when netting partnership adjustments for purposes of determining an imputed underpayment, all limitations under the Code should be considered, including limitations that would otherwise prevent the partnership from netting certain items. Section 6225(b)(4)'s rule regarding taxpayer favorable adjustments subject to additional limitations under the Code if taken into account by any person supports this interpretation. Because certain items could be subject to limitations in the hands of certain partners, the statute requires that limitations be accounted for by assuming they exist for purposes of determining the imputed underpayment during the initial stage of the examination. The partnership may ameliorate any discrepancies caused by that assumption by demonstrating that no such limitations exist either under § 301.6225-1(d)(1) or (e)(1) or in the modification phase. The partnership can also make the election under section 6226, and the partners will account for such limitations when taking into account the adjustments.

The comment suggested specific approaches to ameliorate the concerns it raised. First, it suggested a rule that would allow an ordinary income grouping to be reduced by a capital loss grouping to the extent of $3,000 per direct or indirect individual partner. Second, it suggested a rule that would apply the applicable rate for net negative adjustments to the relevant subgrouping and allow this amount to reduce the imputed underpayment amount. Neither of these specific recommendations was adopted.

The Code permits corporate taxpayers to deduct capital losses to the extent of capital gains. Section 1211(a). In the case of taxpayers other than corporations, the Code allows a deduction for any capital loss exceeding capital gain up to $3,000 ($1,500 in the case of a married individual filing separately). Section 1211(b). A rule allowing an offset of $3,000 against an increase in ordinary income in the situations described by the comment would require the IRS to first determine that the partners in the partnership are taxpayers other than corporations such that the rules under section 1211(b) apply. While this may be a relatively simple determination in some cases, requiring the IRS to engage in making the determination contravenes the principle that partners' tax attributes, including partner identity, are generally not accounted for in the initial imputed underpayment calculation.

To the extent the rule recommended by the comment is based on the premise that each partner would be entitled to a $3,000 capital loss, that premise is faulty. One, such a rule would require the IRS to know whether there are no other capital gains (related or unrelated to the partnership) against which the non-corporate partners would first be required to offset the additional capital loss. Two, the rule would require the IRS to consider whether the partner was not an individual subject to the lower deduction amount of $1,500 allowed by section 1211(b). This process would become more burdensome as the number of partners and tiers increased. Accordingly, this comment was not adopted. To extent that this comment recommended a rule that allowed more flexibility for the IRS to group adjustments according to the facts and circumstances of the partners, that rule is reflected in proposed § 301.6225-1(d)(1) and (e)(1) as revised in the August 2018 NPRM. A partnership that wishes to request that the IRS take into account its partner's tax circumstances, including that certain partners are otherwise entitled to a capital loss deduction under section 1211(b), may utilize the discretionary grouping and subgrouping rules under § 301.6225-1(d)(1) and (e)(1) or make a modification request under § 301.6225-2(d)(6).

With respect to the recommendation that the regulations apply the applicable rate for net negative adjustments to the relevant negative subgrouping and allow this amount to reduce the imputed underpayment amount, this recommendation was also not adopted; however, the final regulations allow for the result requested by the comment depending on the facts and circumstances. The comment suggests that the rate used in determining an imputed underpayment should be applied to negative adjustments that would otherwise be adjustments that do not result in an imputed underpayment and allow those negative adjustments to net with other positive adjustments in an effort to calculate an amount that would more closely reflect what the partners would have paid if they had properly reported the adjusted items. Section 6225(b)(1) provides that the imputed underpayment is determined by appropriately netting all partnership adjustments and applying the highest rate of tax under section 1 or 11. Section 6225(b)(3) requires that the partnership adjustments are first separately determined and netted as appropriate within each category of items that are required to be taken into account separately under section 702(a) or other provision of the Code. When “appropriately netting” under section 6225(b)(1)(A), section 6225(b)(4) requires that negative adjustments that could be subject to any limitation or restriction if taken into account by any person be disregarded unless provided otherwise by regulation. The regulations incorporate this rule in § 301.6225-1(d)(3). The regulations also provide the ability, however, to take facts and circumstances into account to allow negative or downward adjustments, where appropriate, to be subgrouped and thus netted with other adjustments. See § 301.6225-1(d)(1). For these reasons, the final regulations maintain the process for subgrouping and netting as provided for in the proposed regulations.

ii. Subgrouping Principles

Before being revised in the August 2018 NPRM, former proposed § 301.6225-1(d) had provided that after

grouping the adjustments, partnership adjustments are further subgrouped based on preferences, limitations, restrictions, and conventions, such as source, character, holding period, or restrictions under the Code applicable to such items. One comment stated that the proposed grouping and subgrouping rules under former proposed § 301.6225-1(d) unfairly removed many relevant distinctions between different types of items and adjustments and netted items that do not properly net against each other at the entity level, including intangible drilling costs, section 1231 gains and losses, and whether a particular partner is considered active or passive in his or her relationship to the partnership. Another comment recommended that the final regulations should also include a clear statement that the netting process will be applied in accordance with generally applicable tax law. Both comments are addressed by the amendments made by the TTCA to section 6225(b).

Section 202(a) of the TTCA added section 6225(b)(3) to provide that partnership adjustments shall first be separately determined (and netted as appropriate) within each category of items that are required to be taken into account separately under section 702(a) or other provision of the Code. Section 6225(b)(4) provides if any adjustment would (but for section 6225(b)(4)) result in a decrease in the amount of the imputed underpayment, and could be subject to any additional limitation under the provisions of the Code (or not allowed, in whole or in part, against ordinary income) if such adjustment were taken into account by any person, such adjustment shall not be taken into account when appropriately netting partnership adjustments under section 6225(b)(1)(A) except to the extent otherwise provided by the Secretary.

