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Reconciling GAAP Basis and Tax Basis in Partnership
Income Tax Returns and K-1 Schedules
WEDNESDAY, JULY 25, 2018, 1:00-2:50 pm Eastern
FOR LIVE PROGRAM ONLY
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FOR LIVE PROGRAM ONLY
WEDNESDAY, JULY 25, 2018
Reconciling GAAP Basis and Tax Basis in Partnership Income Tax Returns and K-1 Schedules
Jeffrey N. Bilsky, Partner, National Tax Office
BDO USA, Atlanta
jbilsky@bdo.com
Thomas A. Orr, CPA, Senior Manager
BDO USA, Washington, D.C.
torr@bdo.com
Notice
ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY
THE SPEAKERS’ FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY
OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT
MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR
RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.
You (and your employees, representatives, or agents) may disclose to any and all persons,
without limitation, the tax treatment or tax structure, or both, of any transaction
described in the associated materials we provide to you, including, but not limited to,
any tax opinions, memoranda, or other tax analyses contained in those materials.
The information contained herein is of a general nature and based on authorities that are
subject to change. Applicability of the information to specific situations should be
determined through consultation with your tax adviser.
GAAP, Tax, & 704(b) Capital Account
Maintenance
Jeff Bilsky, Partner, National Tax Office
Tommy Orr, Senior Manager, National Tax Office
Agenda
• GAAP, Tax, & 704(b) Capital Account Reporting
• Required Reconciliations for Tax & 704(b) Basis Capital
Account Reporting
• Detailed Reconciliation Example
• Financial Statement Implications for Partnerships (ASC
740, FAS 5) Including New Partnership Audit Rules
6
GAAP, Tax, & 704(b) Capital
Account Reporting
GAAP, Tax, & 704(b) Capital AccountsGAAP vs. Tax vs. 704(b)
Partnerships often maintain multiple capital accounts, including:
- Section 704(b) Basis Capital Accounts: Reflect the partner’s
economic interests in the partnership.
- Tax Basis Capital Accounts: Reflects the partner’s interest in the
partnership based on federal income tax principles.
- GAAP Basis Capital Accounts: Determined in accordance with
various financial accounting principles. Limited impact on Tax
Basis and Section 704(b) Basis capital accounts.
8
GAAP, Tax, & 704(b) Capital AccountsGAAP vs. Tax vs. 704(b)
GAAP Basis Capital
(+ / -) GAAP to Tax Differences
Tax Basis Capital
(+ / -) Sec. 704(c) Adjustments
Sec. 704(b) Basis Capital
9
GAAP, Tax, & 704(b) Capital AccountsTax vs. 704(b)
Section 704(b) Capital Tax Basis Capital
Increases: • FMV of property
contributions, including
money
• Tax basis of property
contributions, including money
• Partner share of Section
704(b) income
• Partner share of taxable income
• Positive Section 704(b)
revaluations (book-ups)
• No change due to Section 704(b)
revaluations (book-ups)
Decreases: • FMV of property
distributions, including
money
• Tax basis of property
distributions, including money
• Partner share of Section
704(b) losses
• Partner share of tax losses
• Negative Section 704(b)
revaluations (book-downs)
• No change due to Section 704(b)
revaluations (book-downs)
10
GAAP, Tax, & 704(b) Capital AccountsEffect of Liabilities on Section 704(b) Capital
• Assumption of partner liability by partnership treated as cash
distribution. Includes contribution of property subject to liability
• Assumption of partnership liability by partner treated as cash
contribution. Includes distribution of property subject to liability
• Changes to allocable share of partnership liabilities is not an
assumption and has no effect on capital
11
AB
Example:
Value Basis
Building $100 $50
Mortgage ($ 60) ($60)
$120 of AB’s liabilities are allocable to
A after the contribution.
A
What is A’s Capital Account?
What is A’s Basis in AB?
GAAP, Tax, & 704(b) Capital AccountsEffect of Liabilities on Section 704(b) Capital
12
AB
AValue Basis
Building $100 $50
Mortgage ($ 60) ($60)
$120 of AB’s liabilities are allocable to A
after the contribution.
Capital = $100 Building Value - $60 Mortgage assumed by AB = $40
Basis = $50 Building Basis - $60 Mortgage + $120 Liability Allocation = $110
GAAP, Tax, & 704(b) Capital AccountsEffect of Liabilities on Section 704(b) Capital
13
• No increase for contribution of a partners’ own note until the note
is sold or as principal payments are made.
