Centralized Partnership Audit Regime: Adjusting Tax Attributes, 4868-4882 [2018-01989]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 83, Number 23 (Friday, February 2, 2018)]
[Proposed Rules]
[Pages 4868-4882]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2018-01989]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 301

[REG-118067-17]
RIN 1545-BO00


Centralized Partnership Audit Regime: Adjusting Tax Attributes

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: This document contains proposed regulations implementing 
section 1101 of the Bipartisan Budget Act of 2015, which was enacted 
into law on November 2, 2015. The Bipartisan Budge Act repeals the 
current rules governing partnership audits and replaces them with a new 
centralized partnership audit regime that, in general, determines, 
assesses and collects tax at the partnership level. These proposed 
regulations provide rules addressing how partnerships and their 
partners adjust tax attributes to take into account partnership 
adjustments under the centralized partnership audit regime.

DATES: Written or electronic comments and requests for a public hearing 
must be received by May 3, 2018.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-118067-17), Room 
5207, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions may be hand delivered Monday through 
Friday between the hours of 8:00 a.m. and 4:00 p.m. to CC:PA:LPD:PR 
(REG-118067-17), Courier's Desk, Internal Revenue Service, 1111 
Constitution Avenue NW, Washington, DC 20224. Alternatively, taxpayers 
may submit comments electronically via the Federal eRulemaking Portal 
at https://www.regulations.gov (REG-118067-17).

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Allison R. Carmody or Meghan M. Howard of the Office of Associate Chief 
Counsel (Passthroughs and Special Industries), (202) 317-5279; 
concerning the submission of comments, Regina L. Johnson, (202) 317-
6901 (not toll-free numbers).

SUPPLEMENTARY INFORMATION: 

Background

    This document contains proposed regulations that supplement the 
regulations proposed in the notice of proposed rulemaking (REG-136118-
15) published in the Federal Register on June 14, 2017 (82 FR 27334) 
(the ``June 14 NPRM'') and amend the Income Tax Regulations (26 CFR 
part 1) under Subpart--Partners and Partnerships and the Procedure and 
Administration Regulations (26 CFR part 301) under Subpart--Tax 
Treatment of Partnership Items to implement the centralized partnership 
audit regime. Furthermore, certain provisions of the June 14 NPRM are 
being amended.

1. The New Centralized Partnership Audit Regime

    For information relating to (1) the new centralized partnership 
audit regime enacted by the Bipartisan Budget Act (BBA), Public Law 
114-74 (129 Stat. 58 (2015)) (as amended by the Protecting Americans 
from Tax Hikes Act of 2015, Pub. L. 114-113 (129 Stat. 2242 (2015))); 
(2) Notice 2016-23 (2016-13 I.R.B. 490 (March 28, 2016)), which 
requested comments on the new partnership audit regime enacted by the 
BBA; and (3) the temporary regulations (TD 9780, 81 FR 51795 (August 5, 
2016)) and a notice of proposed rulemaking (REG-105005-16, 81 FR 51835 
(August 5, 2016)), which provided the time, form, and manner for

[[Page 4869]]

a partnership to make an election into the centralized partnership 
audit regime for a partnership taxable year beginning before the 
general effective date of the regime, see the Background section of the 
June 14 NPRM.

2. Proposed Regulations Implementing the Centralized Partnership Audit 
Regime

    The June 14 NPRM addressed various issues concerning the scope and 
process of the new centralized partnership audit regime. Unless 
otherwise noted, all references to proposed regulations in this 
preamble refer to the regulations proposed by the June 14 NPRM.
    Proposed Sec. Sec.  301.6225-1, 301.6225-2, and 301.6225-3 provide 
rules relating to partnership adjustments, including the computation of 
the imputed underpayment, modification of the imputed underpayment, and 
the treatment of adjustments that do not result in an imputed 
underpayment.
    Proposed Sec.  301.6225-1 sets forth rules for computing the 
imputed underpayment, and proposed Sec.  301.6225-2 sets forth the 
rules under which the partnership may request a modification to adjust 
the imputed underpayment calculated under proposed Sec.  301.6225-1. 
The modification rules contained in proposed Sec.  301.6225-2 generally 
allow: (1) Modifications that result in the exclusion of certain 
adjustments, or portions thereof, from the calculation of the imputed 
underpayment (such as a modification under proposed Sec.  301.6225-
2(d)(2) (amended returns by partners), (d)(3) (tax-exempt partners), 
(d)(5) (certain passive losses of publicly traded partnerships), (d)(7) 
(partnerships with partners that are qualified investment entities 
described in section 860 of the Internal Revenue Code (Code)), (d)(8) 
(partner closing agreements), and, if applicable, (d)(9) (other 
modifications)); (2) rate modifications, which affect only the taxable 
rate applied to the total netted partnership adjustment (described in 
proposed Sec.  301.6225-2(d)(4)); and (3) modifications to the number 
and composition of imputed underpayments (described in proposed Sec.  
301.6225-2(d)(6)).
    Proposed Sec.  301.6225-3 sets forth rules for the treatment of 
adjustments that do not result in an imputed underpayment. In general, 
pursuant to proposed Sec.  301.6225-3(b)(1) the partnership takes the 
adjustment into account in the adjustment year as a reduction in non-
separately stated income or as an increase in non-separately stated 
loss depending on whether the adjustment is to an item of income or 
loss. Proposed Sec.  301.6225-3(b)(2) provides that if an adjustment is 
to an item that is required to be separately stated under section 702 
of the Internal Revenue Code (Code) the adjustment shall be taken into 
account by the partnership on its adjustment year return as an 
adjustment to such separately stated item. Proposed Sec.  301.6225-
3(b)(3) provides that an adjustment to a credit is taken into account 
as a separately stated item.
    Proposed Sec. Sec.  301.6226-1, 301.6226-2, and 301.6226-3 provide 
rules relating to the election under section 6226 by a partnership to 
have its reviewed year partners take into account the partnership 
adjustments in lieu of paying the imputed underpayment determined under 
section 6225, the statements the partnership must send to its partners, 
and the rules for how the partners take into account the adjustments, 
including the computation and payment of the partners' liability. If a 
partnership makes the election under section 6226 to ``push out'' 
adjustments to its reviewed year partners, the partnership is not 
liable for the imputed underpayment. Instead, under proposed Sec.  
301.6226-3, reviewed year partners must pay any additional chapter 1 
tax that results from taking the adjustments reflected on the 
statements into account in the reviewed year and from changes to the 
tax attributes in the intervening years. In addition to being liable 
for the additional tax, the partner must also calculate and pay any 
penalties, additions to tax, or additional amounts determined to be 
applicable during the partnership-level proceeding, and any interest 
determined in accordance with proposed Sec.  301.6226-3(d).
    Finally, proposed Sec.  301.6241-1 provides definitions for 
purposes of the centralized partnership audit regime.
    On December 19, 2017, proposed rules (REG-120232-17 and REG-120233-
17) were published in the Federal Register (82 FR 60144) that would 
allow tiered partnerships to push out audit adjustments through to the 
ultimate taxpayers and provides rules implementing the procedural and 
administrative aspects of the partnership audit regime. For proposed 
rules regarding international provisions under the centralized 
partnership audit regime, see (REG-119337-17) published in the Federal 
Register on November 30, 2017 (82 FR 56765).