Former proposed § 301.6225-1(d) was revised in the August 2018 NPRM to account for the additions of sections 6225(b)(3) and (4). Proposed § 301.6225-1(d)(3)(i) provided that adjustments are subgrouped, when appropriate, according to how the adjustment would be required to be taken into account separately under section 702(a) or any other provision of the Code or regulations applicable to the adjusted partnership-related item. By separating adjustments into subgroupings according to how and whether the adjustments would be separately stated pursuant to section 702(a), the rules under § 301.6225-1(d)(3)(i) ensure that items that do not properly net against each other at the partnership level under section 702(a) do not net against each other for purposes of determining an imputed underpayment.

For example, under § 301.6225-1(c) a positive adjustment to intangible drilling costs and a negative adjustment to gain or loss from a sale of property described in section 1231 are both placed in the residual grouping. Pursuant to § 301.6225-1(d)(3)(i), each adjustment is then placed in a separate subgrouping to reflect that one adjustment is a negative adjustment and that the items being adjusted are required to be separately stated pursuant to section 702(a). See section 702(a)(3), § 1.702-1(a)(8)(i). Under § 301.6225-1(e)(1), adjustments from separate subgroupings cannot be offset against one another. Accordingly, just as a positive amount of intangible drilling costs would not be netted with a section 1231 loss under section 702(a), a positive adjustment to intangible drilling costs would not net against a negative adjustment to 1231 gain or loss for purposes of determining an imputed underpayment.

Some items that are not separately stated pursuant to section 702(a) may nevertheless be subject to other limitations under the Code or may not otherwise be allowed to net against ordinary income. To account for those types of limitations, proposed § 301.6225-1(d)(3)(i) further provided that if any adjustment could be subject to any preference, limitation, or restriction under the Code (or not allowed, in whole or in part, against ordinary income) if taken into account by any person, the adjustment is placed in its own separate subgrouping. For example, an increase in loss attributable to a trade or business activity of the partnership may not be deductible in the hands of a particular partner because that partner did not materially participate in the partnership activity. See section 469. Because the loss may be limited in the hands of a particular partner, the increase in loss is placed in its own separate subgrouping to prevent any inappropriate netting against an adjustment increasing income of the partnership.

Accordingly, both the comment expressing concerns about the netting of items that do not properly net against each other at the entity level and the comment suggesting the regulations apply general principles of tax law were addressed by the changes to section 6225 in the TTCA and the subgrouping rules under § 301.6225-1(d)(3)(i) as revised in the August 2018 NPRM. As a result, the final regulations were not revised in response to these comments.

Generally, under § 301.6225-1(d), reallocation adjustments must be placed into their own subgroupings, but there is an exception for when multiple reallocation adjustments apply to a single partner or group of partners. Proposed § 301.6225-1(d)(3)(ii) provided that if a particular partner or group of partners has two or more reallocation adjustments allocable to such partner or group, such adjustments may be subgrouped in accordance with § 301.6225-1(d)(3)(i) and netted in accordance with § 301.6225-1(e). Proposed § 301.6225-1(d)(3)(iv) provided a similar rule with respect to recharacterization adjustments.

In January 2017, a prior version of the June 2017 NPRM was made publicly available but was not published in the

Federal Register

. The unpublished version of the June 2017 NPRM contained an example under former proposed § 301.6225-1(f) (former Example 3) which was not contained in the June 2017 NPRM that was published in the

Federal Register

. One comment recommended that former Example 3 be added back to the regulations. This comment was not adopted. The Treasury Department and the IRS considered reviving former Example 3, but because of the changes to section 6225 in the TTCA, former Example 3 did not comport with the statute or the proposed regulations. Instead of reviving former Example 3, a new example was added, Example 12, to clarify subgrouping principles in the case of facts similar to, but slightly different from, the facts in former Example 3.

One comment recommended that the regulations clarify whether and under what conditions positive and negative adjustments resulting from different reallocation or recharacterization adjustments are permissibly placed in the same subgrouping. The comment stated that the language of both proposed § 301.6225-1(d)(3)(ii) and (iv) seemed to allow the inclusion in the same subgrouping of unrelated positive and negative adjustments provided that all of the adjustments apply to a particular partner or group of partners. The comment suggested that the final regulations include examples clarifying the proper grouping and netting of adjustments pursuant to § 301.6225-1(d)(3). The addition of Example 12 under § 301.6225-1(h) provides the example suggested by the comment. As discussed earlier in this section of this preamble, Example 12 clarifies operation of the rule under § 301.6225-1(d)(3)(ii) allowing for adjustments to be subgrouped together when the adjustments are allocable to a particular

partner or group of partners. Although Example 12 illustrates these concepts in the context of reallocation adjustments, the example's analysis is equally applicable to recharacterization adjustments. The result demonstrated by Example 12 under § 301.6225-1(h) of the rule under § 301.6225-1(d)(3)(ii) for reallocation adjustment subgroupings would not be the result if the negative adjustments in that example were subject to limitations described in section 6225(b)(4) and § 301.6225-1(d)(3)(i).

iii. Negative Adjustments

Under § 301.6225-1(e), adjustments from each subgrouping (or grouping if there is no subgrouping within that grouping) are netted to produce either a net positive adjustment or a net negative adjustment with respect to each grouping or subgrouping. When determining an imputed underpayment, generally only net positive adjustments are taken into account, and net negative adjustments are generally treated as adjustments that do not result in an imputed underpayment. Adjustments to credits and creditable expenditures are treated separately. See section 3.A.vi. of this preamble.