• No decrease for distribution of the partnership’s own note until the
note is sold or as principal payments are made.
• If note is readily tradable on an established securities market the
forgoing rules are inapplicable.
GAAP, Tax, & 704(b) Capital AccountsEffect of Liabilities on Section 704(b) Capital
14
• Partnership may periodically revalue Section 704(b) capital
accounts
• Regulations provide for Mandatory and Optional revaluations
• Revaluations must reflect fair market value of partnership property
at the date of revaluation
• Allocation of book-up or book-down adjustment must reflect the
way the unrealized gain or loss would be allocated if recognized
• Revaluations have no impact on tax basis of assets therefore create
additional Section 704(c) layers
• Revaluations generally have no GAAP impact, but transactions that
trigger purchase accounting rules may have a similar impact (i.e.
partnership merger)
GAAP, Tax, & 704(b) Capital AccountsRevaluations
15
Mandatory Revaluations
• Partnership is required to revalue distributed assets immediately before
the partnership distributes property to any partner
• Partnership is required to revalue capital accounts immediately after an
exercise of a noncompensatory option
Optional Revaluations
• Partnership may choose to revalue capital accounts upon certain events:
- Contributions of money or property for a partnership interest
- Liquidation or distribution as consideration for a partnership interest
- Grant of a partnership interest as consideration for services rendered
- Issuance by the partnership of a noncompensatory option, or
- Generally accepted industry accounting practices (hedge funds)
GAAP, Tax, & 704(b) Capital AccountsRevaluations
16
GAAP, Tax, & 704(b) Capital AccountsDetermination of Section 704(b) Income
• GAAP Income is the typical starting point
• Determine Taxable Income by adjusting for “M-1” items
• Determine Section 704(b) Income (economic income) by adjusting
for differences between tax basis and Section 704(b) basis
• Section 704(b) basis may not equal tax basis as a result of property
contributed with values different than tax basis and Section 704(b)
revaluations
• Differences between Section 704(b) and Tax basis are addressed
through 704(c) allocations
17
• Section 704(c): Income items with respect to property contributed
to the partnership by a partner shall be shared among the partners
so as to take account of the variation between the basis of the
property to the partnership and its fair market value at the time of
contribution.
- GAAP, Tax, & 704(b) Capital reconcile variances between Tax
Basis and Section 704(b) Basis
- Built-in gain or loss on the sale of contributed property must be
allocated back to the contributing partner
- Tax depreciation/amortization on contributed property is
allocated first to the non-contributing partner in an amount
equal to the partner’s Section 704(b) depreciation
GAAP, Tax, & 704(b) Capital AccountsImpact of Section 704(c)
18
Section 704(c) rules apply to:
- Contributions of property where the Section 704(b) value (FMV) is
not equal to the tax basis (“Forward Section 704(c) Layers”)
- Book up or down adjustments caused by Section 704(b)
revaluations (“Reverse Section 704(c) Layers”)
- Possible to have multiple Forward and Reverse Section 704(c)
Layers
GAAP, Tax, & 704(b) Capital Accounts Impact of Section 704(c)
19
• Traditional Method
• Allocations are limited to the tax items associated with the
contributed property.
• Ceiling rule limitations are not fixed, and the built-in gain shifts to
noncontributing partners.
• Traditional Method with Curative Allocations
• Start with the traditional method
• Reallocate other partnership items to overcome ceiling rule
• Other items must generally have the same effect as depreciation.
• Remedial Method
• Provide correct amount to non-contributing partners.
• If figure that exceeds total tax items, contributing partner picks up
offsetting income.
GAAP, Tax, & 704(b) CapitalSection 704(c) Depreciation Allocation Methods
20
Tax Allocations & Economic Effect
22
Tax Allocations & Economic EffectGeneral Rules
Section 704(a): Except as otherwise provided in the Code, a partner’s
share of partnership income items is determined by the partnership
agreement.
Section 704(b): A partner’s share of income items is determined in
accordance with the partner’s interest in the partnership (“PIP”) if the
allocations per the partnership agreement do not have Economic
Effect. Regulations provide that the allocations must also be
Substantial.
