IRS Proposed Coordination of Partnership Audit Rules with Withholding and Reporting Rules under Chapters 3 and 4

Recently, the IRS proposed regulations addressing how certain international tax rules would operate under the centralized partnership audit regime (“CPAR”), including rules relating to the withholding of tax on foreign persons and withholding of tax to enforce reporting on certain foreign accounts. CPAR was introduced in 2015 to allow for the assessment and collection of tax on audit at the partnership level rather than at the level of the individual partners.  The proposed regulations are designed to coordinate CPAR and the international tax regime, so that tax is collected only once from partnerships that have tax withholding obligations on payments to foreign partners.

Coordination of CPAR with Chapters 3 and 4 of the Code

Under the proposed regulations, CPAR would not apply to any adjustments that the IRS makes when a partnership fails to withhold tax at the correct rate (e.g., under section 1441 on payments made to an unrelated foreign person, or under section 1445 on receiving transfers of U.S. real property interest).  By contrast, CPAR would apply if a partnership fails to report income and withhold tax on that additional income allocable to a foreign partner.  The IRS may, however, make an adjustment to the same item under chapter 3 or 4 outside of CPAR.

Where an item subject to CPAR is also subject to chapter 3 or 4, the proposed regulations would coordinate these tax regimes to prevent double taxation on the same adjustment. For example, if an audit of chapter 3 or 4 compliance is conducted before the CPAR proceedings and the IRS collects withholding tax under chapter 3 or 4 attributable to the adjustment, that adjustment would be disregarded to the extent the IRS collected the tax for purposes of calculating the total netted partnership adjustment (upon which the imputed underpayment amount is determined) under CPAR. In contrast, if the IRS has not collected withholding taxes under chapter 3 or 4 on an amount subject to withholding and the partnership is subject to a CPAR examination; the partnership pays the imputed underpayment pursuant to sections 6225 or 6227; and the total netted partnership adjustment includes an adjustment to an amount subject to withholding under chapter 3 or 4, then the partnership would be treated as having paid the amount required to be withheld with respect to that adjustment for purposes of applying Treasury Regulations §§ 1.1463-1 or 1.1474-4.  Accordingly, the partnership would be considered to have satisfied its withholding tax liability associated with the adjustment.  However, the partnership would not be relieved from any interest, penalties, or additions to tax under chapter 3 and 4 that may otherwise apply for the failure to withhold.

Coordination of Chapters 3 and 4 with Section 6226 Elections

Under section 6226, a partnership may elect to “push out” adjustments to its partners during the year to which an adjustment relates (i.e., reviewed‑year partners are taxed) rather than pay an imputed underpayment (i.e., current-year partners are effectively taxed).  The proposed regulations provide rules that would apply withholding and reporting requirements under chapters 3 and 4 to a partnership that makes a section 6226 election with respect to a reviewed‑year partner that would have been subject to withholding in the reviewed year.  The regulations would also provide rules that apply to the reviewed‑year partner when taking these adjustments into account.

The preamble states that the Treasury and IRS are considering ways to alleviate the need for a reviewed‑year partner that is subject to chapter 3 or 4 withholding to file an income tax return reporting its additional reporting‑year tax (and its share of any penalties, additions to tax, additional amounts and interest) when a partnership pushes out its adjustments and does not make a specific imputed underpayment for adjustments subject to withholding. Specifically, comments are sought on an approach that would allow a partnership that pays the withholding tax to also pay their share of penalties, interest and additional taxes attributable to a partner that would have been subject to withholding in the reviewed year.  Comments are also sought on the application of chapters 3 and 4 to section 6226 in the case of partners that are foreign flow-through entities, including partners that assume primary withholding responsibility as withholding foreign partnerships or withholding foreign trusts.  Comments are due by January 29, 2018.