One comment suggested that the requirement that only net positive adjustments are taken into account in determining an imputed underpayment will frequently result in double taxation of the same income items. The comment cited to Example 4 under proposed § 301.6225-1(h) (Example 3 in former proposed § 301.6225-1(f)) to demonstrate this point. In Example 4, the IRS determines that $125 of long-term capital gain should have been reported as $125 of ordinary income, resulting in a $125 increase in ordinary income and a corresponding $125 decrease in long-term capital gain (a $125 increase in long-term capital loss). The increase in ordinary income results in an imputed underpayment, and the increase in long-term capital loss is an adjustment that does not result in an imputed underpayment.

To the extent the comment was suggesting that the example does not specify what happens with respect to the $125 increase in long-term capital loss, the example was revised in the August 2018 NPRM to clarify that this loss is taken into account in accordance with § 301.6225-3. Under § 301.6225-3(b), the partnership takes into account the adjustment increasing long-term capital loss in the adjustment year. Alternatively, the partnership may request modification under section 6225(c) or make a push out election under section 6226 to ensure that the negative adjustment is taken into account by the partnership's reviewed year partners, rather than in the adjustment year by its adjustment year partners.

To the extent the comment was expressing more general concerns about double taxation, proposed § 301.6225-1(b)(4) was added in the August 2018 NPRM to provide that if the effect of a partnership adjustment under chapter 1 of the Code is reflected in another adjustment taken into account in the imputed underpayment determination, the IRS may treat an adjustment as zero for the purposes of calculating the imputed underpayment. This rule is designed to ensure that when calculating an imputed underpayment, an adjustment is not counted twice if the tax effect of that adjustment is reflected by another adjustment made by the IRS. A partnership may request that the IRS utilize this rule to treat an adjustment as zero if there is the partnership is concerned about double taxation. Accordingly, to the extent the comment was raising concerns about double taxation, no changes were made to the regulations in response to the comment.

The final regulations under § 301.6225-1(b)(4) do, however, clarify that the IRS has the discretion to treat adjustments as zero for purposes of determining the imputed underpayment if the effect of the adjustment under the Code is reflected in another adjustment. The language requiring that the adjustment must have previously been taken into account under § 301.6225-1 was removed. This change provides the IRS the discretion to treat a partnership adjustment as zero in more situations. For instance, the effect of an adjustment may be reflected in an adjustment to an item treated inconsistently under section 6222(c). The final regulations under § 301.6225-1(b)(4) also remove the language limiting the rule's application to chapter 1. Under the final regulations, the rule applies to the effect of an adjustment under the Code in general. This change also gives more flexibility to the IRS to treat partnership adjustments as zero for purposes of determining the imputed underpayment amount.

iv. Other Suggestions Regarding Grouping and Netting Adjustments

One comment suggested that its concerns with the grouping and netting rules might be alleviated by allowing the partnership to treat the partnership adjustment as if it arose during the adjustment year rather than the reviewed year, which would synchronize the imposition of the tax in the adjustment year with the adjustment year partners bearing the liability for the imputed underpayment. This comment was not adopted because it is contrary to the plain language of the statute.

Section 6225(a)(1) refers to adjustments to partnership-related items “with respect to any reviewed year.” Section 6225(b)(1) provides that any imputed underpayment “with respect to any reviewed year” shall be determined by appropriately netting all partnership adjustments “with respect to such reviewed year.” In addition, section 6225(d)(2) defines adjustment year to mean, in the case of an examination, the year in which an FPA is mailed under section 6231 or in the case of adjustment pursuant to a decision in a proceeding under section 6234, the year in which the decision is final. Accordingly, at the time of the modification phase of the examination, the adjustment year will not yet be determined.

If the comment's suggestion were adopted and adjustments were treated as having arisen in the adjustment year, it is unclear whether the reviewed year partners' or the adjustment year partners' tax attributes would be relevant in the modification determination. The modification period will in every case come before the issuance of the FPA. As a result, the adjustment year will not yet have been determined, and therefore the adjustment year partners will not yet be known. In addition, section 6225(c)(2) provides the ability for partners to file amended returns in modification. The statute's use of the phrase “amended return” implies that a prior return must have been filed. A prior return could not have been filed for the adjustment year at this point in the examination because the adjustment year would not yet be determined. The partners from the reviewed year, therefore, must be the partners that utilize the modification procedures under section 6225(c)(2) through the filing of amended returns for the reviewed year. The reviewed year partners' amended returns could not take into account adjustment year adjustments and apply them against reviewed year returns. Accordingly, the plain language of the statute indicates that adjustments for purposes of determining an imputed underpayment are the adjustments with respect to a reviewed year, not the adjustment year.

Furthermore, section 6225(a)(1) provides the partnership shall pay an amount equal to such imputed underpayment in the adjustment year as provided in section 6232. In the case of adjustments that do not result in an imputed underpayment, section

6225(a)(2) provides that such adjustments shall be taken into account in the adjustment year. Section 6225(a)(2)'s explicit statement that adjustments not resulting in an imputed underpayment are taken into account in the adjustment year, and the absence of similar language in section 6225(a)(1) makes clear that only those partnership adjustments that do not result in an imputed underpayment are taken into account in the adjustment year.

Accordingly, a reasonable reading of the statutory language of section 6225(a) supports an interpretation that adjustments with respect to the reviewed year should be treated as such for purposes of determining an imputed underpayment and not treated as adjustments arising in the adjustment year. However, § 301.6225-3 does provide that adjustments that do not result in an imputed underpayment are taken into account in the adjustment year, that is, when the imputed underpayment is also required to be paid. To that extent, any adjustments that do not result in an imputed underpayment may mitigate the burden of the imputed underpayment on adjustment year partners.

Another comment stated that the time shifting of the tax on partnership examination adjustments from the reviewed year to the adjustment year is inappropriate and that tax on partnership examination adjustments should arise in the reviewed year and not in the adjustment year. The comment further states that the burden of the payment in all cases should fall directly on the reviewed year partners and that the rules should require the reviewed year partners to amend their reviewed year tax returns to include their shares of the partnership examination adjustments. The comment was not adopted because all of the changes recommended by the comment would require amendments to the statute.

