California law responds to federal partnership audit procedures

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December 2018

Overview

On September 23, 2018, California enacted S.B. 274. The legislation imposes reporting and assessment requirements for partnership adjustments under the new federal partnership audit procedures as in effect January 1, 2018.

The California legislation allows the Franchise Tax Board (FTB), partnerships, and their partners to take advantage of the efficiencies resulting from a single partnership-level adjustment. For federal purposes, a partnership may either pay any understatement of tax resulting from the adjustment or elect to pass the underpayment of tax through to its partners. The California legislation specifies that a partnership’s federal election regarding partnership-level audits is binding for state purposes unless the FTB approves a separate election. S.B. 274 also clarifies reporting requirements to the state for federal adjustments to the partnership and partners.

The takeaway

S.B. 274 implements California’s reporting requirements related to the new federal partnership audit procedures effective January 1, 2018. Note, however, that the S.B. 274 provisions are only applicable for state adjustments related to federal partnership audits. S.B. 274 does not address assessments resulting from California state-specific partnership audits.

Upper-tier taxpayers in tiered partnership structures, including fund of fund structures, may face challenges in meeting the reporting deadlines identified for tiered partners when an election is made to push out the tax adjustments due to the timing requirements. If the push-out amounts are not timely reported to the state, then, effectively, the lower-tier audited partnership will be required to pay the additional tax due. However, the logistics behind a failed push-out election and the FTB notification procedure involved have yet to be determined.

Inherently, one would expect that a partnership with many tiered non-resident and tax-exempt partners not invested through a blocker corporation would prefer to push out the California Tax to the upper-tier partners, so as to minimize the efforts required to compute the proper amount of the additional assessment. However, assuming the partnership takes steps to identify all of its tiered and indirect partners, it should have the ability to pay the correct amount of tax at the partnership level without a push-out election.

Additional complications for taxpayers may arise because the identity of the partnership’s partners may be different during the tax year compared to the year in which the adjustment occurs, and the tax year in which liability is finally determined. Under a partnership-level adjustment, the current partners will bear the economic impact of the assessment, although they may be different partners than those in the tax year being adjusted.

For more information on the federal partnership audit process, please see the following PwC Insights:

New law makes significant changes to partnership audit and adjustment procedures

IRS re-releases proposed regulations to implement new partnership audit rules

Temporary regulations address election into new partnership audit regime

Proposed regulations would implement new partnership audit rules

Draft model statute and regulation released addressing federal taxable income and partnership audit adjustment reporting

Final BBA Audit regulations address partnership representatives

Guidance on tiered partnership push out election and certain international issues proposed prior to 2018 effective date of BBA audit rules

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Peter Michalowski

Peter Michalowski

State and Local Tax Leader, PwC US

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