General Rules for Amending Partnership Returns
Prior to 2018, partnerships were generally subject to unified partnership audit and litigation rules enacted by the Tax Equity and Fiscal Responsibility Act of 1982, commonly referred to as the TEFRA partnership procedures.
For taxable years beginning after December 31, 2017, the Bipartisan Budget Act of 2015 (BBA) replaced the TEFRA audit procedures with a centralized partnership audit regime. These new audit procedures apply to all partnerships, unless the partnership makes a valid election not to have those procedures apply. Partnerships subject to the centralized partnership audit regime are referred to as BBA partnerships.
Partnerships file annual returns on Form 1065 each taxable year and report each partner’s distributive share of income, gain, loss, deduction and credit on Schedule K-1. Partnerships are required to furnish a copy of Schedule K-1 to each partner.
BBA partnerships are generally prohibited from amending the information required to be furnished to their partners after the due date of the return, unless specifically provided by the Secretary of the Treasury or his delegate. On April 8, 2020, the Internal Revenue Service issued Revenue Procedure 2020-23, which exercises that authority to allow a BBA partnership to file an amended partnership return and issue amended Schedules K-1 for taxable years that began in 2018 or 2019, and only under certain circumstances.
Impact of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act)
The CARES Act provides retroactive tax relief that affects partnerships, including relief for the taxable years ending in 2018, 2019, and, in some cases, 2020. Without the option to file amended returns, BBA partnerships that already filed their Forms 1065 for the affected years generally are unable to take advantage of the CARES Act relief for partnerships except by filing Administrative Adjustment Requests (AARs). Filing an AAR would result in the partners only being able to receive any benefits from that relief on the current taxable year’s federal income tax return. Thus, if an AAR were filed during 2020 affecting taxable years that began in 2018 or 2019, the partners generally would not be able to take advantage of CARES Act benefits from an AAR until they file their current year returns, which could be in 2021. In the view of the IRS, this process would significantly delay the relief provided in the CARES Act intended to provide an immediate benefit to taxpayers.
Special Rule for Filing Amended Partnership Returns
Revenue Procedure 2020-23 allows BBA partnerships the option to file an amended return instead of an AAR. However, the revenue procedure does not prevent a partnership from instead filing an AAR to obtain the benefits of the CARES Act or any other tax benefits to which the partnership is entitled. A BBA partnership that files an amended return pursuant to this revenue procedure is still otherwise subject to the centralized partnership audit procedures enacted by the BBA.
BBA partnerships that filed a Form 1065 and furnished all required Schedules K-1 for the taxable years beginning in 2018 or 2019 prior to the issuance of Revenue Procedure 2020-23 may file amended partnership returns and furnish corresponding Schedules K-1 before September 30, 2020. The amended returns may take into account tax changes brought about by the CARES Act as well as any other tax attributes to which the partnership is entitled by law.
One of the principal tax benefits under the CARES Act for which partnerships may now file amended returns is the correction of the so-called “retail glitch” that prevented investments in qualified improvement property (QIP) from qualifying for bonus depreciation. This drafting error in the Tax Cuts and Jobs Act significantly increased the after-tax cost of making QIP investments. Partnerships who amend 2018 and 2019 tax returns to report bonus deprecation on QIP will issue amended Schedules K-1 to their partners who can file their own amended tax returns to potentially obtain refunds of taxes previously paid.
Notwithstanding the ability to claim bonus depreciation via filing amended returns, partnerships may want to consider filing Form 3115 instead. By filing a Form 3115, the partnership will report a favorable adjustment reducing current year taxable income. The benefit of this adjustment will be allocated to the existing partners which may not be the same partner group as existed during the 2018 and 2019 taxable years.