Section 6225 provides that if the adjustments result in an imputed underpayment, the partnership shall pay an amount equal to such imputed underpayment in the adjustment year as provided in section 6232. Accordingly, the year partnerships must pay is, by statute, the adjustment year, and if the partnership pays the imputed underpayment without modification or does not make an election under section 6226, the statute is designed so that the adjustment year partners bear the burden of that payment. See section 6241(4) and § 301.6241-4 (denying any deduction to the partnership for any payment made by the partnership, including the imputed underpayment). Additionally, there is no authority within subchapter C of chapter 63 to allow the Treasury Department or the IRS to require that reviewed year partners file amended returns, though partners have the option to do so in modification. The partnership may also make the election under section 6226 which would result in adjustments relating to the imputed underpayment for which the election was made being taken into account by the reviewed year partners.

Another comment suggested treating an audited partnership as an “entity” rather than an “aggregate” solely for the purposes of calculating the imputed underpayment based on majority ownership of the partnership (measured by the partners' interest in profits). Specifically, the comment suggested that if more than 50% of the interest in a partnership's profit is held by one or more individuals, S corporations, or closely-held corporations, the provisions of the Code that apply to individuals should apply for purposes of determining the amount of any imputed underpayment. This comment was not adopted.

As discussed earlier in this section of this preamble, section 6225 is prescriptive as to how an imputed underpayment is determined. The determination process expressly does not determine the imputed underpayment as if the partnership were an individual or an entity. Instead, the process for determining the imputed underpayment, including “appropriately netting all partnership adjustments” under section 6225(b)(1)(A) in accordance with § 301.6225-1 generally does not take into account partner tax attributes, including whether a partner is an individual or a person subject to the Code provisions that apply to individuals. The IRS has the discretion to take into account an attribute of a particular partner when grouping or subgrouping the adjustments, but the IRS is not required to do so. § 301.6225-1(d)(1), (e)(1). For instance, the IRS may consider whether a certain ownership percentage of the partnership was held by individuals, S corporations, or closely-held corporations and group adjustments based on information submitted by the partnership. However, a rule

requiring

the IRS to treat all partnership adjustments as if they were being taken into account by an individual as the comment suggests is inconsistent with the statutory requirement to net items appropriately. A rule that required the IRS to do so would also potentially disadvantage certain partnerships depending on the nature of adjustments and the types of the partners.

Moreover, it is not clear that the comment's suggestion of accounting for the individual tax attributes of specific partners and applying the Code's rules regarding those partners would yield an appropriate netting of the adjustments for purposes of determining the imputed underpayment at the partnership level. For example, the Code's rules may apply differently to one individual partner versus another individual partner. Treating all individual partners in the same manner would negate operation of those rules. Accordingly, there is no reason to conclude that treating adjustments according to how some but not all partners' tax attributes would affect an adjustment is any more reasonable than not taking into account any partners' tax attributes. The statute provides a baseline assumption that partners' tax attributes are not taken into account. The imputed underpayment that best reflects the facts and circumstances of the partners should be determined through application of the permissive grouping and subgrouping rules under § 301.6225-1(d)(1), (e)(1) or through modification. Accordingly, the final regulations do not adopt the comment's suggestion to base the imputed underpayment determination on the identity of the majority of the partnership.

Section 6225(b) only provides specific rules with respect to one type of adjustment, that is, the rule that adjustments to distributive shares of partners not be netted under section 6225(b)(2). While it is true a determination regarding an adjustment described in section 6225(b)(2) is usually made with some knowledge of the partners' distributive shares, such a determination does not account for the particular tax attributes of any specific partner. The IRS is not required to know any other information about the specific partners at the initial examination phase to reallocate adjustments between partners. Therefore, in order to effectuate the rule under section 6225(b)(2), there is no need to know whether a partner is an individual, a corporation, a pass-thru partner, or some other entity. Section 6225(b)'s lack of reference to any particular tax attributes of specific partners indicates that the determination of an imputed underpayment is not dependent on knowing any partner's specific tax attributes.

The same comment suggested another alternative in which the grouping and netting rules would account for current year partner attributes for purposes of determining an imputed underpayment.

The comment cited the amendment to section 6225(a) by TTCA that provides if the partnership adjustments do not result in an imputed underpayment, such adjustments shall be taken into account by the partnership in the adjustment year. This comment was not adopted.

Section 6225 does not reference either partner tax attributes or current year partners as a consideration in determining the imputed underpayment. As discussed earlier in this section of this preamble, the Treasury Department and the IRS have determined a reasonable interpretation of section 6225(b) supports a process in which the determination of the imputed underpayment does not depend on specific partners' tax attributes. Moreover, the comment's reference to “current year” is ambiguous; it could refer to any number of different time periods: the adjustment year, the actual calendar year in which the imputed underpayment is being determined, the year the imputed underpayment is proposed in a notice of proposed partnership adjustment, the time during the modification period prior to issuance of the FPA, or, if the partnership contests the partnership adjustments in court, the year the court decision is final. It is not administrable for the IRS to determine an imputed underpayment based on the potential tax attributes from time periods that are not fixed relative to the reviewed year and that may result in different partners being the relevant partners. The final regulations reflect the amendments to section 6225 by the TTCA, and therefore the final regulations were not revised in response to this comment.

v. Recharacterization Adjustments

One comment recommended that the grouping and subgrouping rules be reconsidered due to the concern that under the proposed regulations, the inability to net certain overpayments and underpayments could lead to taxpayers not receiving an appropriate adjustment for taxes previously paid. The comment cited to Example 4 under proposed § 301.6225-1(h) to highlight this concern. In Example 4, the IRS determines that $125 of long-term capital gain should have been reported as $125 of ordinary income, resulting in a $125 increase in ordinary income and a corresponding $125 decrease in long-term capital gain (effectively, a $125 increase in long-term capital loss). The increase in ordinary income results in an imputed underpayment, and the increase in long-term capital loss is an adjustment that does not result in an imputed underpayment.