Section 704(c): Income items with respect to property contributed to
the partnership by a partner shall be shared among the partners so as
to take account of the variation between the basis of the property to
the partnership and its fair market value at the time of contribution.
23
Tax Allocations & Economic EffectSafe-Harbor Allocations
Economic Effect
• An allocation must be consistent with the underlying economic arrangement
of the partners.
• Partners that are allocated income or loss must ultimately bear the
economic benefit or burden associated with the allocations
• Regulatory Safe-Harbors
- General Test for Economic Effect
- Alternate Test for Economic Effect
- Economic Effect Equivalence
• Allocations that do not meet a regulatory safe-harbor are allocated based
on the partner’s interest in the partnership (“PIP”)
24
Tax Allocations & Economic EffectSafe-Harbor Allocations
General Test for Economic Effect
1. Partnership maintains Section 704(b)
Capital Accounts;
2. Liquidating distributions made in
accordance with positive Section 704(b)
Capital Accounts; and
3. Partners have obligation to restore any
negative capital account balance (a
“Deficit Restoration Obligation” or
“DRO”)
Alternate Test for Economic Effect
1. Partnership maintains Section 704(b)
Capital Accounts;
2. Liquidating distributions made in
accordance with positive Section 704(b)
Capital Accounts; and
3. In lieu of a DRO, the partnership
agreement contains a Qualified Income
Offset (“QIO”) provision
Economic Effect Equivalence Partnership agreement does not satisfy the General or
Alternate Test of economic effect. However, allocations are deemed to have economic
effect if, as of the end of each partnership taxable year, a liquidation of the partnership at
the end of such year or at the end of any future year would produce the same economic
results to the partners as would occur if the General Test of economic effect had been
satisfied.
25
Tax Allocations & Economic EffectSafe-Harbor Allocations
Substantiality
• The economic effect of an allocation is substantial if there is a reasonable
possibility that the allocation will affect substantially the dollar amounts to
be received by the partners from the partnership, independent of tax
consequences.
- Overall Tax Effect Rule: One partner benefits at the expense of another
- Shifting Tax Consequences: The net increases/decreases in the partners'
respective capital accounts won’t differ substantially from the baseline allocations
and the aggregate tax liability of the partners will be reduced
- Transitory Allocations: There is a possibility that original allocations will be
largely offset by offsetting allocations, providing there is a strong likelihood that
the net increases/decreases in the partners' capital accounts won’t differ
substantially from the baseline allocations and the total tax liability of the
partners will be reduced in present value terms
26
Tax Allocations & Economic EffectTargeted or PIP Allocations
In General
• Liquidating distributions are not based solely on the partner’s
Section 704(b) Capital Accounts
• General and Alternate Test of Economic Effect cannot apply
• Targeted Allocations may have Economic Effect Equivalence or may
be in accordance with PIP
• Profits & loss allocations (including gross income) are generally
made in the amounts necessary to ensure ending Section 704(b)
Capital Accounts reflect the partner’s liquidating distribution rights
27
Tax Allocations & Economic EffectTargeted Allocations
Safe-Harbor Allocations
Capital
Account
Beginning $50
Income/(Loss) $100
Ending
CapitalCalculated
Targeted Allocations
Capital
Account
Beginning $50
Income/(Loss) Calculated
Distribution
Rights$150
28
• Client financial data generally comes as GAAP financial statements,
so you will already have total GAAP capital to begin
• The GAAP amounts by partner are generally presented on the
schedule K-1s as the partner’s ending section 704(b) capital ratio
times total ending GAAP capital
• Difference between GAAP and 704(b) capital will result based on
the schedule M-1/M-3 differences as well as any 704(c) amounts
• Additional differences may result from liabilities that exist for
GAAP purposes but not for tax or 704(b) purposes
• The same event may give rise to GAAP/704(b) differences (i.e. a
purchase accounting transaction for GAAP purposes treated as a
carryover basis transaction for tax purposes, partnership
consolidated for GAAP purposes but stand alone for tax purposes,
etc.)
GAAP, Tax, & 704(b) Capital AccountsGAAP Capital In Summary
29
Detailed Reconciliation Example
30
Exercise 1, Part 1
Individuals A, B and C form equal partnership ABC. A contributes
depreciable equipment worth $18,000 with a basis of $9,000 subject to a
$8,000 liability. B contributes land with a basis of $7,200 and value of
$10,000. C contributes $10,000 cash. In the first year of operations, ABC
earns GAAP net income of $10,000. In the first year tax and book
depreciation are $3,000 and $5,000, respectively. The traditional
method is chosen to apply section 704(c).
