United States: Large Partnership Audits – Part 2: Update And Some Basics

In our first article in this series, we discussed the impending large partnership compliance (LPC) program operated by the IRS's Large Business & International Division (LB&I) and described the anticipated audit selection process, audit issues, and audit process.¹ As discussed in that article, the LPC program is designed to increase audit coverage of this important taxpayer pool and leverages the partnership audit changes effected through the Bipartisan Budget Act of 2015 (commonly known as the BBA). The BBA streamlines the IRS audit and collection process by (1) appointing liability for any proposed tax liability to the partnership in the first instance (absent a "pushout" election to the contrary) and (2) concentrating partnership decision-making power in one person, the partnership representative.

With several months of audit information now available about the LPC program, it is opportune to consider recently released information regarding BBA audits and outline the BBA audit process that will be a part of any LPC audit.

Report on BBA Audits

Earlier this year, the Treasury Inspector General for Tax Administration (TIGTA) issued a report providing the results of its review of 84 BBA audits conducted by LB&I as of the end of fiscal year 2021. TIGTA made three recommendations to the IRS as a result of its review: (1) determine how to reduce the rate of "no-change" audits to better allocate resources to cover noncompliant taxpayers,; (2) establish overall partnership examination goals and measurements that address the expected outcomes from the implementation of the BBA audit regime,; and (3) implement a fully systemic method of monitoring and verifying that pushouts are properly reported on partners' returns.² Most, if not all, of the cases reviewed by TIGTA predated the implementation of the LPC. However, understanding TIGTA's recommendations could be helpful in understanding the conduct of any LPC audit to the extent that the IRS, specifically LB&I, incorporates aspects of those recommendations in its audit practice.

We note that while TIGTA was generally critical of the number of no-change audits and the low rate of proposed adjustments, we agree with the IRS's response that it is too early in the process to form conclusions. Complex audits with more significant audit issues take months to develop and reach the point where a Notice of Proposed Partnership Adjustment (NOPPA) can issue from an examination team (Exam). In our experience, it can easily take more than a year from the opening of the audit for Exam to issue a proposed adjustment. Speaking at a September Tax Executives Institute (TEI) conference, LB&I Deputy Commissioner Holly Paz confirmed the same by noting that the lifecycle of an LPC audit "is a lot longer than a year."³ We also agree with the IRS declining to set benchmarks for no-change rates. At a minimum, setting such benchmarks could be perceived by taxpayers as pressuring Exam to make adjustments.

BBA Audit Steps Overview

LPC audits proceed in accordance with the requirements of the BBA, implementing regulations, and LB&I adopted protocols as described in the Internal Revenue Manual (IRM).⁴ The scope of this article precludes a detailed consideration of all these procedures, so we present here a summary of the audit major milestones and important considerations.

1. Initiation of Audit

After determining which partnerships will be selected for audit, the IRS will deliver audit selection notices (Letter 2205-D, Initial Contact to Schedule Appointment – Partnership Returns) to those partnerships.⁵ The notice itself will not disclose whether it is an LPC audit. If there are timely filed administrative adjustment requests, the IRS will initiate the audit through a standard notice (Letters 5893 and 5893-A) issued within 30 to 60 days from the date of the selection notice.

Letter 5893 is the Notice of Administrative Proceeding – Partnership, and Letter 5983-A is the Notice of Administrative Proceeding – Partnership Representative (NAP). The NAP informs the partnership and partnership representative that the IRS has started an examination.⁶ After this notice is issued, the partnership may not file an AAR. Under certain circumstances, an examiner may withdraw a NAP and close the audit; however, that is unlikely to occur in the context of an LPC audit, given the significant pre-audit effort of the IRS to identify large partnerships worthy of audit.

2. Examination Process

IRM 4.31.9 provides a general guide to IRS field examiners for LPC audits. The IRM educates examiners regarding various procedural matters:

The lead Exam agent is charged with keeping various control checklists to ensure that Exam is properly handling these procedures, including, most importantly, the maintenance of sufficient lead time on the statute of limitations for adjustment (generally three years from the time of return filing under IRC section 6235(a)). The Exam team itself will be comprised of a lead revenue agent, manager, and team specialists as required for the various issues that were identified in the pre-audit risk analysis phase.

As with any audit, the main tool that Exam uses to develop the facts relating to return positions is the Information Document Request (Form 4564) or IDR. There are standardized IDRs in every large corporate audit that have been modified to apply to the large partnership context. For example, IDR 1 of every general corporate audit requests all basic corporate information, e.g., organization chart. In the LPC context, IDR 1 will request the equivalent information. At the conclusion of the fact-gathering process, LB&I auditors issue the Acknowledgment of Facts IDR (AOF IDR). The AOF IDR is intended to establish the material facts relating to a proposed audit adjustment. It is generally in the taxpayer's interest to engage with the auditors on identifying the material facts so as to make an accurate record for subsequent audit steps, including the NOPPA, the protest letter, and discussions with the IRS Independent Office of Appeals (Appeals), if necessary.

3. Completing the Audit

If at the conclusion of the fact-gathering and issue analysis process, Exam believes no adjustments should be made, it will issue a no-change letter and the audit concludes. If, however, Exam believes adjustments are required, it will provide the partnership representative (and any person authorized under a power of attorney on Form 2848) with notice of preliminary partnership examination changes and any resulting imputed underpayment computations, called the summary report package in the IRM. This package is sent via IRS Letter 5895 and will include Form 886-A, which provides Exam's explanation of adjustments. If there is no resolution, Exam will issue Letter 5891, which enables the partnership to seek review of the adjustments with the IRS Appeals within 30 days of the date of the letter.⁸ This period can be extended by consent of Exam.