The comment noted that the example does not specify what happens with respect to the $125 increase in long-term capital loss. As discussed earlier in section 3.A.iii. of this preamble, the example has been revised to clarify that $125 increase in long-term capital loss is taken into account in the adjustment year in accordance with § 301.6225-3. The comment also noted that it is unknown whether the partnership will be able to use the increased capital loss in the future. To avoid this potential adverse consequence, the comment recommended that the regulations permit a partnership to net adjustments across different categories of gain or loss to reflect taxes that were previously paid. This comment was not adopted for several reasons.

As an initial matter, implicit in the comment's suggestion is that either the IRS or the partnership have knowledge of taxes previously paid by the partners. As discussed earlier in section 3.A.i. of the preamble, facts and circumstances unique to specific partners are generally not taken into account in determining whether the adjustments result in an imputed underpayment. The regulations give the IRS wide latitude to consider such facts and circumstances, but the rules do not narrowly define the circumstances when that occurs. See § 301.6225-1(d)(1) and (e)(1). The regulations are designed to maintain flexibility for both the IRS and the partnership to allow for the particular examination to accommodate the unique circumstances of each examination. Based on these reasons alone, the comment's suggestion was not adopted.

The comment's suggestion was also not adopted because it is inconsistent with the overall approach applied to how recharacterization adjustments are taken into account in determining an imputed underpayment. Proposed § 301.6225-1(c)(6)(iii) provided that a recharacterization adjustment results in at least two separate adjustments: One adjustment reversing the improper characterization of the partnership-related item, and the other adjustment effectuating the proper characterization of the partnership-related item. Generally, one of those adjustments is a positive adjustment and the other is a negative adjustment, but each adjustment is normally the same numerical amount ($125 in the case of Example 4 under proposed § 301.6225-1(h)). Under proposed § 301.6225-1(d)(3)(iv), the positive adjustment and the negative adjustment are each placed into its own separate subgrouping. Because an adjustment in one subgrouping may not be netted against an adjustment from another subgrouping, the positive adjustment is not offset by the negative adjustment, and the result is a net positive adjustment that forms the base for an imputed underpayment amount. Proposed § 301.6225-1(e)(2) and (3)(i).

These rules are adopted largely without change in the final regulations in order to ensure that recharacterization adjustments are not inappropriately netted when determining an imputed underpayment, as required by section 6225(b)(1)(A). Allowing for the netting of the negative adjustment against the positive adjustment in the case of a recharacterization adjustment, as suggested by the comment, could cause the positive adjustment to be negated in its entirety, which would defeat the purpose of making the adjustment in the first place. It would also result in the recharacterization adjustment not properly being reflected in the imputed underpayment calculation. For instance, allowing the capital loss to fully offset the ordinary income in Example 3 under § 301.6225-1(h) would not adequately reflect the fact that there was an underreporting of ordinary income by the partnership for that taxable year. Furthermore, if there were no imputed underpayment because recharacterization adjustments were allowed to net, there would be no statutory basis for imposing an interest charge on the partnership as suggested by the comment.

Accordingly, the comment's suggestion to net adjustments across different categories of gain or loss to reflect taxes that were previously paid was not adopted, though the effect of such adjustments may be mitigated, in whole or in part, under certain circumstances through the modification procedures or by making a push out election under section 6226. The final regulations under § 301.6225-1(e)(2) do clarify, however, that positive adjustments and negative adjustments within the same subgrouping may only net within that same subgrouping. No netting is permitted across subgroupings.

vi. Credits and Creditable Expenditures

In determining whether partnership adjustments result in an imputed underpayment, adjustments to credits are placed in the credit grouping described under § 301.6225-1(c)(3). One comment suggested that for administrative efficiency, it would make sense to group and order credits in accordance with Form 3800 and recommended that the regulations provide for grouping and ordering

credits in such a manner. This comment was not adopted.

As discussed earlier in section 3.A.ii. of this preamble, the subgrouping rules under § 301.6225-1(d)(3)(i), including the application of those rules to the credit grouping, take into account any limitations or restrictions under the Code. Therefore, to the degree the Code would require certain credits to be subgrouped within the credit grouping to reflect any limitations or restrictions, the rules under § 301.6225-1(d)(3)(i) allow for that result. In addition, when determining subgroupings the IRS may take into account the facts and circumstances of a partnership and its partners. It may be the case that the subgroupings with respect to a particular set of adjustments ultimately reflects the manner in which credits are grouped and ordered on Form 3800, but that may not always be the case. The regulations provide the necessary flexibility to achieve the result suggested by the comment without binding the IRS and partnerships to a particular manner in which credits must be subgrouped.

Additionally, because the Form 3800 and the underlying statutory rules it reflects may change over time, it is unwise to link the regulatory rules for subgrouping with the form's methodology for grouping credits. Relying on the general subgrouping rules under § 301.6225-1(d)(3)(i) gives the IRS and partnerships the flexibility to adapt to changes in the Code and any form changes without needing to amend the regulations.

Adjustments to creditable expenditures are placed in the creditable expenditure grouping described under § 301.6225-1(c)(4). Proposed § 301.6225-1(c)(4)(B), (d)(3)(iii), and (e)(3)(iii) provided specific rules relating to foreign creditable tax expenditures. Aside from the general rule regarding what constitutes a creditable expenditure, no additional rules relating to creditable expenditures were proposed.