• Determine the section 704(b) and tax basis capital accounts.
GAAP, Tax, & 704(b) CapitalExercise
31
704(b) Book A B C
Contribution
Income
Depreciation
Tax Basis A B C
Contribution
Income
Depreciation
GAAP, Tax, & 704(b) CapitalExercise
32
704(b) Book A B C
Contribution 10,000.
Income
Depreciation
Tax Basis A B C
Contribution 1,000.
Income
Depreciation
A contributes depreciable equipment worth $18,000 with a basis
of $9,000 subject to a $8,000 liability.
GAAP, Tax, & 704(b) CapitalExercise
33
704(b) Book A B C
Contribution 10,000. 10,000.
Income
Depreciation
Tax Basis A B C
Contribution 1,000. 7,200.
Income
Depreciation
B contributes land with a basis of $7,200 and value of $10,000.
GAAP, Tax, & 704(b) CapitalExercise
34
704(b) Book A B C
Contribution 10,000. 10,000. 10,000.
Income
Depreciation
Tax Basis A B C
Contribution 1,000. 7,200. 10,000.
Income
Depreciation
C contributes $10,000 cash.
GAAP, Tax, & 704(b) CapitalExercise
35
GAAP, Tax, & 704(b) CapitalExercise
GAAP to Tax Income Conversion:
GAAP Net Income 10,000
GAAP Depreciation 5,000
Taxable Income Before Depreciation 15,000
Tax Depreciation -3,000
Taxable Income 12,000
Tax to 704(b) Income Conversion:
Taxable Income Before Depreciation 15,000
704(b) Depreciation (Tax depr. on $18,000 of basis) -6,000
704(b) Net Income 9,000
36
704(b) Book A B C
Contribution 10,000. 10,000. 10,000.
Income 5,000. 5,000. 5,000.
Depreciation
Tax Basis A B C
Contribution 1,000. 7,200. 10,000.
Income 5,000. 5,000. 5,000.
Depreciation
In the first year of operations, ABC earns taxable income of
$15,000 before tax depreciation on the equipment of $3,000.
GAAP, Tax, & 704(b) CapitalExercise
37
704(b) Book A B C
Contribution 10,000. 10,000. 10,000.
Income 5,000. 5,000. 5,000.
Depreciation (2,000) (2,000) (2,000)
13,000. 13,000. 13,000.
Tax Basis A B C
Contribution 1,000. 7,200. 10,000.
Income 5,000. 5,000. 5,000.
Depreciation
704(b) Depreciation is proportionate to tax depreciation:
Equipment Tax Depr./ Tax Basis = $3,000 / $9,000 = 1/3rd
Equipment 704(b) Depr. = 1/3 x $18,000 = $6,000
GAAP, Tax, & 704(b) CapitalExercise
38
Under the traditional method, tax depreciation is allocated first to the non-contributing
partners to match 704(b) depreciation, but only to the extent of tax depreciation
704(b) Book A B C
Contribution 10,000. 10,000. 10,000.
Income 5,000. 5,000. 5,000.
Depreciation (2,000) (2,000) (2,000)
13,000. 13,000. 13,000.
Tax Basis A B C
Contribution 1,000. 7,200. 10,000.
Income 5,000. 5,000. 5,000.
Depreciation (0) (1,500) (1,500)
6,000. 10,700. 13,500.
GAAP, Tax, & 704(b) CapitalExercise
39
704(b) Book A B C
Contribution 10,000. 10,000. 10,000.
Income 5,000. 5,000. 5,000.
Depreciation (2,000) (2,000) (2,000)
13,000. 13,000. 13,000.
Tax Basis A B C
Contribution 1,000. 7,200. 10,000.
Income 5,000. 5,000. 5,000.
Depreciation* 1,000. (2,000) (2,000)
7,000. 10,200. 13,000.* Remedial Method
Under the remedial method, tax depreciation is allocated first to the non-contributing
partners to match 704(b) depreciation whether or not there is enough tax depreciation
GAAP, Tax, & 704(b) CapitalExercise
40
704(b) Book A B C
Contribution 10,000. 10,000. 10,000.