Explanation of Provisions

1. In General

    These proposed regulations provide rules that were reserved in the 
June 14 NPRM under proposed Sec. Sec.  301.6225-4 and 301.6226-4. It 
also provides related proposed amendments to Sec. Sec.  1.704-1, 1.705-
1, and 1.706-4. Specifically, these rules address how and when 
partnerships and their partners adjust tax attributes to take into 
account partnership adjustments under both sections 6225 and 6226. The 
public provided comments in response to the June 14 NPRM, and some 
comments discussed issues relevant to the reserved sections under 
proposed Sec. Sec.  301.6225-4 and 301.6226-4, which were taken into 
consideration in drafting these proposed regulations.
    Because these regulations are supplementing the regulations 
published in the June 14 NPRM, the numbering and ordering of some of 
the provisions do not follow typical conventions. The Department of the 
Treasury (Treasury Department) and the IRS anticipate that these 
provisions will be appropriately integrated when both these regulations 
and the proposed regulations in the June 14 NPRM are finalized.
    These proposed rules are consistent with the policy described in 
``The General Explanation of Tax Legislation Enacted for 2015'' 
(Bluebook), which explained that ``[u]nder the centralized partnership 
audit regime, the flowthrough nature of the partnership under 
subchapter K of the Code is unchanged, but the partnership is treated 
as a point of collection of underpayments that would otherwise be the 
responsibility of partners.'' Joint Comm. on Taxation, JCS-1-16, 
``General Explanations of Tax Legislation Enacted in 2015'', 57 (2016).
    The preamble to the June 14 NPRM announced that the Treasury 
Department and the IRS intended to provide additional rules providing 
for adjustments to the basis of partnership property and book value of 
any partnership property if the partnership adjustment is a change to 
an item of gain, loss, amortization or depreciation (i.e., the change 
is basis derivative). These proposed regulations, when finalized, will 
provide this guidance.

2. Provisions Relating to Section 6225

A. In General
    The June 14 NPRM defines a partnership adjustment as any adjustment 
to any item of income, gain, loss, deduction, or credit of a 
partnership (as defined in proposed Sec.  301.6221(a)-1(b)(1)), or any 
partner's distributive share thereof (as described in proposed Sec.  
301.6221(a)-1(b)(2)). See proposed Sec.  301.6241-1(a)(6). Under the 
rules in proposed Sec.  301.6225-1, each partnership adjustment is 
either (i) taken into account in the determination

[[Page 4870]]

of an imputed underpayment, or (ii) considered a partnership adjustment 
that does not give rise to an imputed underpayment. For a partnership 
adjustment that is taken into account in the determination of the 
imputed underpayment, these proposed regulations provide rules for 
adjusting partnership asset basis and book value, rules for the 
creation of notional items, rules for allocating these notional items 
under section 704(b), successor rules for situations in which reviewed 
year partners (as defined in proposed Sec.  301.6241-1(a)(9)) are not 
adjustment year partners (as defined in proposed Sec.  301.6241-
1(a)(2)), and rules for determining the impact of notional items on tax 
attributes in certain situations. See section (2)(B) of this preamble. 
These regulations also provide rules for the allocation of any 
partnership expenditure related to the imputed underpayment. See 
section (2)(B)(vii) of this preamble. Finally, these regulations 
provide guidance in the case of a partnership adjustment that does not 
give rise to an imputed underpayment. See section (2)(C) of this 
preamble.
B. Adjustments in the Case of a Partnership Adjustment That Results in 
an Imputed Underpayment
i. In General
    Prior to the enactment of the centralized partnership audit regime, 
in the case of an adjustment to an item of income, gain, loss, 
deduction or credit in the context of an examination by the IRS for or 
related to a partnership, partnership adjustments were generally taken 
into account by the partners of the partnership for the year under 
examination by a new or corrected allocation of the relevant item, and 
partners took those items into account with respect to the partnership 
year under examination. In contrast, under the centralized partnership 
audit regime, for a partnership adjustment that is taken into account 
in the determination of an imputed underpayment, the partnership 
adjustment is generally taken into account by the partnership in the 
year in which the related payment obligation (the imputed underpayment) 
arises. Further, in light of the fact that these partnership 
adjustments are with respect to a partnership year that is earlier than 
the year in which the imputed underpayment arises, the partners of the 
partnership may have changed in the later year.
    Under subchapter K, a partnership generally computes items of 
income, gain, loss, deduction or credit under section 703, which are 
then allocated to the partners under section 704. Under section 705, a 
partner increases its basis in its partnership interest (outside basis) 
by its distributive share of taxable income of the partnership as 
determined under section 703(a). However, in the case of a positive 
partnership adjustment that is taken into account in the determination 
of an imputed underpayment, section 6225 does not itself provide for an 
item of taxable income under section 703(a) to be allocated to 
partners. Instead, calculations are made at the partnership level and 
the partnership pays the liability in the form of an imputed 
underpayment. Failure to provide adjustments to outside basis that 
reflect the partnership adjustments that resulted in the imputed 
underpayment could lead to a partner being effectively taxed twice on 
the same item of income, once indirectly on payment of the imputed 
underpayment and again on a disposition of the partnership interest or 
on a distribution of cash by the partnership. Taxing the same item of 
income twice is not consistent with the flowthrough nature of 
partnerships under subchapter K. Thus, these proposed regulations 
provide for adjustment to a partner's basis in its interest--and 
certain other tax attributes that are interdependent with basis under 
subchapter K--in order to prevent effective double taxation or other 
distortions.
    Specifically, under proposed Sec.  301.6225-4(a)(1), when there is 
a partnership adjustment (as defined in proposed Sec.  301.6241-
1(a)(6)), the partnership and its adjustment year partners (as defined 
in proposed Sec.  301.6241-1(a)(2)) generally must adjust their 
specified tax attributes (as defined in proposed Sec.  301.6225-
4(a)(2)). Specified tax attributes are the tax basis and book value of 
a partnership's property, amounts determined under section 704(c), 
adjustment year partners' bases in their partnership interests, and 
adjustment year partners' capital accounts determined and maintained in 
accordance with Sec.  1.704-1(b)(2). See proposed Sec.  301.6225-
4(a)(2).
    In the case of a partnership adjustment that results in an imputed 
underpayment, the adjustments to specified tax attributes must be made 
on a partnership-adjustment-by-partnership-adjustment basis, and thus 
are created separately for each partnership adjustment (whether a 
negative adjustment or a positive adjustment) without regard to their 
summation as part of the determination of the total netted partnership 
adjustment in proposed Sec.  301.6225-1(c)(3). See proposed Sec.  
301.6225-4(b)(1).
ii. Manner of Adjusting Specified Tax Attributes
    The partnership must first make appropriate adjustments to the book 
value and basis of property to take into account any partnership 
adjustment. See proposed Sec.  301.6225-4(b)(2). This rule also 
requires amounts determined under section 704(c) to be adjusted to take 
into account the partnership adjustment. The partnership does not make 
any adjustments to the book value or basis of partnership property with 
respect to property that was held by the partnership in the reviewed 
year but is no longer held by the partnership in the adjustment year. 
Comments are requested as to whether, in these situations, a 
partnership should be allowed to adjust the basis (or book value) of 
other partnership property (such as in a manner similar to the rules 
that apply in allocating section 734(b) adjustments under section 755 
(i.e., Sec.  1.755-1(c))).
    Proposed Sec.  301.6225-4(b)(3) provides that notional items are 
then created with respect to the partnership adjustment, and these 
notional items are then allocated according to the rules described in 
section (2)(B)(iii) of this preamble. The items are considered notional 
items because their sole purpose is to affect partner-level specified 
tax attributes, and thus they are not considered to be items for 
purposes of adjusting other tax attributes.
    In the case of a partnership adjustment that is an increase to 
income or gain, a notional item of income or gain is created in an 
amount equal to the partnership adjustment. Similarly, in the case of a 
partnership adjustment that is an increase to an expense or a loss, a 
notional item of expense or loss is created in an amount equal to the 
partnership adjustment. See proposed Sec.  301.6225-4(b)(3)(ii) and 
(iii).
    However, in the case of a partnership adjustment that is a decrease 
to income or gain, a notional item of expense or loss is created in an 
amount equal to the partnership adjustment. Similarly, in the case of a 
partnership adjustment that is a decrease to an expense or a loss, a 
notional item of income or gain is created in an amount equal to the 
partnership adjustment. See proposed Sec.  301.6225-4(b)(3)(iv) and 
(v). These rules have the effect of reversing out the reviewed year 
allocation to the extent necessary to reflect the partnership 
adjustment.
    Thus, under these proposed regulations, an adjustment year partner

