CARES Act tax provisions may cause partnerships to adjust filing positions taken on previously-filed returns. However, to adjust for taxpayer-unfavorable consequences of the Bipartisan Budget Act, the IRS announced temporary relief from some provisions.
CARES Act changes may require amended returns
In response to the widespread economic distress caused by the COVID-19 outbreak, Congress recently passed the Coronavirus Aid, Relief, and Economic Security (CARES) Act, the third federal recovery package enacted over the last few weeks. This historic package includes several tax relief provisions. One of the requirements within the CARES Act may cause tax partnerships to amend their returns, the sought-after technical correction to the “retail glitch” from the 2017 Tax Cuts and Jobs Act (TCJA). This technical correction prevented qualified improvement property (QIP) from being eligible for bonus depreciation in 2018 and later tax years. It also allows the property to be immediately expensed as bonus depreciation or depreciated over a much shorter 15-year life. The QIP is required to depreciate over 39 years. However, there is a 20-year life created for any QIP that requires depreciation under the alternative system. This correction is retroactive to the date of the enactment of the TCJA.
Partnerships seeking to amend 2018 or 2019 tax returns may be subject to the Bipartisan Budget Act of 2015 (BBA) Administrative Adjustment Request (AAR) rules. These rules may result in a loss of some or all of the benefits that you may expect. However, the IRS recently issued Revenue Procedure 2020-23 in an attempt to provide limited relief to partnerships from these rules.
IRS relief: Revenue Procedure 2020-23
Rev. Proc. 2020-23 provides welcome guidance for BBA partnerships that, in the short term, should alleviate the issues and uncertainties arising out of Administrative Adjustment Request (AAR) filings. BBA partnerships have the option to file amended returns if they’ve filed 2018 or 2019 partnership returns before the Apr. 8, 2020 issuance of the revenue procedure. Under this relief, the partnership files an amended partnership return and issues revised K-1s to its partners. Each partner will then be able to amend their return for the tax year to reflect the impact.
Using the amended return process may allow partners to recognize the tax benefit more quickly. A partner receiving a negative adjustment resulting from an AAR filed in 2020 likely wouldn’t have seen that benefit earlier than 2021 (when the partner files its 2020 return). By submitting an amended return, the partner can receive a refund quicker, especially if the IRS puts a high-priority on processing these refund claims in the coming months. The amended return relief provided in the revenue procedure is available for any type of adjustment, not solely those resulting from provisions of the CARES Act.
BBA partnerships considering relying on the relief to file an amended return instead of an AAR should consider that the assistance is only available for partnership tax years beginning in 2018 or 2019. The relief is only available until Sept. 30, 2020. After that date, only AARs are permitted to be filed for BBA partnerships and amended returns will no longer be permitted for any tax year.
Some states that have adopted the AAR procedure as outlined in the BBA may not choose this relief, which means that the AAR process may still need filing for amending certain state partnership returns. This applies even if the option to apply pre-BBA rules is used for amending the federal return.
A final consideration is that the operating agreement of a BBA partnership may contain language around the AAR process when revising a previously filed return. If this is the case, the partnership should confirm that following the relief provided in Rev. Proc. 2020-23 isn’t in conflict with its operating agreement. If it is, the partnership should amend its operating agreement to provide an exception for the administrative relief provided in Rev. Proc. 2020-23.
Overview of the BBA AAR rules
Partnerships, who are otherwise subject to the BBA partnership audit rules, that don’t follow the relief provided in Rev Proc. 2020-23 by Sept. 30, 2020, will be required to follow the BBA AAR rules. The BBA partnership audit rules introduced a dramatically different procedure for partnerships that want to amend their returns.
If an AAR results in a taxpayer-favorable adjustment (negative adjustment), it will always be “pushed out” to the partners. The impact of a pushed-out adjustment is reflected in the partner’s tax return. If the partnership has a taxpayer-unfavorable adjustment as a result of the AAR, an imputed underpayment of tax is calculated and paid at the partnership level. However, the partnership is permitted to make an election to push out the adjustment to the partners.
Reporting AAR adjustments at the partner level
It’s important to distinguish between the partnership tax year that gives rise to the adjustment (reviewed year) and the year the partner takes the adjustment. The partner reflects the impact of the adjustment in the “adjustment year;” a taxable year that includes the date when the partnership reports their share of the adjustment to the partner. The partner will usually see the tax impact of the adjustment on the partner’s return for the tax year that the AAR was filed.
The partner-level reporting for a pushed-out AAR adjustment requires the partner to recalculate its tax liability for the reviewed year and any other years between the reviewed year and the adjustment year. The revised tax liabilities are compared to the tax liabilities reported on previously-filed returns for the same years. If multiple years are recalculated, the tax liability correction amounts are accumulated. When a partner has an overall reduction in tax, the correction amount becomes a nonrefundable credit in the adjustment year.
AAR negative corrections as nonrefundable tax credits
The treatment of a negative correction as a nonrefundable credit in the adjustment year will be a significant problem in many situations. In addition to being nonrefundable, the credit isn’t eligible to be carried back or forward to a different tax year. As a result, if the partner doesn’t have sufficient tax liability in the adjustment year to absorb the nonrefundable credit, some or all of the tax benefits from the negative adjustment will be permanently lost. This can be a particularly challenging issue for taxpayers who pay less tax in the adjustment year due to reduced profitability or net operating losses, such as those that are negatively impacted by the COVID-19 pandemic.
Negative adjustments that generate net operating losses
Another key provision within the CARES Act is the reinstatement of net operating loss (NOL) carrybacks. Federal NOLs incurred in tax years 2018 – 2020 can now be carried back for up to five years. This creates an exciting interplay with AAR negative adjustments. If a partnership files an AAR for 2018 and has a partner that’s allocated a negative adjustment that creates an NOL for the partner in 2018, can the partner now carry that NOL back, and factor it into its cumulative tax correction? The BBA rules state that tax attributes are adjusted in the intervening and subsequent years, but don’t address a potential carryback of an attribute. This wasn’t previously an issue because NOL carrybacks were generally not permitted in any BBA year before the enactment of the CARES Act. It’s uncertain at this time if the IRS will issue clarifying guidance on this question. Consideration should be given to this uncertainty when deciding whether and when to file an AAR.
As a result of the negative impact of COVID-19, many companies taxed as partnerships may consider amending 2018 partnership returns. Given the COVID-19 outbreak’s overall effect on the economy, it’s expected that many taxpayers will be in either a reduced taxable income or taxable loss position for 2020, which could eliminate some or all of the benefit of a negative adjustment arising from an AAR filing. Rev. Proc. 2020-23 gives BBA partnerships the short-term flexibility to forego filing an AAR and to use the amended return process instead. Thus, a BBA partnership looking to implement the CARES Act should consider whether the amended return process provides a better result for its partners. If a partnership requests an amended return under the relief guidance, it should ensure that the amended return is filed by Sept. 30, 2020.