Income 5,000. 5,000. 5,000.
Depreciation (2,000) (2,000) (2,000)
13,000. 13,000. 13,000.
Tax Basis A B C
Contribution 1,000. 7,200. 10,000.
Income 6,000. 4,500. 4,500.
Depreciation* 0. (1,500) (1,500)
7,000. 10,200. 13,000.* Curative Method
Under the curative method, tax depreciation is allocated first to the non-
contributing partners using the tradition method, and other items are reallocated
to make up for any shortfall
GAAP, Tax, & 704(b) CapitalExercise
41
Assuming the GAAP contributions were equal to fair market value, the same as 704(b)
capital, the GAAP capital should be as follows
GAAP Books A B C
Contribution 10,000. 10,000. 10,000.
Income 5,000. 5,000. 5,000.
Depreciation (1,667) (1,667) (1,666)
13,333. 13,333. 13,334.
GAAP, Tax, & 704(b) CapitalExercise
• In this example income and depreciation are broken out for
consistent presentation, the full net income would be allocated in
proportion to ownership in this case
42
Exercise 1, Part 2
On the first day of year 2, the value of land has increased to $16,000 and
the company has created goodwill value of $30,000. Partner D is
admitted as an equal partner in exchange for a $25,000 cash
contribution.
What are the 704(b) capital accounts immediately after D’s admission…
• If the partnership agreement calls for revaluations?
• If the partnership agreement does not call for revaluations?
GAAP, Tax, & 704(b) CapitalExercise
43
With Revaluation A B C D
Beginning 13,000. 13,000. 13,000. 0.
Revaluation Gain
Contribution
Without Reval. A B C D
Beginning 13,000. 13,000. 13,000. 0.
Revaluation Gain
Contribution
GAAP, Tax, & 704(b) CapitalExercise
44
With Revaluation A B C D
Beginning 13,000. 13,000. 13,000. 0.
Revaluation Gain 12,000. 12,000. 12,000. 0.
Contribution
Without Reval. A B C D
Beginning 13,000. 13,000. 13,000. 0.
Revaluation Gain0. 0. 0. 0.
Contribution
The value of land has increased by $6,000 to $16,000 and the company
has created goodwill value of $30,000 ($36,000 unrealized gain)
GAAP, Tax, & 704(b) CapitalExercise
45
With Revaluation A B C D
Beginning 13,000. 13,000. 13,000. 0.
Revaluation Gain 12,000. 12,000. 12,000. 0.
Contribution 25,000.
25,000. 25,000. 25,000. 25,000.
Without Reval. A B C D
Beginning 13,000. 13,000. 13,000. 0.
Revaluation Gain 0. 0. 0. 0.
Contribution 25,000.
13,000. 13,000. 13,000. 25,000.
Partner D is admitted as an equal partner in exchange for a $25,000 cash
contribution.
GAAP, Tax, & 704(b) CapitalExercise
46
With Revaluation A B C D
Beginning 25,000. 25,000. 25,000. 25,000.
704(b) Gain on Sale
Final Distribution
Without Reval. A B C D
Beginning 13,000. 13,000. 13,000. 25,000.
704(b) Gain on Sale
Final Distribution
The partnership sells all its property shortly after D’s admission for $100,000 and
distributes the proceeds in accordance with the Capital Accounts (ignore pre-sale activity)
GAAP, Tax, & 704(b) CapitalExercise
47
With Revaluation A B C D
Beginning 25,000. 25,000. 25,000. 25,000.
704(b) Gain on Sale 0. 0. 0. 0.
Final Distribution
Without Reval. A B C D
Beginning 13,000. 13,000. 13,000. 25,000.
704(b) Gain on Sale9,000. 9,000. 9,000. 9,000.
Final Distribution
The partnership sells all its property shortly after D’s admission for $100,000
and distributes the proceeds in accordance with the Capital Accounts (ignore
pre-sale activity)
GAAP, Tax, & 704(b) CapitalExercise
48
With Revaluation A B C D
Beginning 25,000. 25,000. 25,000. 25,000.
704(b) Gain on Sale 0. 0. 0. 0.
Final Distribution 25,000. 25,000. 25,000. 25,000.
Without Reval. A B C D
Beginning 13,000. 13,000. 13,000. 25,000.
704(b) Gain on Sale9,000. 9,000. 9,000. 9,000.