[[Page 4871]]

increases its outside basis for notional income that is allocated to 
it. Similarly, a partnership that determines and maintains capital 
accounts in accordance with Sec.  1.704-1(b)(2)(iv) also adjusts 
capital accounts for notional items. See proposed Sec.  301.6225-4(e), 
Example 1. In the case of a partnership adjustment that reflects a net 
increase or net decrease in credits as determined under proposed Sec.  
301.6225-1(d), the partnership creates one or more notional items of 
income, gain, loss, or deduction that reflects the change in the item 
giving rise to the credit. See proposed Sec.  301.6225-4(b)(3)(vi).
    Under these proposed regulations, only specified tax attributes are 
adjusted. Treasury Department and the IRS considered proposing broader 
rules for adjusting other tax attributes than those included in these 
proposed regulations. Tax attributes are defined in the June 14 NPRM as 
anything that can affect, with respect to a partnership or a partner, 
the amount or timing of an item of income, gain, loss, deduction, or 
credit (as defined in proposed Sec.  301.6221(a)-1(b)(1)) or that can 
affect the amount of tax due in any taxable year. Examples of tax 
attributes include, but are not limited to, basis and holding period, 
as well as the character of items of income, gain, loss, deduction, or 
credit and carryovers and carrybacks of such items. See proposed Sec.  
301.6241-1(a)(10).
    Comments are requested as to whether tax attributes other than 
specified tax attributes should be adjusted, at either the partner or 
the partnership level, when the partnership pays an imputed 
underpayment. Specifically, commenters are requested to address whether 
guidance should provide a general rule that partnership adjustments and 
notional items are taken into account as items for all purposes of 
Subtitle A, except to the extent of the partner's actual tax due. For 
example, guidance could provide that the partner level tax calculation 
includes notional items for purposes of calculating the tentative tax 
due, but that for purposes of determining the ultimate tax due, the 
partner's share of the imputed underpayment would be subtracted. 
Alternatively, guidance could provide a list of tax attributes that are 
generally adjusted, and a list of those that are not.
    Specific tax attributes for which comments are requested include 
gross income rules for publicly traded partnerships under section 
7704(b) and qualified investment entities described in section 860. 
Other tax attributes for which comments are requested include net 
operating loss carryforwards, other tax accounting under subchapter K, 
and those that contain limitations based on adjusted gross income (for 
example, the earned income credit allowed under section 32, the child 
tax credit allowed under section 24). Comments are also requested as to 
whether any special rules should be provided for adjustments to tax 
attributes in the cross-border context, and how those adjustments 
should differ, if at all, from adjustments to tax attributes made in 
the domestic context.
    These regulations also contain rules to coordinate the changes to 
specified tax attributes made under these rules with other rules of the 
Code, including the rest of the centralized partnership audit regime. 
See proposed Sec.  301.6225-4(a)(4). To the extent a partner or 
partnership appropriately adjusted tax attributes prior to a final 
determination under subchapter C of chapter 63 with respect to a 
partnership adjustment (for example, in the context of an amended 
return modification described in proposed Sec.  301.6225-2(d)(2) or a 
closing agreement described in proposed Sec.  301.6225-2(d)(8)), those 
tax attributes are not adjusted under this section. For example, when a 
partnership requests a modification of the imputed underpayment with 
respect to a partner-specific tax attribute (for example, a net 
operating loss) by the filing of an amended return by a partner or by 
entering into a closing agreement, the partner-specific tax attribute 
must be reduced to the extent it is used to modify the imputed 
underpayment.
    The IRS is considering providing in forms, instructions, or other 
guidance that partnerships will be required to provide information to 
their partners about the amount and nature of changes to tax attributes 
and any other information needed by the partners.
iii. Allocation of Notional Items
    Under section 704(b), a partner's distributive share of income, 
gain, loss, deduction, or credit (or item thereof) is determined under 
the partnership agreement if the allocation under the agreement has 
substantial economic effect. Section 1.704-1(b)(2)(i) provides that the 
determination of whether an allocation of income, gain, loss, or 
deduction (or item thereof) to a partner has substantial economic 
effect involves a two-part analysis that is made at the end of the 
partnership year to which the allocation relates. In order for an 
allocation to have substantial economic effect, the allocation must 
have both economic effect (within the meaning of Sec.  1.704-
1(b)(2)(ii)) and be substantial (within the meaning of Sec.  1.704-
1(b)(2)(iii)). If the allocation does not have substantial economic 
effect, or the partnership agreement does not provide for the 
allocation, then the allocation must be made in accordance with the 
partners' interest in the partnership under Sec.  1.704-1(b)(3).
    Commenters recommended applying the existing rules in subchapter K, 
including section 704(b), in the context of section 6225. While the 
basic principles of section 704(b) remain sound in the context of 
notional items, the unique nature of partnership adjustments under 
section 6225 requires the application of these principles to be 
modified. See proposed Sec.  1.704-1(b)(1)(viii)(a). Specifically, the 
allocation of notional items cannot have substantial economic effect 
because the allocation relates to two different years--while generally 
determined with respect to the reviewed year, notional items are taken 
into account in the adjustment year. Thus, the proposed regulations 
provide that the allocation of a notional item does not have 
substantial economic effect, but, to address this issue, further 
provide that the allocation will be deemed to be in accordance with the 
partners' interests in the partnership if the allocation of a notional 
item of income or gain described in proposed Sec.  301.6225-
4(b)(3)(ii), or expense or loss described in proposed Sec.  301.6225-
4(b)(3)(iii), is made in the manner in which the corresponding actual 
item would have been allocated in the reviewed year under the section 
704 regulations. Additionally, the allocation of a notional item of 
expense or loss described in proposed Sec.  301.6225-4(b)(3)(iv), or a 
notional item of income or gain described in proposed Sec.  301.6225-
4(b)(3)(v), must be allocated to the reviewed year partners that were 
originally allocated that excess item in the reviewed year (or their 
successors). See proposed Sec.  1.704-1(b)(4)(xi). As described in 
section (2)(B)(iv) of this preamble, however, these rules require 
treating successors as reviewed year partners.
iv. Successors
    While the determination of partnership adjustments under section 
6225 is made with respect to reviewed year partners, it is the 
adjustment year partners that bear the economic burden (or benefit) of 
a partnership adjustment. As noted in section (2)(B)(i) of this 
preamble, outside basis adjustments must be made to avoid effectively 
taxing the same item of income twice. While this concern is clearest 
when a reviewed year partner remains a partner in the adjustment year, 
the same concern generally exists when the interest is

[[Page 4872]]

