Practitioners are weighing in with recommendations for the IRS and Treasury to provide relief for some partnerships that can’t take advantage of coronavirus tax benefits because of a procedural quirk in the audit regime.
One suggestion, by the Real Estate Roundtable in an April 4 letter, is for the government to extend original return due dates for tax years 2018 and 2019 to the extent taxpayers have already timely filed original returns for those years.
“This would allow taxpayers, including partnerships, to file a superseding tax return that would be treated as replacing the originally filed 2018 tax return,” the group said.
The changes were requested so that businesses taxed as partnerships can take advantage of the bonus depreciation technical correction and business interest limit increase in the Coronavirus Aid, Relief, and Economic Security (CARES) Act (P.L. 116-136).
The CARES Act technical correction retroactively allows qualified improvement property (QIP) to qualify for 100 bonus depreciation, and it reduces the depreciable life of QIP under the alternative depreciation system from 40 years to 20 years.
The new law also increased the business interest deduction limitation from 30 percent to 50 percent of adjusted taxable income for tax years 2019 and 2020 and provided special rules for partnerships.
Practitioners were quick to point out that the changes meant to help businesses through the economic downturn won’t help some partnerships because of the changes made under the centralized audit regime, which was effective for the 2018 tax year and allows the IRS to audit partnerships at the entity level.
Among the other vast changes to the partnership landscape under the audit regime is that partnerships subject to the regime aren’t able to simply file amended returns; instead, they must file administrative adjustment requests (AARs). If the result of an AAR is an imputed underpayment, the partnership can pay that amount or elect to use rules based on the push-out election in which reviewed-year partners would pay the amounts.
But if a partnership files an AAR that doesn’t result in an imputed underpayment, rules similar to the push-out regime under section 6226 apply, and reviewed-year partners must take into account the adjustments in the year in which they received them and refunds aren’t generally available.
The Real Estate Roundtable provided an example of how that poses a problem for partnerships. If a partnership paid $100 million in 2019 for QIP, it would have reported $2.56 million of depreciation on its 2019 return based on the law without the CARES Act changes. But now that QIP qualifies for bonus depreciation in 2019, the partnership would have been able to deduct an additional $97.44 million as bonus depreciation, and the partners would have ended up paying $36 million less in tax as a result.
But the way that audit regime works, that partnership would have to file an AAR this year to report the $100 million of bonus depreciation for tax year 2019, which results in $36 million that can be used in the same manner as a nonrefundable credit for tax year 2020, the year the AAR was filed.
“Unfortunately, the partners have net losses for 2020 — so they get no tax benefit from the $36 [million],” the Real Estate Roundtable said. “They are also precluded from carrying that amount back to a prior year or forward to a future year. Thus, the partners get no benefit from the bonus depreciation.”
Reduced Bases
Another potential problem is that the partners from 2019 might have to reduce their bases in their partnership interests by the $100 million of bonus depreciation reported on the AAR, even though they didn’t receive a tax benefit from that depreciation, the group said.
The IRS has indicated it’s aware of the issue and is considering various ways of providing relief. Last summer, it allowed some partnerships to file superseding returns in limited circumstances when they couldn’t amend returns because of the audit regime.
The roundtable recommended that the IRS and Treasury provide relief by extending the original due dates for tax years 2018 and 2019, which would allow taxpayers to file superseding tax returns that would be treated as replacing the originally filed returns.
“Pursuant to the Internal Revenue Manual Section 21.6.7.4.10, a superseding return is a ‘second return submitted by a taxpayer before the due date which changes information on a return previously submitted,’” the group said. “Generally, the superseding return is treated as the taxpayer’s return and any corrections made on the superseding return are incorporated into and modify the original return.”
That fix would also provide relief for taxpayers that elected out of the business interest limitations in section 163(j) because they were considered an excepted real property trade or business, the group said. Changes made under the CARES Act that are retroactive could affect whether businesses would have preferred to elect out of the section 163(j) limits.
Glenn Dance of Holthouse Carlin & Van Trigt LLP asked the IRS and Treasury for filing relief for partnerships that elected out of section 163(j) as excepted real estate businesses.
In a March 28 letter, Dance urged the government to use procedures similar to the automatic relief provisions of reg. section 1.9100-2 to allow taxpayers to retroactively make or revoke section 163(j) elections.
“We also want to reiterate our request that partnerships subject to the [audit regime] be permitted to file amended returns in situations in which partnership items would be affected by the CARES Act, including situations in which a partnership seeks to file an amended return to make or revoke the election to apply the real estate exception to 163(j), and reflect appropriate adjustments to partnership items reported on previously filed returns,” Dance said.