Final Distribution 22,000. 22,000. 22,000. 34,000.
The partnership sells all its property shortly after D’s admission for $100,000
and distributes the proceeds in accordance with the Capital Accounts (ignore
pre-sale activity)
GAAP, Tax, & 704(b) CapitalExercise
49
Partnership Audit Rules
51
• Bipartisan Budget Act of 2015 (the “BBA”) significantly changes the way in which
partnerships are audited:
• Applicable to tax years beginning after 12/31/2017
• Default rules apply to ALL partnerships
• Small partnerships may be eligible to elect out
• Audits are conducted at partnership level
• Unfavorable audit adjustments result in an “imputed underpayment” obligation
payable by the partnership
• Favorable audit adjustments allocated out to the partners in the year the audit is
completed
• Push-out election eliminates partnership’s obligation to satisfy the imputed
underpayment obligation
Partnership Audit RulesOverview
52
Eligible Partners:
- Individuals
- C-corporations
- Foreign entities that would be treated
as a C-corporation if domestic
- S-corporations (each shareholder is
counted for purposes of determining
the 100 partner limit)
- An estate of a deceased partner
Ineligible Partners:
- Partnership entities, i.e., upper-tier
partnerships
- Trusts
- Disregarded entities such as single-
member LLCs and grantor trusts
- Estate of an individual other than a
deceased partner
- Nominee partner
• Small Partnerships (those with 100 or fewer eligible partners) may elect out of the
new rules
• In order to elect out, partnerships must make an annual affirmative election and
disclose required partner information
Partnership Audit RulesOverview
• (Net Positive Adjustments * Highest Tax Rate) – Adjusted Credits
Step 1: Partnership first groups its adjustments into (i) Reallocation Grouping;
(ii) Credit Grouping, or (iii) Residual Grouping
Step 2: Partnership adjustments within each grouping/sub-grouping are then
netted. Netted amounts resulting in a non-positive adjustment are disregarded
for purposes of calculating the imputed underpayment.
Step 3: The total netted partnership adjustment calculated in Step 2 is
multiplied by the highest effective federal tax rate under section 1 or section
11.
Step 4: The product resulting from Step 3 is then reduced, but not below $0 by
the net adjustments to partnership credits.
Partnership Audit RulesOverview
54
Ordinary
Sub-Group
Capital
Sub-Group
Increase Ordinary Income 200.00 - -
Decrease Depreciation Expense 30.00 - -
Increase Long-Term Capital Gain - 75.00 -
Decrease Long-Term Capital Loss - 50.00 -
Decrease Tax Credit - - 2.00
Total Audit Adjustments 230.00 125.00 2.00
Assumed Highest Tax Rate 40% 40%
Initial Imputed Underpayment 92.00 50.00 2.00
Imputed Underpayment Obligation
Imputed Underpayment (Ordinary Sub-Group) 92.00
Imputed Underpayment (Capital Sub-Group) 50.00
Imputed Underpayment - Residual Grouping 142.00
Add: Credit Grouping 2.00
Net Imputed Underpayment 144.00
Residual GroupingCredit
GroupingAudit Adjustments
Partnership Audit RulesOverview
55
Ordinary
Sub-Group
Capital
Sub-Group
Increase Ordinary Income 125.00 - -
Decrease Long-Term Capital Gain - (125.00) -
Decrease Tax Credit - - -
Total Audit Adjustments 125.00 (125.00) -
Assumed Highest Tax Rate 40% 0%
Initial Imputed Underpayment 50.00 - -
Imputed Underpayment Obligation
Imputed Underpayment (Ordinary Sub-Group) 50.00
Imputed Underpayment (Capital Sub-Group) -
Imputed Underpayment - Residual Grouping 50.00
Add: Credit Grouping -
Net Imputed Underpayment 50.00
Audit Adjustments
Residual GroupingCredit
Grouping
Partnership Audit RulesOverview
56
Partner A
Sub-Group
Partner B
Sub-Group
Reallocate Ordinary Income 30.00 (30.00)
Reallocate Depreciation Expense (70.00) 70.00
Total Audit Adjustments (40.00) 40.00
Assumed Highest Tax Rate 0% 40%
Initial Imputed Underpayment - 16.00
Imputed Underpayment Obligation
Imputed Underpayment (Partner A Sub-Group) -
Imputed Underpayment (Partner B Sub-Group) 16.00
Imputed Underpayment - Residual Grouping 16.00
Audit Adjustments
Reallocation Grouping
Partnership Audit RulesOverview
57
• In lieu of the default payment rules the partnership can elect to push-out the
imputed obligation to its partners.