transferred as the failure to provide outside basis would result in 
effectively taxing the same item of income twice, just with respect to 
two different taxpayers. Thus, these regulations provide successor 
rules under proposed Sec.  1.704-1(b)(1)(viii)(b) for purposes of 
adjusting specified tax attributes, including outside basis.
    A reviewed year partner's successor is generally defined as either 
a transferee that succeeds to the transferor partner's capital account 
under proposed Sec.  1.704-1(b)(2)(iv)(l), or, in the case of a 
complete liquidation of a partner's interest, as the remaining partners 
to the extent their interests increased as a result of the liquidated 
partner's departure. See proposed Sec. Sec.  1.704-1(b)(1)(viii)(b) and 
301.6225-4(e), Example 3.
    The June 14 NPRM provides that if any reviewed year partner with 
respect to whom an amount was reallocated is not also an adjustment 
year partner, the portion of the adjustment that would otherwise be 
allocated to such reviewed year partner is allocated instead to the 
adjustment year partner or partners who are the successor or successors 
to the reviewed year partner. See proposed Sec.  301.6225-3(b)(4). 
Further, this rule provides that if the partnership cannot identify an 
adjustment year partner that is a successor to the reviewed year 
partner described in the previous sentence or if a successor does not 
exist, the portion of the adjustment that would otherwise be allocated 
to that reviewed year partner is allocated among the adjustment year 
partners according to the adjustment year partners' distributive 
shares.
    A commenter stated that this rule in the June 14 NPRM allocating a 
reallocation adjustment that does not result in an imputed underpayment 
could result in situations in which partners in a publicly traded 
partnership described in section 7704(b) own units that are not 
fungible. In response to this comment and due to administrability 
concerns, the Treasury Department and the IRS reconsidered this rule 
and have concluded that it is appropriate to provide rules in these 
proposed regulations relating to any situation in which a partnership 
is unable, after exercising reasonable diligence, to determine a 
successor for a partnership adjustment under section 6225 (not only 
reallocation adjustments). These rules require that the proposed 
standard in the June 14 NPRM be replaced with a new proposed 
regulation. Therefore, these regulations amend proposed Sec.  301.6225-
3(b)(4) by removing the final two sentences and provide a rule in 
proposed Sec.  1.704-1(b)(1)(viii)(b)(3) that if a partnership cannot 
determine the transferee for a partnership interest under proposed 
Sec.  1.704-1(b)(1)(viii)(b)(2), the successor is deemed to be those 
partners in the adjustment year who were not also partners in the 
reviewed year or otherwise identifiable as successors to reviewed year 
partners, in proportion to their respective interests in the 
partnership.
    Comments are requested as to whether these new proposed rules would 
similarly result in issues with respect to the fungibility of these 
partnership interests and, if so, specific recommendations for the 
final regulations to address fungibility concerns consistent with the 
centralized partnership audit regime, the rules of subchapter K, and 
the general framework of these proposed regulations. Specifically, 
commenters are requested to consider how the successor rules should 
operate when, due to the redemption of all reviewed year partners, 
there are no identifiable successors to reviewed year partners in the 
adjustment year.
    Treasury and the IRS considered other alternatives to the successor 
rules in these proposed regulations, including allocating notional 
items only to adjustment year partners that were reviewed year 
partners, either solely in the amount for which they would have been 
allocated the notional item, or allocating to them (and no other 
partners) the full amount of the notional items. These proposed rules 
contain successor rules because that approach preserves the economics 
of the partners that were partners in both the reviewed and the 
adjustment year, and also facilitates any necessary private contracts 
between buyers and sellers of partnership interests. Comments are 
requested as to whether an approach other than successor rules are 
better suited to preserving the single-layer of tax in subchapter K 
while avoiding potential for abuse or other inappropriate tax results.
    Comments are also requested as to how these successor rules should 
apply in the case of partnership mergers and divisions.
    Finally, comments are requested on issues similar to those noted in 
the June 14 NPRM in section (5)(D)(ii) of the preamble, namely whether 
the allocation of adjustments to a successor of a reviewed year partner 
that was a tax-exempt partner may raise issues concerning private 
benefit to a person other than a tax-exempt partner, including issues 
that might affect the tax-exempt partner's status under section 501(c); 
excise taxes under chapter 42 of subtitle D of the Code or under 
sections 4975, 4976, or 4980; or requirements under title I of the 
Employee Retirement Income Security Act of 1974, Public Law 93-406 (88 
Stat. 829 (1974)) as amended (ERISA), such as the fiduciary 
responsibility rules under part 4 thereof. The Treasury Department and 
the IRS request comments from the public on whether these potential 
issues may be adequately addressed in partnership agreements or whether 
guidance is needed to address these potential issues. Any comments 
related to title I of ERISA will be shared with the Department of 
Labor.
v. Adjusting Specified Tax Attributes in Certain Circumstances
    For certain types of partnership adjustments, notional items are 
not created. Specifically, notional items are not created for a 
partnership adjustment that does not derive from items that would have 
been allocated in the reviewed year under section 704(b), such as a 
partnership adjustment based upon a partner's failure to report gain 
under section 731, a partnership adjustment that is a change of an item 
of deduction to a section 705(a)(2)(B) expenditure, or a partnership 
adjustment to an item of tax-exempt income. See proposed Sec.  
301.6225-4(b)(4). Nevertheless, in these situations specified tax 
attributes are adjusted for the partnership and its reviewed year 
partners (or their successors) in a manner that is consistent with how 
the partnership adjustment would have been taken into account under the 
partnership agreement in effect for the reviewed year taking into 
account all facts and circumstances. See proposed Sec.  301.6225-4(e), 
Example 5.
vi. Special Rules for Outside Basis in Certain Cases
    As noted in section (2)(B)(i) of this preamble, partners normally 
adjust their outside bases for notional items that are allocated to 
them. However, in certain cases, the proposed rules do not provide for 
adjustments to outside basis. Specifically, when a tax-exempt partner 
transfers its interest to a partner that is not tax-exempt (taxable 
partner) between the reviewed year and the adjustment year and the 
partnership requests a modification because of the reviewed year 
partner's status as a tax-exempt entity, the successor taxable partner 
is disallowed a basis adjustment. See proposed Sec.  301.6225-
4(b)(6)(iii)(B). Without this rule, a taxable successor partner would 
have a basis increase when no imputed underpayment was paid with 
respect to the partner's share of the partnership

[[Page 4873]]

adjustment. Comments are requested as to whether this rule should be 
extended to rate modifications described in proposed Sec.  301.6225-
2(d)(4) as well. A basis adjustment is also disallowed when a reviewed 
year partner transfers its interest to a related party in a transaction 
in which not all gain or loss is recognized during an administrative 
proceeding under subchapter C of chapter 63 of the Code (subchapter C 
of chapter 63) and a principal purpose of the transfer was to shift the 
economic burden of the imputed underpayment among related parties. 
Comments are requested regarding whether basis adjustments should be 
disallowed in any other circumstances.
vii. Accounting and Allocation of Partnership Section 705(a)(2)(B) 
Expenditures
    Proposed Sec.  301.6225-4(c) describes how the partnership's 
expenditure arising from an imputed underpayment and any other amount 
under subchapter C of chapter 63 is taken into account by the 
partnership and its partners. No deduction is allowed under subtitle A 
of the Code for any payment required to be made by a partnership under 
subchapter C of chapter 63 and the amount is treated as an expenditure 
described in section 705(a)(2)(B). See proposed Sec.  301.6241-4(a).
    For an allocation to have economic effect, it must be consistent 
with the underlying economic arrangement of the partners. This means 
that, in the event that there is an economic benefit or burden that 
corresponds to the allocation, the partner to whom the allocation is 
made must receive such economic benefit or bear such economic burden. 
See Sec.  1.704-1(b)(2)(ii). Generally, an allocation of income, gain, 
loss, or deduction (or item thereof) to a partner will have economic 
effect if, and only if, throughout the full term of the partnership, 
the partnership agreement provides: (1) For the determination and 
maintenance of the partners' capital accounts in accordance with Sec.  
1.704-1(b)(2)(iv); (2) for liquidating distributions to the partners to 
be made in accordance with the positive capital account balances of the 
partners; and (3) for each partner to be unconditionally obligated to 
restore the deficit balance in the partner's capital account following 
the liquidation of the partner's partnership interest. In lieu of 
satisfying the third criterion, the partnership may satisfy the 
qualified income offset rules set forth in Sec.  1.704-1(b)(2)(ii)(d).
    Section 1.704-1(b)(2)(iv)(i) provides specific rules for 
determining whether an allocation of a section 705(a)(2)(B) expenditure 
has substantial economic effect. Specifically, it requires that a 
partner's capital account be decreased by allocations made to such 
partner of expenditures described in section 705(a)(2)(B). See also 
Sec.  1.704-1(b)(2)(iv)(b). Further, under section 705(a)(2)(B), the 
adjusted basis of a partner's interest in a partnership is decreased 
(but not below zero) by expenditures of the partnership that are not 
deductible in computing its taxable income and not properly chargeable 
to capital account.
    Several commenters addressed how the partnership's payment of an 
imputed underpayment should be allocated among its partners and how the 
payment should be given effect. With respect to the payment's 
allocation, commenters recommended that the expenditure be allocated 
among the partners in accordance with their partnership agreement, 
subject to the rules of section 704(b) (including the regulatory 
requirements for substantial economic effect). The Treasury Department 
and the IRS agree with the commenters that the expenditure should be 
allocated under section 704. These proposed regulations contain special 
rules for allocating the expenditure under section 704(b).
    With respect to book capital account adjustments for the imputed 
underpayment, commenters recommended that partners' capital accounts be 
adjusted to reflect the partnership's payment of the imputed 
underpayment. The Treasury Department and the IRS agree with this 
comment but conclude that because the expenditure is treated as an 
expenditure under section 705(a)(2)(B) pursuant to the June 14 NPRM 
(proposed Sec.  301.6241-4(a)), existing rules provide this result.
    The Treasury Department and the IRS have concluded, however, that 
the existing rules that determine whether the economic effect of an 
allocation is substantial should be modified to take into account the 
unique nature of these expenditures. When a partnership pays an imputed 
underpayment under section 6225, it has the effect of converting what 
would have been a non-deductible partner-level expenditure into a non-
deductible partnership-level expenditure. The proposed regulations 
provide that an allocation of the nondeductible expenditure will be 
considered to be substantial only if the partnership allocates the 
expenditure in proportion to the notional item to which it relates, 
taking into account appropriate modifications. See proposed Sec. Sec.  
1.704-1(b)(2)(iii)(a) and (f), 301.6225-4(c) and 301.6225-4(e), Example 
4. This rule aligns the economics of the income allocation (in this 
case, the notional income allocation) with the directly associated 
imputed underpayment expense in a manner consistent with the 
flowthrough nature of partnerships under subchapter K. Absent this 
substantiality rule in the regulations, partnerships could 
inappropriately allocate expenses to partners in the adjustment year in 
a manner inconsistent with the underlying economic arrangement of the 
partners. These new substantiality rules also apply to a payment made 
by a pass-through partner under proposed Sec.  301.6226-3(e)(4).
    Similarly, for partnerships that do not maintain capital accounts, 
the allocation of the expenditure cannot be in accordance with the 
partners' interests in the partnership to the extent it shifts the 
economic burden of the payment of the imputed underpayment away from a 
partner (or its successor) that would have been allocated the 
corresponding notional income item. However, the regulations provide 
that an allocation of an expense that satisfies the new substantiality 
rule and in which the partner's distribution rights are reduced by the 
partner's share of the imputed underpayment is deemed to be in 
accordance with the partners' interests in the partnership. See 
proposed Sec.  1.704-1(b)(4)(xii). These proposed regulations do not 
address the extent to which the partnership may later reverse this 
allocation with a special chargeback or similar provision. Comments are 
requested on this issue.
    One commenter recommended rules specifying that a partner's 
contribution of funds to the partnership for payment of an imputed 
underpayment will result in an increase in that partner's capital 
account. This comment is not adopted because the existing rules in 
subchapter K provide sufficient guidance for this circumstance. A 
commenter also recommended rules addressing the availability of a 
corporation's deduction under temporary Sec.  1.163-9T(b)(2) for a 
payment of interest in respect of an underpayment of tax. This comment 
is not adopted because it is beyond the scope of these proposed 
regulations.
    The proposed regulations also provide that in order for an 
allocation of an expenditure for interest, penalties, additions to tax, 
or additional amounts as determined under section 6233 to be 
substantial, it must be allocated to the reviewed year partner in 
proportion to the allocation of the related imputed underpayment, the 
related payment made by a pass-through partner under proposed Sec.  
301.6226-3(e)(4), or the