If the partnership agrees with the preliminary audit results (or adjustments remain after review by Appeals is complete), the IRS will issue a Notice of Proposed Partnership Adjustment (NOPPA) to the partnership and partnership representative via Letters 5892 and 5892A, respectively. The NOPPA starts a 270-day modification period in which the partnership representative may submit a request to modify the imputed underpayment (IU). Based on this request, the IRS may agree to modify the IU computation. If it disagrees with the modified IU, the partnership can seek Exam managerial review and subsequent review by Appeals. The IRS's determination of a modification request is transmitted through Letter 5975.

At the conclusion of the modification period and any Appeals review, Exam will issue a Notice of Final Partnership Adjustment (FPA) via Letters 5933/5933A. The FPA allows the partnership to either pay the asserted tax liability or push out the liability to its partners within 45 days of the date of the FPA. The FPA also allows the partnership to petition to the U.S. Tax Court for review of the final adjustments so long as the petition is filed within 90 days of the date of the FPA. The partnership representative may waive the FPA process, the effect of which is to remove the partnership's ability to (1) push out and (2) seek Tax Court review.

LPC Audit Data So Far

As noted, LPC audits started last October. Specifics as to issues raised, resolutions thereof, and adjustment amounts are not publicly available. Regarding issues of any complexity, it is unlikely that Exam has issued even a NOPPA. In other words, we are nowhere close to seeing the audit strategy of the IRS through Tax Court filings. Sometimes audits are contentious and Exam must resort to administrative summons and summons enforcement actions to compel a taxpayer to produce information. To our knowledge, no such summons cases have been reported to date.

Nonetheless, key IRS officials have provided some insight into LPC audits. Speaking at the Federal Bar Association Section on Taxation Annual Tax Law Conference earlier this year, IRS officials updated the audience on several matters relating to the LPC program.⁹ The first round of LPC audits involve partnership returns for tax year 2019. The Exam teams include revenue agents with partnership exam experience, individuals recently hired for their subchapter K background, and revenue agents with issue expertise. An LPC exam team "is encouraged to consider coordination with another exam team if other returns are under exam within the same partnership structure," said one of the officials, Adrienne Cooper of Team 1124 of LBI. Although personnel in the other exam team may not be partnership experts, this will not be problematic, according to Cooper, because IRS is focused on issues beyond subchapter K issues. The official explained that LPC audits have revealed that large partnerships have similar compliance issues to those presented by large corporations that often involve affiliates. Therefore, LB&I will expend resources to coordinate cases that involve other entities within the partnership structure.

At the September TEI conference, the following further information was provided:¹⁰

• Fifty large partnerships were selected for the first round of audits (confirming 2019 returns).
• No decision will be made regarding whether the subsequent returns of the audited group will also be examined until after the review of the 2019 returns.
• The LPC program is expected to be ongoing, but it is not expected that audits will become continuous once a partnership is selected.
• IRS management is receiving feedback from LPC field agents to make refinements in LPC audit methods. Such refinements may be publicized at a later date.
• LB&I is considering whether LPC examiners can inform taxpayers of risk levels and specific issues flagged prior to audit.

In some respects, the LPC is similar to the Global High Wealth audit initiative in which LB&I examined the whole network of entities affiliated with the wealthy individual.¹¹ In that initiative, teams with varying expertise were formed at the onset of the audit to address various issues identified in the risk assessment phase. Here, a large partnership is selected for audit based on specific noncompliance issues presented by the partnership return and, as the audit unfolds, LB&I coordinates with other audit teams to the extent there is a convergence of potentially noncompliant taxpayers within the partnership structure.

Footnotes

1. See https://www.mofo.com/resources/insights/211004-the-impending-large-partnership-audits.

2. Centralized Partnership Audit Regime Rules Have Been Implemented; However, Initial No-Change Rates Are High and Measurable Goals Have Not Been Established, accessible at https://www.oversight.gov/sites/default/files/oig-reports/TIGTA/202230020fr.pdf.

3. LB&I Could Approve Divulging Large Partnership Audit Focus, TAX NOTES TODAY (K. Parillo, September 22, 2022).

4. See IRC Sections 6221–6234 and implementing regulations; IRM 4.31.9 Centralized Partnership Audit Regime (BBA) Field Examination Procedures (October 29, 2021); IRS (LB&I) Publication 5125.

5. LB&I conducts audits of partnerships under the LPC that meet a certain asset value criteria (as well as risk potential). Partnerships that do not meet this threshold are audited by the Small Business/Self-Employed division of the IRS. At the September TEI conference, Ms. Paz indicated LB&I may consider providing each partnership with the risk level that they've been assigned and the issues that were flagged for review. See supra n. 3.

6. Under the BBA, a partnership must designate a partnership representative (person, entity, or even itself) on its tax return for each taxable year unless it has elected out of the BBA. The partnership representative has the sole authority to act on behalf of the partnership.

7. IRM 4.31.9.2.

8. Prior to Covid-19 modifications of the audit process, large corporate audits were conducted in-person, i.e., field audits. At this time, the IRS has not yet fully returned to field audits. This may change in the future; however, LB&I is currently constructing a taxpayer portal online through which most of the IDR process will occur. The portal will utilize a secure encrypted database and email server system.

9. IRS Will Coordinate Large Partnership Examinations if Needed, K. Parillo, March 7, 2022 (2022 TNTF 44-8).

10. See supra. n. 3.

11. We previously reported on the IRS's Global High Wealth audits.