The Tax Cuts and Jobs Act added limitations on excess business losses for noncorporate taxpayers (IRC section 461(l)) for tax years beginning after December 31, 2017, and before January 1, 2026, limiting the ability above a threshold amount to offset business losses against non-business income. The CARES Act suspended these excess loss rules for tax years 2018 through 2020. If noncorporate partners (e.g., individuals) are allocated additional bonus depreciation expenses and they amend their 2018 or 2019 income tax returns, assuming that other loss limitation rules do not apply (e.g., basis, at-risk or passive activity limitations), they are not subject to the excess loss rules and may generally take a deduction against non-business income without limitation.
The CARES Act permits taxpayers to carry back net operating losses that arise in tax years 2018, 2019 and 2020 to their five preceding taxable years. If a bonus depreciation deduction allocated to a partner results in generating a net operating loss for that partner, the partner can potentially obtain a refund of taxes paid by carrying back the net operating loss to its five preceding taxable years.
The relief provisions under Revenue Procedure 2020-23 is not limited to provisions relating to the CARES Act. Partnerships can take advantage of these rules to amend their 2018 and 2019 tax returns for other matters. For example, an amended return could be filed to correct prior income or loss allocations which could create net operating losses eligible for the carryback provisions.
The CARES Act generally increases the business interest expense limitation percentage under Section 163(j) from 30% to 50% of adjusted taxable income. However, the CARES Act also creates a special rule for the business interest expense limitation under section 163(j) as it applies to partnerships. Specifically, there is an increase in the adjusted taxable income considered in determining the limitation from 30% to 50%. However, this increased adjusted taxable income percentage does not apply to a partnership’s 2019 tax year. Instead, 50% of the excess business interest expense from 2019 may be carried forward to 2020 and deducted exclusive of the Section 163(j) limitation. This rule is not impacted by Revenue Procedure 2020-23.
Eligible partnerships may have previously made an election to be treated as an electing real property trade or business in order to be exempt from the business interest expense limitation under Section 163(j). The cost for making such an election is that the partnership must use the alternative depreciation system for any nonresidential real property, residential rental property, and qualified improvement property used in its trade or business (i.e. no bonus depreciation permitted for qualified improvement property). Now that the CARES Act has corrected the retail glitch and bonus depreciation may be taken on qualified improvement property, partnerships are undoubtedly thinking about whether they can revoke their election to be an electing real property trade or business. Unfortunately, Revenue Procedure 2020-23 does not provide relief for partnership wanting to revoke their prior election. We await further guidance from the IRS on this issue.
REITs and other entities that either chose to use ADS life or are required to use ADS life for QIP may still benefit from the technical correction of the “retail glitch” as the CARES Act, in addition to correcting QIP to be 15-year property, also changes the ADS life to a 20-year life. REITs may prefer to file a Form 3115 to report a favorable adjustment in the current year in order to reduce their distribution requirements and retain more cash in 2020.
The relief under Revenue Procedure 2020-23 is available only to BBA partnerships that filed Forms 1065 and furnished Schedules K-1 for the partnership taxable years beginning in 2018 or 2019 prior to the issuance of this revenue procedure. The amended return replaces any prior return (including any AAR filed by the partnership) for the taxable year for purposes of determining the partnership’s treatment of partnership-related items.
To take advantage of the option to file an amended return, a BBA partnership must file a Form 1065 (with the “Amended Return” box checked) and furnish corresponding amended Schedules K-1. The BBA partnership must clearly indicate the application of this revenue procedure on the amended return and write “FILED PURSUANT TO REV PROC 2020-23” at the top of the amended return and attach a statement to each Schedule K-1 sent to its partners with the same notation. The BBA partnership may file electronically or by mail, but the IRS notes that filing electronically may allow for faster processing of the amended return. It is important to note that the revenue procedure explicitly provides that the amended partnership returns are to be filed via Form 1065. Consequently, Form 1065-X should not be used for purposes of filing an amended partnership return pursuant to this revenue procedure.
There are special rules for BBA partnerships whose returns are under examination or who have previously filed an AAR. In addition, the revenue procedure provides clarifying guidance about a partnership’s obligation to provide information under the proposed regulations for Global Intangible Low-Taxed Income, or GILTI.