[[Page 4874]]

related notional item to which it relates (whichever is appropriate), 
taking into account modifications under proposed Sec.  301.6225-2 
attributable to that partner. See proposed Sec.  1.704-
1(b)(2)(iii)(f)(3). This rule has a similar purpose as the rule in 
proposed Sec.  1.704-1(b)(2)(iii)(f)(2) in that it aligns the economics 
of these expenses with the partnership items to which they relate. 
Under this rule, an expense for interest imposed under the Code will 
generally be allocated in proportion to the imputed underpayment from 
which it derives. Also, an expense arising from a substantial 
understatement of tax under section 6662(d) for an imputed underpayment 
will generally be allocated in proportion to the notional income item 
to which it relates.
    In situations in which the reviewed year partner is not an 
adjustment year partner, the successor rules in proposed Sec.  1.704-
1(b)(1)(viii)(b) apply to the allocation of these expenditures. Under 
those rules, a partner admitted after the reviewed year will not 
ordinarily be allocated any section 705(a)(2)(B) expenditure in the 
adjustment year.
C. Partnership Adjustments That Do Not Result in an Imputed 
Underpayment
    The June 14 NPRM provides that the rules under subchapter K apply 
in the case of a partnership adjustment that does not result in an 
imputed underpayment. See proposed Sec.  301.6225-3(c). Further, 
proposed Sec.  1.704-1(b)(4)(xiii) of these regulations provides that 
an allocation of an item arising from a partnership adjustment that 
does not result in an imputed underpayment (as defined in proposed 
Sec.  301.6225-1(c)(2)) does not have substantial economic effect but 
will be deemed to be in accordance with the partners' interests in the 
partnership if it is allocated in the manner in which the item would 
have been allocated in the reviewed year under the regulations under 
section 704, taking into account the successor rules described in 
section (2)(B)(iv) of this preamble.
3. Provisions Relating to Section 6226
A. In General
    Section 6226(b) describes how partnership adjustments are taken 
into account by the reviewed year partners if a partnership makes an 
election under section 6226(a). Under section 6226(b)(1), each 
partner's tax imposed by chapter 1 of subtitle A of the Code (chapter 1 
tax) is increased by the aggregate of the adjustment amounts as 
determined under section 6226(b)(2). This increase in chapter 1 tax is 
reported on the return for the partner's taxable year that includes the 
date the statement described under section 6226(a) is furnished to the 
partner by the partnership (reporting year). The aggregate of the 
adjustment amounts is the aggregate of the correction amounts. See 
proposed Sec.  301.6226-3(b).
    The adjustment amounts determined under section 6226(b)(2) fall 
into two categories. Under section 6226(b)(2)(A), in the case of the 
taxable year of the partner that includes the end of the partnership's 
reviewed year (first affected year), the adjustment amount is the 
amount by which the partner's chapter 1 tax would increase for the 
partner's first affected year if the partner's share of the adjustments 
were taken into account in that year. Under section 6226(b)(2)(B), in 
the case of any taxable year after the first affected year, and before 
the reporting year (that is, the intervening years), the adjustment 
amount is the amount by which the partner's chapter 1 tax would 
increase by reason of the adjustment to tax attributes determined under 
section 6226(b)(3) in each of the intervening years. The adjustment 
amounts determined under section 6226(b)(2)(A) and (B) are added 
together to determine the aggregate of the adjustment amounts for 
purposes of determining additional reporting year tax, which is the 
increase to the partner's chapter 1 tax in accordance with section 
6226(b)(1).
    Section 6226(b)(3) provides two rules regarding adjustments to tax 
attributes that would have been affected if the partner's share of 
adjustments were taken into account in the first affected year. First, 
under section 6226(b)(3)(A), in the case of an intervening year, any 
tax attribute must be appropriately adjusted for purposes of 
determining the adjustment amount for that intervening year in 
accordance with section 6226(b)(2)(B). Second, under section 
6226(b)(3)(B), in the case of any subsequent taxable year (that is, a 
year, including the reporting year, that is subsequent to the 
intervening years referenced in 6226(b)(3)(A)), any tax attribute must 
be appropriately adjusted.
    Under the June 14 NPRM, a reviewed year partner's share of the 
adjustments that must be taken into account by the reviewed year 
partner must be reported to the reviewed year partner in the same 
manner as originally reported on the return filed by the partnership 
for the reviewed year. See proposed Sec.  301.6226-2(f). If the 
adjusted item was not reflected in the partnership's reviewed year 
return, the adjustment must be reported in accordance with the rules 
that apply with respect to partnership allocations, including under the 
partnership agreement. However, under proposed Sec.  301.6226-2(f)(1), 
if the adjustments, as finally determined, are allocated to a specific 
partner or in a specific manner, the partner's share of the adjustment 
must follow how the adjustment is allocated in that final 
determination.
    Section 301.6226-4(b) of these proposed regulations provides that 
the reviewed year partners or affected partners (as described in Sec.  
301.6226-3(e)(3)(i)) must take into account items of income, gain, 
loss, deduction or credit with respect to their share of the 
partnership adjustments as contained on the statements described in 
proposed Sec.  301.6226-2 (pushed-out items) in the reporting year (as 
defined in proposed Sec.  301.6226-3(a)). Similarly, partnerships 
adjust tax attributes affected by reason of a pushed-out item in the 
reviewed year. In the case of a reviewed year partner that disposed of 
its partnership interest prior to the reporting year, that partner may 
take into account any outside basis adjustment under these rules in an 
amended return to the extent otherwise allowable under the Code.
    Unlike the proposed rules under section 6225 and subchapter K 
described in section 2 of this preamble, under section 6226, all tax 
attributes (as defined in proposed Sec.  301.6241-1(a)(10)) are 
adjusted for pushed out items of income, gain, deduction, loss or 
credit.
B. Section 704(b)
    Section (2)(B)(iii) of this preamble discusses the general 
mechanics of section 704(b). In accordance with the principles set 
forth in section 704(b), an allocation of a pushed-out item does not 
have substantial economic effect within the meaning of section 
704(b)(2). However, the allocation of such an item will be deemed to be 
in accordance with the partners' interests in the partnership if it is 
allocated in the adjustment year in the manner in which the item would 
have been allocated under the rules of section 704(b), including Sec.  
1.704-1(b)(1)(i) (or otherwise taken into account under subtitle A) in 
the reviewed year (as defined in proposed Sec.  301.6241-1(a)(8)), 
followed by any subsequent taxable years, concluding with the 
adjustment year (as defined in proposed Sec.  301.6241-1(a)(1)). See 
proposed Sec.  1.704-1(b)(4)(xiv).
C. Timing
    Under the June 14 NPRM, a reviewed year partner that is furnished a 
statement under proposed Sec.  301.6226-2 is required to pay any 
additional chapter 1 tax (additional reporting year tax) for the 
partner's taxable year which