The Treasury Department and the IRS requested comments on the appropriate treatment of creditable expenditures. One comment suggested any items that may be treated as a credit when taken into account by a partner and not otherwise limited (for instance, by their non-creditable status against the alternative minimum tax) be credited against the imputed underpayment amount. For other items which may be subject to limitations at the individual level, the comment suggested that the regulations provide rules similar to those rules proposed under proposed § 301.6225-3, regarding adjustments that do not result in an imputed underpayment, because any adjustment to a credit would not result in an imputed underpayment.

With the exception of the rules under § 301.6225-1 regarding foreign tax creditable expenditures, the Treasury Department and the IRS have determined not to issue regulations regarding the treatment of creditable expenditures at this time. However, the final regulations do clarify that the general subgrouping principles under § 301.6225-1(d)(3)(i) apply when subgrouping adjustments to creditable expenditures. The comments received with respect to creditable expenditures remain under consideration, and future guidance will be issued when appropriate. The final regulations also clarify that a net positive adjustment to creditable foreign tax expenditures is excluded from the calculation of the total netted partnership adjustment under § 301.6225-1(b)(2).

Comments were also requested regarding how credit recapture situations should work under the centralized partnership audit regime. One comment offered suggestions with respect to two credit recapture situations. The first situation involved a credit recapture that results from a partnership adjustment. The comment recommended in that situation that the regulations should incorporate any credit recapture into the calculation of any imputed underpayment to the extent that the originating credits were generated from partnership activities, but that this incorporation should be limited to partnerships with partners that actually would have benefited from the original credits. This recommendation was partially adopted.

A recapture of a credit generated by partnership activities constitutes a partnership adjustment as defined under § 301.6241-1(a)(6), and the credit recapture would constitute a positive adjustment under § 301.6225-1(d)(2)(iii)(A) and be placed in the credit grouping under § 301.6225-1(c)(3). The full amount of the credit recapture would be taken into account in the determination of the imputed underpayment, unless the partnership requests, subject to IRS approval, that the credit recapture should be taken into account differently during the partnership-level proceeding or pursuant to a modification request. See § 301.6225-1(d)(1), (e)(1), § 301.6225-2. This rule is necessary because, as discussed earlier in this section of this preamble, in general, the initial determination of an imputed underpayment does not account for the attributes of the partnership's partners, including whether and to what extent any partners actually benefited from the original credits. Accordingly, the final regulations include a credit recapture amount in the amount of the imputed underpayment, and this amount is not limited to the amount partners actually benefited from the recaptured credits unless the partnership can affirmatively demonstrate to the satisfaction of the IRS during exam either before issuance of the NOPPA or on modification the appropriate partner-level tax treatment.

The second situation described by the comment involves a partnership adjustment that results in a credit that is incorporated into the imputed underpayment calculation, presumably as a reduction to the imputed underpayment and that may later be subject to recapture. The comment recommended that the regulations require the partnership to notify partners that they received the benefit of such credits and that the partners may be obligated to recapture those credits at a later date. The comment suggested this notice could be provided as notes to the adjustment year Schedule K-1. This comment was not adopted. The final regulations do not require that the partnership notify the partners of any risk of future credit recapture, though the partnership is not prohibited from doing so if the partnership determines that such notification would be beneficial to the partners and the partnership. Except where required for the operation of the provisions of the centralized partnership audit regime, the Treasury Department and the IRS do not generally regulate communications between the partnership and the partners, and therefore the final regulations do not impose a requirement for notification by the partnership concerning possible credit recaptures.

Because a net negative adjustment to a credit, that is, an increase in an item of credit, would generally be subject to limitations under the Code, the final regulations under § 301.6225-1(e)(3)(ii) clarify that a net negative adjustment to a credit is treated as an adjustment that does not result in an imputed underpayment as described in § 301.6225-1(f)(1), unless the IRS determines otherwise. This rule ensures that the total netted partnership adjustment is not inappropriately reduced by an increase in credit that would subject to limitations in the hands of the partners of the partnership.

B. Modification of an Imputed Underpayment

Proposed § 301.6225-2 provided the rules and procedures regarding modification of an imputed

underpayment by the partnership. The Treasury Department and the IRS received multiple comments regarding proposed § 301.6225-2 focusing on the following areas: (1) Modification in general; (2) timing of modification requests and determinations; (3) amended return modification; (4) the alternative procedure to filing amended returns; (5) rate modification; (6) modification pertaining to certain passive losses of publicly traded partnerships; (7) modification pertaining to qualified investment entities; (8) closing agreement modification; and (9) recommendations to add additional types of modifications.

i. Comments Pertaining to Modification in General

The modification provisions under § 301.6225-2 are designed to determine an imputed underpayment amount that reflects, as closely as possible, the tax the partners would have paid had they correctly reported the adjusted items, while at the same time maintaining the efficiencies of a streamlined examination and collection process. See JCS-1-16 at 65-66. One comment suggested, that the modification provisions do not operate as intended because those provisions do not expressly permit a modification to reflect how the partners actually took an item into account, to account for reductions that would be permitted to offset an increase under generally applicable law, or to otherwise expressly challenge the IRS's method of calculating a proposed adjustment amount. Except as described later in this section, no changes to the regulations were made in response to this comment.

The Treasury Department and the IRS do not agree with the comment's characterization of how the modification provisions operate because the modifications available under § 301.6225-2 permit a partnership to achieve the results sought by the comment. For instance, both the amended return procedure and the alternative procedure to filing amended returns provide an opportunity for the partnership to request modification to reflect how an item was actually taken into account by its partners and to account for offsetting reductions permitted under generally applicable law. When a partner files an amended return including his share of the partnership adjustments, the amended return reflects a tax amount based on how the partner originally reported the partnership-related item prior to adjustment compared to how the partnership adjustment affects the partner's original return. This tax amount is the correct amount of tax for that partner after taking into account the partnership adjustment and includes any allowable reductions that may offset any additional income determined at the partnership level.

