IRS Issues Final Regulations for Electing Out of Centralized Partnership Audit Regime

The IRC § 6221(b) Election
For tax years beginning after December 31, 2017, all partnerships are subject to the new centralized partnership audit regime, which generally provides for the assessment and collection of unpaid taxes at the partnership level. IRC § 6221(b) allows partnerships to make an annual election out of the new audit regime (subjecting the partnership to the Code’s partner-level deficiency procedures) if: (1) the partnership has 100 or fewer partners, (2) all of the partners are eligible partners, and (3) the partnership follows the required procedure for making the election. The final regulations address these substantive and procedural requirements for making the IRC § 6221(b) election.

100 or Fewer Partners
Under the final regulations, a partnership has 100 or fewer partners when the partnership is required to furnish 100 or fewer statements under IRC § 6031(b) for the taxable year. Treas. Reg. § 301.6221(b)-1(b)(2)(i). In other words, the number of partners is determined by the number of Schedule K-1s the partnership is required to issue for the partnership taxable year. Note that under IRC § 6031(b) rules, the partnership may be required to issue multiple statements for the “same” partnership interest for the taxable year – for example, if a partner sells his partnership interest to a third party during the taxable year, under IRC § 6031(b), the partnership is required to issue two statements for the taxable year, one to the original partner and one to the new partner. Each statement is counted as a “partner” for purposes of the 100 or fewer partner determination. For partnerships with S corporation partners, statements required to be issued by the S corporation to its own shareholders under IRC § 6037(b) are also counted when determining the number of statements furnished by the partnership. Treas. Reg. § 301.6221(b)-1(b)(2)(ii). The IRS received comments suggesting that statements furnished to certain types of partners (for example, pass-through entities, disregarded entities, and spouses) not be counted for purposes of the 100-or-fewer partner threshold. The IRS generally declined those suggestions, retaining the requirement that the IRC § 6031(b) rules govern the 100-or-fewer partner determination.

Eligible Partners
Under the final regulations, an “eligible partner” is a partner that is an individual, C corporation (as defined under IRC §1361(a)(2)), eligible foreign entity (as defined under Treas. Reg. § 301.6221(b)-1(b)(3)(iii)), S corporation, or estate of a deceased partner. The final regulations retain the requirement that only those entities expressly provided under IRC § 6221(b)(1)(C) are eligible partners. Accordingly, the term “eligible partner” does not include partnerships, disregarded entities, trusts, non-eligible foreign entities, persons holding an interest in the partnership on behalf of another person, or estates of someone other than a deceased partner. An S corporation is an eligible partner even if one or more of its shareholders would be considered an ineligible partner if the shareholder(s) held a direct interest in the partnership. Treas. Reg. § 301.6221(b)-1(b)(3).

Election Procedure
An IRC § 6221(b) election must be made with a timely filed partnership return (including extensions) for the taxable year for which the election applies. Once the election is made, it cannot be revoked without the consent of the IRS. IRC § 6221(b)(1)(D)(i); Treas. Reg. § 301.6221(b)-1(c)(1). The election must include information about each person that was a partner during the partnership taxable year, including the partner’s name, U.S. taxpayer identification number (TIN), tax classification, an affirmative statement that the partner is an eligible partner, and other information that the IRS requires. This means that all partners, including eligible foreign partners with no US filing requirements, must have a TIN in order for the partnership to make the IRC § 6221(b) election.  For partnerships with S corporation partners, the election must also include the name, TIN, and tax classification of each person who was a shareholder in the S corporation at any time during the S corporation taxable year ending with or within the partnership’s taxable year. IRC § 6221(b)(1)(D)(ii); Treas. Reg. § 301.6221(b)-1(c)(2). A partnership that makes the election must notify each of its partners of the election within 30 days of making the election in the form and manner determined by the partnership. IRC § 6221(b)(1)(E). Treas. Reg. § 301.6221(b)-1(c)(3).

Conclusion
Partnerships (and LLCs taxed as partnerships) need to be aware of the substantive and procedural requirements for making the election under IRC § 6221(b) and the final regulations. Below are a few important points to remember:

• The partnership must have 100 or fewer partners. Whether a partnership has 100 or fewer partners is determined by the number of statements (Schedule K-1) the partnership is required to furnish under IRC § 6031(b) for the partnership taxable year. For partnerships with S corporation partners, any statements required to be issued by the S corporation to its own shareholders under IRC § 6037(b) are also counted when making this determination.
• The partnership must have only “eligible partners” at all times during the partnership taxable year. If a partnership has an ineligible partner (such as a partnership or disregarded entity) during the taxable year, the partnership will not be eligible to make the election for that taxable year.
• The partnership must make the election annually with its timely filed partnership return. The election must include required information about each person who was a partner during the partnership taxable year, and each partner must have a TIN. For partnerships with S corporation partners, the election must also include information about each shareholder of the S corporation.

Partnerships considering the IRC § 6221(b) election should consult their tax professional as soon as possible to determine what steps the partnership should take (e.g., amending the partnership agreement to restrict the number and/or types of partners) to ensure that the partnership is eligible for the election. If you would like more information about the IRC § 6221(b) election, please contact a member of the Haynsworth Sinkler Boyd Tax Practice Group.