[[Page 4875]]

includes the date the statement was furnished to the partner in 
accordance with proposed Sec.  301.6226-2 (the reporting year) that 
results from taking into account the adjustments reflected in the 
statement. See proposed Sec.  301.6226-3. The additional reporting year 
tax is the aggregate of the adjustment amounts, as determined in 
proposed Sec.  301.6226-3(b) and described in (3)(A) of this preamble.
    A commenter recommended that adjustments to capital accounts and 
basis should be made to the reviewed year partners in the reviewed year 
to prevent distortions. This comment is not adopted because, in this 
context, section 6226 clearly applies to the adjustment year. These 
proposed regulations provide that adjustments to partnership-level tax 
attributes are calculated with respect to each year beginning with the 
reviewed year, followed by subsequent taxable years, concluding with 
the adjustment year. See proposed Sec.  301.6226-4(b).
D. Effect of a Payment by Pass-Through Partner
    These proposed regulations provide that to the extent a pass-
through partner (as defined in proposed Sec.  301.6241-1(a)(5)) makes a 
payment in lieu of issuing statements to its owners described in 
proposed Sec.  301.6226-3(e)(4), that payment will be treated similarly 
to the payment of an amount under subchapter C of chapter 63 for 
purposes of any adjustments to bases and capital accounts, and 
accordingly, the rules contained in proposed Sec.  301.6225-4 will 
apply to determine any appropriate adjustments to bases and capital 
accounts. See proposed Sec.  301.6226-3(e). To the extent that the 
pass-through partner continues to push out the partnership adjustments 
to its partners in accordance with proposed Sec.  301.6226-3(e)(3), the 
partners receiving those adjustments will adjust their bases and 
capital accounts in accordance with the guidance provided in proposed 
Sec.  301.6226-4.
    Comments are requested as to how S corporations, trusts, and 
estates that are pass-through partners that pay an amount under 
proposed Sec.  301.6226-3(e), and their shareholders and beneficiaries, 
respectively, should take these payments into account and adjust tax 
attributes.

Special Analyses

    Certain IRS regulations, including this one, are exempt from the 
requirements of Executive Order 12866, as supplemented and reaffirmed 
by Executive Order 13563. Therefore, a regulatory impact assessment is 
not required. Because the proposed regulations would not impose a 
collection of information on small entities, the Regulatory Flexibility 
Act (5 U.S.C. chapter 6) does not apply.
    Pursuant to section 7805(f), this notice of proposed rulemaking has 
been submitted to the Chief Counsel for Advocacy of the Small Business 
Administration for comment on its impact on small business.

Statement of Availability of IRS Documents

    IRS Revenue Procedures, Revenue Rulings, Notices and other guidance 
cited in this preamble are published in the Internal Revenue Bulletin 
(or Cumulative Bulletin) and are available from the Superintendent of 
Documents, U.S. Government Publishing Office, Washington, DC 20402, or 
by visiting the IRS website at https://www.irs.gov.

Comments and Requests for Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any electronic and written comments that 
are submitted timely to the IRS as prescribed in this preamble under 
the ADDRESSES heading. The Treasury Department and the IRS request 
comments on all aspects of the proposed rules. All comments will be 
available at https://www.regulations.gov or upon request. A public 
hearing will be scheduled if requested in writing by any person that 
timely submits written comments. If a public hearing is scheduled, then 
notice of the date, time, and place for the public hearing will be 
published in the Federal Register.

List of Subjects

26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 301

    Employment taxes, Estate taxes, Excise taxes, Gift taxes, Income 
taxes, Penalties, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR parts 1 and 301 are proposed to be amended as 
follows:

PART 1--INCOME TAX

0
Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

    Authority:  26 U.S.C. 7805 * * *

0
Par. 2. Section 1.704-1 is amended by:
0
1. Adding paragraph (b)(1)(viii).
0
2. Adding a sentence to the end of paragraph (b)(2)(iii)(a).
0
3. Adding paragraphs (b)(2)(iii)(f), (b)(2)(iv)(i)(4), and (b)(4)(xi), 
(xii), (xiii), (xiv), and (xv).
    The additions read as follows:


Sec.  1.704-1   Partner's distributive share.

* * * * *
    (b) * * *
    (1) * * *
    (viii) Items relating to a final determination under the 
centralized partnership audit regime--(a) In general. Certain items of 
income, gain, loss, deduction or credit may result from a final 
determination under subchapter C of chapter 63 of the Internal Revenue 
Code (subchapter C of chapter 63) (relating to the centralized 
partnership audit regime). Special rules under section 704(b) and Sec.  
1.704-1(b) apply to these items that take into account that the item 
relates to the reviewed year (as defined in Sec.  301.6241-1(a)(8) of 
this chapter) but occurs in the adjustment year (as defined in Sec.  
301.6241-1(a)(1) of this chapter). See paragraphs (b)(2)(iii)(a) and 
(f), (b)(2)(iv)(i)(4), and (b)(4)(xi), (xii), (xiii), (xiv), and (xv) 
of this section.
    (b) Successors--(1) In general. In the case of a transfer or 
liquidation of a partnership interest subsequent to a reviewed year, a 
successor has the meaning provided in paragraph (b)(1)(viii)(b) of this 
section. In the case of a subsequent transfer by a successor of a 
partnership interest, the principles of paragraph (b)(1)(viii)(b) of 
this section will also apply to the new successor.
    (2) Identifiable transferee partner. Except as otherwise provided 
in paragraph (b)(1)(viii)(b)(3) of this section, in the case of a 
transfer of all or part of a partnership interest during or subsequent 
to the reviewed year, a successor is the partner to which the reviewed 
year transferor partner's capital account carried over (or would carry 
over if the partnership maintained capital accounts) under paragraph 
(b)(2)(iv)(l) of this section (an identifiable transferee partner).
    (3) Unidentifiable transferee partner. If, after exercising 
reasonable diligence, the partnership cannot determine an identifiable 
transferee partner under paragraph (b)(1)(viii)(b)(2) of this section, 
each partner in the adjustment year that is not an identifiable 
transferee partner and was not a partner in the reviewed year, (an 
unidentifiable transferee partner) is a successor to the extent of the 
proportion of its interest in the partnership to the total interests of 
unidentifiable transferee partners in the

