IRS emailed advice is always tricky to interpret, since we are seeing only one side of a conversation in these cases—only the IRS attorney’s response is provided.  And, unlike more formal advice from the Chief Counsel’s office, these emails do not follow a formal structure where the facts under consideration are outlined in the attorney’s response.

But Chief Counsel Email 202129012[1] contains one side of a discussion that outlines an issue that arises with partnership examinations under the BBA centralized partnership audit regime, discussing if it matters that the partnership can show that if an item of adjustment had been properly reported by the partners no additional income tax would have resulted.  The partnership would want to have this amount excluded from the imputed adjustment (IU) under the regime, which is generally subjected to tax at the highest marginal tax rate when paid by the partnership.

If the item is includable in income generally under Chapter 1 of Subtitle A of the IRC (normal taxes for federal income taxes), the email concludes that it does not matter if, due to other factors, these particular partners would not have paid any tax in the year in question if the amount had been properly reported:

All adjustments to partnership-related items (PRIs) go into the computation of the imputed underpayment (IU) regardless of whether they would result in additional income tax if properly reported by the partners. The issue of whether there is a chapter 1 impact doesn’t go into consideration of whether an adjustment goes into the IU computation but rather goes into the analysis of whether the item is a PRI or not. We are treating like 14 as a PRI (* * *).[2]

A simple example of how this could happen would relate to cancellation of indebtedness.

Example

Mary and Twila are equal partners in the MT Partnership, a partnership subject to the BBA 2015 audit regime.  The IRS examines the partnership’s income tax return and it is determined that the partnership failed to report $25,000 of cancellation of indebtedness income.  Under IRC §61(a)(11) cancellation of indebtedness is counted as income under IRC §61(a)(11) and thus is part of the imputed adjustment (IU).

Both Mary and Twila were insolvent at the date the debt was cancelled and had no attributes to be reduced under IRC §108(b) at the end of that year.  Under IRC §108(a)(1)(B) cancellation of indebtedness of income is excluded from income when the taxpayer is insolvent at the time the debt is cancelled.  However, per IRC §108(d)(6), the partnership itself does not qualify to apply this relief—rather, each partner must demonstrate their personal insolvency to qualify for the exclusion.

In this case, had the $25,000 of cancellation of indebtedness income been properly reported by the partnership on its original return, neither Mary nor Twila would have paid any additional tax, since they each would have qualified under IRC §108(a)(1)(B) to exclude the amount from income.  However, in computing the imputed adjustment (IU) that would be used to compute the payment the partnership would make for the exam, the entire $25,000 would be treated as subject to tax at the highest marginal individual rates for the year in question.

In this scenario, to avoid the imposition of a tax, the partnership would either need to elect to use the option under IRC §6226 to push out the adjustment to the partners (who then would compute a net zero addition to tax for the item) or have the partners voluntarily amend the prior year returns under the provisions of IRC §6225(c)(2) to avoid tax being paid by any party on these items.

Note, though, that in the case of an administrative adjustment request (AAR) under §6227, the amended return option to remove the partners’ share of the IU is not available.[3]  Partnerships subject to the BBA regime cannot simply amend the original partnership return, but rather must make use of the AAR procedures under §6227 to voluntarily fix issues found in prior years.  In that situation, only a push-out election under IRC §6226 would avoid paying tax on this item of income under the position taken in this emailed advice.

Of course, if a partnership is eligible to opt-out of the application of the BBA via the election under IRC §6221(b) and its related regulations, it could avoid this problem by opting out of the BBA regime by checking the appropriate box on Schedule B of Form 1065 and filing a properly completed Schedule B-2 with the return.  In that case, the traditional amended return procedures are available to the partnership, which would have the tax impact computed on amended returns of the individual partners.

[1] CCE 202129012, July 23, 2021, https://www.taxnotes.com/research/federal/irs-private-rulings/e-mail-chief-counsel-advice/no-excluding-partnership-related-items-from-imputed-underpayment/76x8b (retrieved July 25, 2021)

[2] CCE 202129012, July 23, 2021

[3] IRC §6227(b)(1) which bars the use of IRC §6226(c)(2) provisions to reduce the IU