IRS Proposes to Permit Push-Out Election for Feeder Funds
December 18, 2017
On December 15, 2017, the IRS released Proposed Treasury Regulations that would permit a partnership (the “upper-tier partnership”) to make a “push-out” election under the new partnership audit rules if the IRS imposes additional taxes on a partnership in which the upper-tier partnership is a partner (the “lower-tier partnership”). This is a welcome development that will permit a domestic feeder fund to make a “push-out” election if a master fund is subject to an IRS audit.
The new partnership audit rules were enacted in 2015. For more information regarding these new rules, see our previous memorandum titled “Major Changes to IRS Partnership Audit Procedures Requires Review of Fund Documents.” Under these rules, additional taxes owed as a result of an IRS audit of a partnership will be assessed at the partnership level, rather than the partner level (as under prior law). The amount of any additional tax will be determined by the IRS based upon the highest tax rate applicable to individuals or corporations with appropriate adjustments for lower tax rates applicable to long-term capital gain and qualified dividend income of individuals as well as for amounts properly allocable to tax-exempt partners. Therefore, under these rules a partner in an adjustment year could economically bear a tax liability for an earlier year in which he or she was not a partner or in which his or her partnership percentage was lower than in the earlier year.
However, the rules permit a partnership to elect (within 45 days after the conclusion of an audit) to have any additional taxes paid by the persons who were partners during the year under audit (the “push-out election”). The net result of this election is a mechanism that is largely similar to the current system of audit adjustments. Under Treasury Regulations proposed earlier this year, the IRS requested comments on whether an upper-tier partnership would be permitted to make the push-out election if a lower-tier partnership made a push-out election.
For example, in an investment fund structured as a master-feeder structure, if the IRS audited the master fund and the master fund made a push-out election, the domestic feeder fund would need to make this election so that any additional taxes could be borne by the partners in the domestic feeder fund (rather than the domestic feeder fund itself). There was substantial concern within the investment management industry regarding whether the IRS would permit a domestic feeder fund to make the push-out election in such a situation.
The Proposed Regulations (if finalized) would permit an upper-tier partnership to make a push-out election if a lower-tier partnership made a push-out election, provided that the upper-tier partnership follows certain specified procedures.
The new partnership audit rules are effective for taxable years beginning on or after January 1, 2018. The IRS has still not issued most of the final regulations that will interpret these rules, but it is anticipated that final regulations will be issued over the next several months. We will of course keep you apprised of any developments in this area.
For additional information on the partnership audit rules, please contact one of the attorneys listed below.