The Bipartisan Budget Act (BBA) of 2015 changed the way partnerships make adjustments to their previously filed tax returns for tax years beginning after December 31, 2017, and included centralized partnership audit rules. If your partnership did not elect out, it is subject to these rules. It may work in your favor to file an extension for your partnership’s tax return this year and future years.
By extending your partnership’s Form 1065, U.S. Return of Partnership Income, you move the due date from March 15th to September 15th, which can allow your partnership flexibility to make corrections for a given tax year without having to go through the new audit rules.
The BBA’s Partnership Audit Rules
In 2015, the BBA replaced the partnership procedures enacted by the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA). Further amendments were made to the BBA by the Protecting Americans from Tax Hikes Act (PATH Act) of 2015 and sections 201 through 207 of the Tax Technical Corrections Act (TTCA) of 2018.
Under BBA, as amended, the determination of adjustments and the assessment and collection of related tax occurs at the partnership level, rather than passing tax, penalty, and interest adjustments through to the partners. A partnership is allowed to make an election to push the adjustments out to its reviewed-year partners, which are those who held an interest in a partnership in the reviewed year. Unless your partnership makes a valid election out of the BBA for the partnership’s tax year:
- your partnership is subject to the BBA’s partnership audit rules;
- you must designate a partnership representative (PR) for the partnership tax year; and
- if the designated P.R. is an entity, you must also appoint a designated individual (DI) for the partnership tax year.
Criteria for Electing Out
Electing out of the BBA partnership rules must be done on an annual basis. To be eligible to elect out for a taxable year:
- The partnership must have 100 or fewer partners.
- Add the number of Schedules K-1 for partners, including all shareholders for any partner that is an S corporation
- The partnership’s partners must all fall into the following categories:
- estates of deceased partners;
- S corporations;
- C corporations; or
- foreign entities that, if they were domestic, would be treated as C corporations.
- None of the partnership’s partners can be:
- disregarded entities;
- estates of individuals other than deceased partners
- individuals who hold an interest in the partnership on behalf of another person; or
- foreign entities that, if they were domestic, would NOT be treated as C corporations.
A superseding return is a second return filed before the originally filed return’s due date, including extensions. Superseding returns are considered returns of record because they replace any other returns previously filed within the filing period. When filing electronically, partnerships must check the designated “Superseding Return” box within their tax preparation software. When paper-filing, partnerships must write “Superseding Return” at the top of Form 1065 and Schedules K-1.
Because you can modify a tax return by submitting a superseding return if the return’s deadline has not yet passed, it is best practice to consider filing an extension request. In this case, you can easily revise a previously filed return up to its extended due date using a superseding return, if necessary. A superseding Form 1065 also provides the partnership a subsequent opportunity to file missed elections and attachments that might have been considered or treated as late.
Amended Returns & AARs
An amended return is different from a superseding return; it is a return filed after its original due date, including extensions. If eligible, a partnership may elect out of the BBA and still change a previous partnership return by filing an amended return without submitting an AAR for taxable years beginning on or after January 1, 2018.
Generally, a partnership that has filed a valid election to opt out may still file an amended partnership return, as long as it is within three years after the later of:
- the filing date for the partnership return for that year; or
- the filing deadline for the partnership return for that year, excluding extensions.
However, in general, partnerships that have not elected out of the BBA are no longer allowed to file an amended Form 1065, including amended Schedules K-1s. If your partnership has not elected out and wishes to change the amount of one or more partnership-related items on a previously-filed partnership return, you ordinarily must file an administrative adjustment request (AAR). More specifically, how you file changes to your partnership returns depends on factors specific to your partnership, including whether you are filing electronically and whether the partnership holds an interest in another partnership.
Issue in Action
Suppose you file your partnership’s 2021 Form 1065 before the original due date of March 15, 2022, and that, later this summer, you discover a necessary change in income. In this case, the adjustments would need to be made at the partnership level, resulting in direct changes for the partnership and indirect changes for partners for tax year 2022, rather than the 2021 tax year. Not only would an adjustment assessed at the partnership level be automatically taxed at the maximum federal rate bracket of 37%, but it could also deny the partners their ability to receive an increased Section 199A deduction, which, subject to several limitations, could have provided the partners with a write-off of up to 20% of the gross adjustment the partnership identified.
If, on the other hand, your partnership filed Form 7004 and extended the return to September 15, 2022, the partners can avoid the permanent losses above by filing a superseding return. In this case, the change would impact the same 2021 partners and in the same 2021 tax year. Some partners may be subject to lower tax brackets and able to receive an increased Section 199A deduction.
Understanding these regulations and filing complaint returns can be complex. The IRS provided one-time transition relief to eligible partnerships for tax years beginning in 2018. And while the CARES Act established special rules to govern making adjustments to BBA partnership returns for 2018 and 2019, the IRS’s era of leniency has, in general, come to an end. The IRS has launched a concerted enforcement effort to address partnership issues, and additional legislative proposals are in the works.
Filing an extension for your partnership’s tax return doesn’t do any harm and can help you stay ahead of issues. I can answer your questions, help you extend or file your partnership return, or help you file an election to opt out of the BBA rules. Contact me today to get started.
John Hadwen joined ARB in 2021 as a tax director. He specializes in providing individuals and businesses with comprehensive tax compliance and consulting services related to manufacturing, construction, real estate, closely-held business, and professional services firm taxation. Prior to joining ARB, John was a Tax Principal at a large, regional CPA firm.