[[Page 4876]]

partnership (considering all facts and circumstances).
    (4) Liquidation of partnership interest. In the case of a 
liquidation of a partner's entire interest in the partnership during or 
subsequent to the reviewed year, the successors to the liquidated 
partner are certain adjustment year partners (as defined in Sec.  
301.6241-1(a)(2) of this chapter) as provided in this paragraph 
(b)(1)(viii)(b)(4). The determination of the extent to which the 
adjustment year partners are treated as successors under this section 
must be made in a manner that reflects the extent to which the 
adjustment year partners' interests in the partnership increased as a 
result of the liquidating distribution (considering all facts and 
circumstances).
    (2) * * *
    (iii) * * *
    (a) * * * Notwithstanding any other sentence of this paragraph 
(b)(2)(iii)(a), an allocation of any of the following will be 
substantial only if the allocation is described in paragraph 
(b)(2)(iii)(f) of this section: An expenditure for any payment required 
to be made by a partnership under subchapter C of chapter 63 (relating 
to the centralized partnership audit regime), adjustments reflected on 
a statement furnished to a pass-through partner (as defined in Sec.  
301.6241-1(a)(5) of this chapter) under Sec.  301.6226-3(e)(4) of this 
chapter, or interest, penalties, additions to tax, or additional 
amounts described in section 6233.
* * * * *
    (f) Certain expenditures under the centralized partnership audit 
regime--(1) In general. The economic effect of an allocation of an 
expenditure for any payment required to be made by a partnership under 
subchapter C of chapter 63 (as described in Sec.  301.6241-4(a) of this 
chapter) is substantial only if the expenditure is allocated in the 
manner described in this paragraph (b)(2)(iii)(f). For partnerships 
with allocations that do not satisfy paragraph (b)(2)(ii) of this 
section, see paragraph (b)(4)(xi) of this section.
    (2) Expenditures for imputed underpayments or similar amounts. 
Except as otherwise provided, an expenditure for an imputed 
underpayment under Sec.  301.6225-1 of this chapter (or for an amount 
computed in the same manner as an imputed underpayment under Sec.  
301.6226-3(e)(4)(iii) of this chapter) is allocated to the reviewed 
year partner (or its successor, as defined in paragraph (b)(1)(viii)(b) 
of this section) in proportion to the allocation of the notional item 
(as described in Sec.  301.6225-4(b) of this chapter) to which the 
expenditure relates, taking into account modifications under Sec.  
301.6225-2 of this chapter attributable to that partner.
    (3) Interest, penalties, additions to tax, or additional amounts 
described in section 6233. An expenditure for interest, penalties, 
additions to tax, or additional amounts as determined under section 
6233 (or penalties and interest described in Sec.  301.6226-3(e)(4)(iv) 
of this chapter) is allocated to the reviewed year partner (or its 
successor, as defined in paragraph (b)(1)(viii)(b) of this section) in 
proportion to the allocation of the portion of the imputed underpayment 
with respect to which the penalty applies (or amount computed in the 
same manner as an imputed underpayment under Sec.  301.6226-3(e)(4) of 
this chapter) or related notional item to which it relates (whichever 
is appropriate), taking into account modifications under Sec.  
301.6225-2 of this chapter attributable to that partner.
    (4) Imputed underpayments unrelated to notional items. In the case 
of an imputed underpayment that results from a partnership adjustment 
for which no notional items are created under Sec.  301.6225-4(b)(2) of 
this chapter, the expenditure must be allocated to the reviewed year 
partner (or its successor, as defined in paragraph (b)(1)(viii)(b) of 
this section) that would have borne the economic benefit or burden of 
the partnership adjustment if the partnership and its partners had 
originally reported in a manner consistent with the partnership 
adjustment that resulted in the imputed underpayment with respect to 
the reviewed year.
    (iv) * * *
    (i) * * *
    (4) Certain expenditures under the centralized partnership audit 
regime. Notwithstanding paragraph (b)(2)(iv)(i)(1) of this section, the 
economic effect of an allocation of an expenditure for any payment 
required to be made by a partnership under subchapter C of chapter 63 
(as described in Sec.  301.6241-4(a) of this chapter) is substantial 
only if the expenditure is allocated in the manner described in 
paragraph (b)(2)(iii)(f) of this section. For partnerships with 
allocations that do not satisfy paragraph (b)(2)(ii) of this section, 
see paragraph (b)(4)(xii) of this section.
* * * * *
    (4) * * *
    (xi) Notional items under the centralized partnership audit regime. 
An allocation of a notional item (as described in Sec.  301.6225-4(b) 
of this chapter) does not have substantial economic effect within the 
meaning of paragraph (b)(2) of this section. However, the allocation of 
a notional item of income or gain described in Sec.  301.6225-
4(b)(1)(ii) of this chapter, or expense or loss described in Sec.  
301.6225-4(b)(1)(iii) of this chapter, will be deemed to be in 
accordance with the partners' interests in the partnership if the 
notional item is allocated in the manner in which the corresponding 
actual item would have been allocated in the reviewed year under the 
rules of this section, treating successors (as defined in paragraph 
(b)(1)(viii)(b) of this section) as reviewed year partners. 
Additionally, the allocation of a notional item of expense or loss 
described in Sec.  301.6225-4(b)(3)(iv) of this chapter, or a notional 
item of income or gain described in Sec.  301.6225-4(b)(3)(v) of this 
chapter, will be deemed to be in accordance with the partners' 
interests in the partnership if the notional item is allocated to the 
reviewed year partners (or their successors as defined in paragraph 
(b)(1)(viii)(b) of this section) in the manner in which the excess item 
was allocated in the reviewed year.
    (xii) Certain section 705(a)(2)(B) expenditures under the 
centralized partnership audit regime. An allocation of an expenditure 
for any payment required to be made by a partnership under subchapter C 
of chapter 63 (relating to the centralized partnership audit regime and 
as described in Sec.  301.6241-4(a) of this chapter) will be deemed to 
be in accordance with the partners' interests in the partnership, as 
provided in paragraph (b)(3) of this section, only if the expenditure 
is allocated in the manner described in paragraph (b)(2)(iii)(f) of 
this section and if the partners' distribution rights are reduced by 
the partners' shares of the imputed underpayment.
    (xiii) Partnership adjustments that do not result in an imputed 
underpayment under the centralized partnership audit regime. An 
allocation of an item arising from a partnership adjustment that does 
not result in an imputed underpayment (as defined in Sec.  301.6225-
1(c)(2) of this chapter) does not have substantial economic effect 
within the meaning of paragraph (b)(2) of this section. However, the 
allocation of such an item will be deemed to be in accordance with the 
partners' interests in the partnership if allocated in the manner in 
which the item would have been allocated in the reviewed year under the 
rules of this section, treating successors as defined in paragraph 
(b)(1)(viii)(b) of this section as reviewed year partners.

[[Page 4877]]

    (xiv) Partnership adjustments subject to an election under section 
6226. An allocation of an item arising from a partnership adjustment 
that results in an imputed underpayment for which an election is made 
under Sec.  301.6226-1 of this chapter does not have substantial 
economic effect within the meaning of paragraph (b)(2) of this section. 
However, the allocation of such an item will be deemed to be in 
accordance with the partners' interests in the partnership if allocated 
in the adjustment year (as defined in Sec.  301.6241-1(a)(1) of this 
chapter) in the manner in which the item would have been allocated 
under the rules of this section (or otherwise taken into account under 
subtitle A of the Code) in the reviewed year (as defined in Sec.  
301.6241-1(a)(8) of this chapter), followed by any subsequent taxable 
years, concluding with the adjustment year (as defined in Sec.  
301.6241-1(a)(1) of this chapter).
    (xv) Substantial economic effect under sections 168(h) and 
514(c)(9)(E)(i)(ll). An allocation described in paragraphs (b)(4)(xi) 
through (xiv) of this section will be deemed to have substantial 
economic effect for purposes of sections 168(h) and 514(c)(9)(E)(i)(ll) 
if the allocation is deemed to be in accordance with the partners' 
interests in the partnership under the applicable rules set forth in 
paragraphs (b)(4)(xi) through (xiv) of this section.
* * * * *
0
Par. 3. Section 1.705-1 is amended by adding paragraph (a)(10) to read 
as follows:


Sec.  1.705-1   Determination of basis of partner's interest.