• Reviewed year partners are liable for tax, penalties and interest on their
respective shares of partnership adjustments
• Reviewed year partners are bound by the election and must take the
adjustments into account and report and pay additional tax, penalties and
interest
• A partnership making the push-out election must furnish statements to the
reviewed year partners with respect to the partner’s share of the
adjustments and file those statements with the IRS
• The rate of interest imposed on the underpayment is increased by two
percentage points creating a surcharge to use the push-out method
• Under proposed regulations, make push-out election through multiple tiers
Partnership Audit RulesOverview
58
Partner A
Sub-Group
Partner B
Sub-Group
Reallocate Ordinary Income 30.00 (30.00)
Reallocate Depreciation Expense (70.00) 70.00
Total Audit Adjustments (40.00) 40.00
Assumed Highest Tax Rate 0% 40%
Initial Imputed Underpayment - 16.00
Imputed Underpayment Obligation
Imputed Underpayment (Partner A Sub-Group) -
Imputed Underpayment (Partner B Sub-Group) 16.00
Imputed Underpayment - Residual Grouping 16.00
Audit Adjustments
Reallocation Grouping
Partnership Audit RulesOverview
59
• Partnerships are required to have a person function in the role of partnership
representative (“PR”). The PR has sole authority to act on behalf of the
partnership
• All partners are bound by the actions of the PR and they have no right to
contradict its decisions. This broad authority cannot be limited by state law,
the partnership agreement or any other document or agreement
• The PR does not have to be a partner but can be any person, including an
entity, as long as it has a substantial presence in the United States and the
capacity to act
• The proposed regulations require a partnership to designate the PR on the
partnership’s return filed for each taxable year
• If a partnership fails to designate a PR the proposed regulations allow the IRS to
select a PR
Partnership Audit RulesOverview
60
Operating Partnership
Equity Investor
Legacy Partners
GPManager
Limited Partners
CorporatePartner
Entity StructureSpecific considerations vary based
on entity characteristics
Common considerations
• Partnership agreement
amendments
• Risk assessment of existing
positions for
partners/partnerships
• Transactional considerations
(i.e., enhanced due-diligence)
• Financial statement impact
Partnership Audit RulesConsiderations
61
Operating Partnership
Equity Investor
Legacy Partners
GPManager
Limited Partners
CorporatePartner
Entity StructureCONSIDERATIONS
• Not eligible to elect out because Equity
Investor is an ineligible partner
• Should not have ASC 740 exposure but
consider FAS 5 liabilities
• Consider due diligence exposure if
potential candidate for capital
transaction
• Increased reporting requirements for
investors to assess tax risk (and
reserves)
• Amend partnership agreement
• Imputed underpayment obligation risk
assessment
• Analyze capital accounts and
allocations
• Develop information needed by
partners for ASC 740 or due diligence
purposes
Partnership Audit RulesConsiderations
62
Operating Partnership
Equity Investor
Legacy Partners
GPManager
Limited Partners
CorporatePartner
Entity StructureCONSIDERATIONS
• Not eligible to elect out because GP
Manager is an ineligible partner
• Consider ASC 740 implications if issuing
audited financial statements
• Consider due diligence exposure if
potential candidate for capital
transaction
• Assess LP indemnification potential
(and fund indemnification for LPs)
• Consider co-investor rights and
obligations
• Amend partnership agreement
• Imputed underpayment obligation risk
assessment
• Analyze capital accounts and
allocations
• Financial statement impact analysis
Partnership Audit RulesConsiderations
63
Operating Partnership
Equity Investor
Legacy Partners
GPManager
Limited Partners
CorporatePartner
Entity StructureCONSIDERATIONS
• Evaluate possible ASC 740
exposure resulting from imputed
underpayment obligations at the
partnership level
• Exposure exists regardless of
whether Operating Partnership
decides to pay the imputed
underpayment obligation
directly or make the push-out
election
• Financial statement impact
analysis
• Understand potential exposure
from investment in Operating
Partnership
Partnership Audit RulesConsiderations
64
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