Regarding the comment's concern that a partnership does not have an opportunity to challenge the IRS's method of calculating a proposed adjustment amount, proposed § 301.6225-2(d)(6) provided a procedure for modifying the composition of an imputed underpayment. Under § 301.6225-2(d)(6), a partnership may request that the IRS include one or more partnership adjustments in a particular grouping or subgrouping. If certain negative partnership adjustments should be treated as if no limitations or restrictions in fact apply to the partners to whom the adjustments are allocated and the partnership can establish this result, if approved, on modification, such negative adjustments may be properly grouped or subgrouped with other adjustments and therefore allowed to net against those adjustments in accordance with § 301.6225-1(e) to reduce the amount of the imputed underpayment.

To the extent the comment was suggesting that the modification procedures do not provide the partnership an opportunity to challenge the substance of partnership adjustments, the comment is correct but no change is made in response to the comment. The statutory modification procedures are designed to allow the partnership to modify the amount of the imputed underpayment, not adjust the substance of the partnership adjustments that underlie the imputed underpayment. The substance of partnership adjustments are determined by the IRS on examination, and may be further revised in the IRS Appeals Office (IRS Appeals) or by a court in a proceeding for readjustment brought under section 6234. Although the comment did not explicitly state it as such, to the extent the comment was recommending a rule under § 301.6225-2 that allows a modification to reflect a circumstance where a partner actually took an item into account in a manner consistent with how that item was adjusted by the IRS during the partnership proceeding, this suggestion was adopted. As discussed later in section 3.B.ix. of this preamble, the final regulations under § 301.6225-2(d)(2)(ii) allow a partnership to request modification based on how adjusted items were taken into account by a partner prior to the item being adjusted by the IRS.

The same comment also suggested that the modification procedures permit a partnership to demonstrate how an adjustment would impact its partners and reduce an imputed underpayment without a need for the partners to file an amended return. The other proposed modification procedures provided multiple opportunities for partnerships to demonstrate the impact of adjustments on specific partners. The alternative procedure to filing amended returns is one way in which this type of modification may be achieved. Under § 301.6225-2(d)(2)(x), a partnership may submit on behalf of a partner, in accordance with forms, instructions, and other guidance prescribed by the IRS, all information and payment of any tax, penalties, additions to tax, additional amounts, and interest that would be required to be provided if the partner were filing an amended return. If the partnership avails itself of this procedure with respect to a partner, the partner does not need to also file an amended return in order for modification to be approved. The amended return procedures and the alternative procedure to filing amended returns are discussed further in sections 3.B.iii. and 3.B.iv. of this preamble.

Other modification procedures also provide the partnership with an opportunity to demonstrate the effect of adjustments on specific partners. For instance, tax-exempt modification provides an opportunity for the partnership to demonstrate that partnership adjustments are allocable to a partner that would not owe tax by reason of its status as a tax-exempt entity. Rate modification allows partnerships to demonstrate that partners would be subject to a lower rate than the highest rate of tax applied to calculate the imputed underpayment. Because the partnership has many avenues within modification to demonstrate the effect a partnership adjustment would have on specific partners, no new modification procedures were adopted in response to this comment.

Former proposed § 301.6225-2 permitted a partnership to request modification with respect to an indirect partner (as defined in § 301.6241-1(a)(4)). See, for example, former proposed § 301.6225-2(d)(2). One comment suggested that permitting partnerships to modify their imputed underpayment to account for direct and indirect partners is consistent with the objective of determining an imputed underpayment amount that is as close as possible to the tax due if the partnership and partners had correctly reported and paid. The comment further suggested

that permitting modifications for direct and indirect partners would also reduce the disincentives for partnerships to pay the imputed underpayment and recommended the final regulations adopt rules permitting modification with respect to indirect partners, consistent with the proposed regulations.

The final regulations are consistent with the comment's request and adopt the proposed rules allowing modification with respect to indirect partners, provided the indirect partner is a relevant partner as defined in § 301.6225-2(a). The August 2018 NPRM introduced, the term “relevant partner” to describe any person for whom modification is requested by the partnership that is a reviewed year partner, including a pass-through partner, or an indirect partner. The term relevant partner does not include, however, any person that is a wholly-owned entity disregarded as separate from its owner for Federal income tax purposes. No comments were received regarding the definition of relevant partner. The final regulations maintain the definition of relevant partner from proposed § 301.6225-2(a).

Accordingly, under the final regulations a partnership may request modification with respect to reviewed year partners (direct partners), including pass-through partners, and indirect partners. A partnership may not request modification, however, with respect to a direct or indirect partner that is a wholly-owned entity disregarded as separate from its owner for Federal income tax purposes.

One comment noted some concerns regarding the interaction between the centralized partnership audit regime and ERISA. The comment expressed concerns about situations in which the partnership representative must decide whether to request a modification that benefits non-ERISA partners over ERISA partners and how that affects the discharge of any fiduciary duties under ERISA. To address these concerns, the comment made three recommendations. First, the comment recommended that the regulations provide that the partnership representative may solicit a vote of the partners in the partnership in determining whether to request a modification. This recommendation was not adopted.

The decision whether to solicit a vote of the partners in the partnership as part of determining whether to request modification or a particular type of modification is fully within the authority of the partnership representative. Nothing in the final regulations prevents or requires the solicitation of a vote by the partnership representative. Additionally, if the partnership and its partners impose such a condition on the partnership representative through an agreement with the partnership representative, any failure to adhere to that agreement does not affect actions taken by the partnership representative. See § 301.6223-2(d).

Second, the comment recommended that the IRS agree to automatically grant a request for an extension of the 270-day period for requesting modification if a vote of the partners whether to request modification has been solicited. This comment was not adopted for the reasons discussed in section 3.B.ii. of this preamble.

Lastly, the comment recommended that the Treasury Department and the IRS share a suggestion with the Department of Labor that the Department of Labor clarify that a partnership representative will not be treated as a fiduciary with respect to any ERISA plan partner if the partnership representative requests or fails to request a modification based on the results of a vote of the partners. The rules regarding who is treated as a fiduciary with respect to any ERISA plan are beyond the scope of these regulations. However, as requested, the comment has been forwarded to the Department of Labor.

Another comment recommended that the IRS revise proposed § 301.6225-2(c)(2)(ii) to limit the required information submitted with any modification request to that specific information relevant to the type of modification requested. The comment noted that requiring extensive and detailed documentation for each modification request will limit the ability of some partnerships to take advantage of the modification procedure. The comment also urged the IRS to establish realistic minimal documentation requirements for any modification request and create additional specific relevant requirements for the various types of modification requests permitted under the proposed regulations. The comment further noted that the ability of the IRS to request supplemental information prior to approval (as provided in proposed § 301.6225-2(c)(4)) will ensure that the IRS obtains documentation they deem necessary for a particular set of facts and circumstances. This comment was adopted.

The final regulations under § 301.6225-2(c)(2)(ii) clarify that the partnership representative must furnish to the IRS information as required by forms, instructions, or other guidance prescribed by the IRS or as is otherwise requested by the IRS. The final regulations provide examples of such information, including the information that was described previously in proposed § 301.6225-2(c)(ii). The information listed in the proposed regulations pertained to items that are necessary to process the majority of modification requests. It is possible, however, that certain items may not be necessary in every case, and if such items are not necessary, or if different items are more appropriate, the IRS will describe the information required in forms, instructions, or other guidance. In this way, the regulations provide the flexibility for the IRS to request what is needed for efficient and effective processing of modification requests, while maintaining the flexibility to adapt information requests in the future.

The final regulations under § 301.6225-2(c)(2)(i) also clarify that, pursuant to section 6241(10), the partnership may be required to submit or file items required to be provided to the IRS under § 301.6225-2 in an electronic format. The form and manner for submission of anything required to be submitted under § 301.6225-2 will be described in forms, instructions, and other guidance prescribed by the IRS. Lastly, the final regulations under § 301.6225-2(c)(2)(i) clarify that the IRS will deny modification not only for the failure to substantiate a modification request but also for the failure to pay anything required under § 301.6225-2.

ii. Timing of Modification

Proposed § 301.6225-2(c)(3) provided rules regarding the time for submitting modification information to the IRS. One comment made three recommendations regarding these rules. First, the comment suggested that the final regulations provide a specified time frame in which the IRS must respond to a request for modification. This suggestion was not adopted because the regulations under section 6235 provide a time frame within which the IRS will respond to a partnership's modification request.

Pursuant to § 301.6235-1(a)(2) and (b), in the case of any modification of an imputed underpayment, no partnership adjustment may be made later than the date that is 270 days after the date on which everything required to be submitted under § 301.6225-2 for modification is so submitted. The date on which everything required to be submitted is so submitted is the date the modification period ends or expires. § 301.6235-1(b)(2). Accordingly, in the case of a modification request, the IRS

must generally mail an FPA to make a partnership adjustment within 270 days of the date the modification period ends.

To the extent the comment was requesting a deadline by which the IRS must respond to a request for modification prior to the time limit for making adjustments under section 6235, the comment was not adopted. It is not administrable for the IRS to impose a deadline that would apply in every case that is earlier than the statutory deadline imposed by section 6235. The facts and circumstances of each administrative proceeding, the partnership adjustments made during that proceeding, and the modifications that are requested may differ greatly. Similarly, the complexity of the modification process may range from simple and straight forward to highly complex. Finally, for those modification requests that are more complex or that require additional documentation, the partnership may extend the time period for submitting modifications under § 301.6225-2(c)(3) to allow for additional time and any additional documentation. For the reasons discussed in section 3.B.iii. of this preamble, the IRS plans to adopt procedures under which the IRS will respond to a request for modification in the FPA, including the planned time frame for responses. It is important to tax administration that these procedures are developed in separate guidance to allow for additional flexibility as the IRS gains more experience with the centralized partnership audit regime and the modification process. The 270-day period for mailing an FPA therefore acts as the outside time frame within which the IRS must respond to a request for modification. Because this time frame exists elsewhere in the regulations, the final regulations under § 301.6225-2 do not provide a separate time frame for providing a response to a modification request.

The comment also recommended that the final regulations provide that if there is a pending request for modification at the expiration of the 270-day period, the IRS will automatically agree to an extension of that period until at least 30 days after they provide their response. It is not clear from the face of the comment which 270-day period the comment was referring to—the 270-day period under § 301.6225-2(c)(3)(i) in which everything required for modification must be submitted or the 270-day period under § 301.6235-1(b) in which the IRS must mail an FPA to make a partnership adjustment. Both periods may be extended at the request of the partnership or the IRS. See §§ 301.6225-2(c)(3)(ii); 301.6235-1(d).

Regardless of which 270-day period the comment was referring to, the comment was not adopted. The final regulations do not provide that the IRS will automatically agree to an extension of either period under any circumstance. Whether an extension of the time to submit modification information, or an extension of the time to consider such information, is warranted is based on the facts and circumstances. In some cases an extension may be appropriate, for example, where there is a pending request and additional information would help clarify the issues. In other cases an extension may not be appropriate, for example, where it is clear that more information is likely to be of little to no value. Accordingly, while the regulations allow for an extension of both the period to submit modification information and the period in which the IRS has to consider such information, neither extension is automatic but rather must be based on the facts and circumstances of the particular case.

Lastly, the comment suggested the regulations provide a time frame for a partnership to respond to an IRS request for additional information during the IRS's review of a modification request. The comment recommended the time frame for responding be a

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