    (a) * * *
    (10) For rules relating to determining the adjusted basis of a 
partner's interest in a partnership following a final determination 
under subchapter C of chapter 63 of the Internal Revenue Code (relating 
to the centralized partnership audit regime), see Sec. Sec.  301.6225-4 
and 301.6226-4 of this chapter.
* * * * *
0
Par. 4. Section 1.706-4 is amended by redesignating paragraphs 
(e)(2)(viii) through (xi) as paragraphs (e)(2)(ix) through (xii), 
respectively, and adding a new paragraph (e)(2)(viii) to read as 
follows:


Sec.  1.706-4   Determination of distributive share when a partner's 
interest varies.

* * * * *
    (e) * * *
    (2) * * *
    (viii) Any item arising from a final determination under subchapter 
C of chapter 63 of the Internal Revenue Code (relating to the 
centralized partnership audit regime) with respect to a partnership 
adjustment resulting in an imputed underpayment for which no election 
is made under Sec.  301.6226-1 of this chapter.
* * * * *

PART 301--PROCEDURE AND ADMINISTRATION

0
Par. 5. The authority citation for part 301 continues to read in part 
as follows:

    Authority:  26 U.S.C. 7805 * * *

0
Par 6. Section 301.6225-3 as proposed to be amended at 82 FR 27334 
(June 14, 2017) is further amended by revising paragraph (b)(4) to read 
as follows:


Sec.  301.6225-3   Treatment of partnership adjustments that do not 
result in an imputed underpayment.

* * * * *
    (b) * * *
    (4) Reallocation adjustments. A partnership adjustment that does 
not result in an imputed underpayment pursuant to Sec.  
[thinsp]301.6225-1(c)(2)(i) is taken into account by the partnership in 
the adjustment year as a separately stated item or a non-separately 
stated item, as required by section 702. The portion of an adjustment 
allocated under this paragraph (b)(4) is allocated to adjustment year 
partners (as defined in Sec.  301.6241-1(a)(2)) who are also reviewed 
year partners (as defined in Sec.  [thinsp]301.6241-1(a)(9)) with 
respect to whom the amount was reallocated.
* * * * *
    Par. 7. Section 301.6225-4 is added to read as follows:


Sec.  301.6225-4   Effect of a partnership adjustment on specified tax 
attributes of partnerships and their partners.

    (a) Adjustments to specified tax attributes--(1) In general. When 
there is a partnership adjustment (as defined in Sec.  301.6241-
1(a)(6)), the partnership and its adjustment year partners (as defined 
in Sec.  301.6241-1(a)(2)) generally must adjust their specified tax 
attributes (as defined in paragraph (a)(2) of this section) in 
accordance with the rules in this section. For a partnership adjustment 
that results in an imputed underpayment (as defined in Sec.  301.6241-
1(a)(3)), specified tax attributes are generally adjusted by making 
appropriate adjustments to the book value and basis of partnership 
property under paragraph (b)(2) of this section, creating notional 
items based on the partnership adjustment under paragraph (b)(3) of 
this section, allocating those notional items as described in paragraph 
(b)(5) of this section, and determining the effect of those notional 
items for the partnership and its reviewed year partners (as defined in 
Sec.  301.6241-1(a)(9)) or their successors (as defined in Sec.  1.704-
1(b)(1)(viii)(b) of this chapter) under paragraph (b)(6) of this 
section. Paragraph (c) of this section describes how to treat an 
expenditure for any payment required to be made by a partnership under 
subchapter C of chapter 63 of the Internal Revenue Code (subchapter C 
of chapter 63) including any imputed underpayment. Paragraph (d) of 
this section describes adjustments to tax attributes in the case of a 
partnership adjustment that does not result in an imputed underpayment 
(as described in Sec.  301.6225-1(c)(2)).
    (2) Specified tax attributes. Specified tax attributes are the tax 
basis and book value of a partnership's property, amounts determined 
under section 704(c), adjustment year partners' bases in their 
partnership interests, and adjustment year partners' capital accounts 
determined and maintained in accordance with Sec.  1.704-1(b)(2) of 
this chapter.
    (3) Timing. Adjustments to specified tax attributes under this 
section are made in the adjustment year (as defined in Sec.  301.6241-
1(a)(1)). Thus, to the extent that an adjustment to a specified tax 
attribute under this section is reflected on a federal tax return, the 
partnership adjustment is generally first reflected on any return filed 
with respect to the adjustment year.
    (4) Effect of other sections. The determination of specified tax 
attributes under this section is not conclusive as to tax attributes 
determined under other sections of the Internal Revenue Code (Code), 
including the centralized partnership audit regime. For example, a 
partnership that files an administrative adjustment request (AAR) under 
section 6227 adjusts tax attributes as appropriate. Further, to the 
extent a partner or partnership appropriately adjusted tax attributes 
prior to a final determination under subchapter C of chapter 63 with 
respect to a partnership adjustment (for example, in the context of an 
amended return modification described in Sec.  301.6225-2(d)(2) or a 
closing agreement described in Sec.  301.6225-2(d)(8)), those tax 
attributes are not adjusted under this section. Similarly, to the 
extent a partner filed a return inconsistent with the treatment of 
items on a partnership return, a reviewed year partner (or its 
successor) does not adjust tax attributes to the extent the partner's 
prior return was consistent with the partnership adjustment. For the 
rules

[[Page 4878]]

regarding consistent treatment by partners, see Sec.  301.6222-1.
    (5) Election under section 6226--(i) In general. Except as 
otherwise provided in paragraph (a)(5)(ii) of this section, tax 
attributes are adjusted for a partnership adjustment that results in an 
imputed underpayment with respect to which an election is made under 
Sec.  301.6226-1 in accordance with Sec.  301.6226-4, and not the rules 
of this section.
    (ii) Pass-through partners and indirect partners. A pass-through 
partner (as defined in Sec.  301.6241-1(a)(5)) that is a partnership 
and pays an amount under Sec.  301.6226-3(e)(4) treats its share of 
each partnership adjustment reflected on the relevant statement as a 
partnership adjustment described in paragraph (a)(1) of this section, 
treats the amount computed in the same manner as an imputed 
underpayment under Sec.  301.6226-3(e)(4)(iii) as an imputed 
underpayment determined under Sec.  301.6225-1 for purposes of Sec.  
1.704-1(b)(2)(iii)(a) and (f) of this chapter, treats items arising 
from an adjustment that does not result in an imputed underpayment as 
an item under paragraph (d) of this section, and finally treats amounts 
with respect to any penalties, additions to tax, and additional amounts 
and interest computed as an amount described in Sec.  1.704-
1(b)(2)(iii)(f)(3) of this chapter.
    (6) Reflection of economic arrangement. This section and the rules 
in Sec.  1.704-1(b)(1)(viii), (b)(2)(iii)(a) and (f), (b)(2)(iv)(i)(4), 
and (b)(4)(xi), (xii), (xiii), (xiv), and (xv) of this chapter must be 
interpreted in a manner that reflects the economic arrangement of the 
parties and the principles of subchapter K of the Code, taking into 
account the rules of the centralized partnership audit regime.
    (b) Adjusting specified tax attributes in the case of a partnership 
adjustment that results in an imputed underpayment--(1) In general. 
This paragraph (b) applies with respect to each partnership adjustment 
that was taken into account in the calculation of the imputed 
underpayment under Sec.  301.6225-1(c).
    (2) Book value and basis of partnership property--Partnership-level 
specified tax attributes must be adjusted under this paragraph (b)(2). 
Specifically, the partnership must make appropriate adjustments to the 
book value and basis of property to take into account any partnership 
adjustment. No adjustments are made with respect to property that was 
held by the partnership in the reviewed year but is no longer held by 
the partnership in the adjustment year. Amounts determined under 
section 704(c) must also be adjusted to take into account the 
partnership adjustment.
    (3) Creation of notional items based on partnership adjustment--(i) 
In general. In order to give appropriate effect to each partnership 
adjustment for partner-level specified tax attributes, notional items 
are created with respect to each partnership adjustment, except as 
provided in paragraph (b)(4) of this section.
    (ii) Increase in income or gain. In the case of a partnership 
adjustment that is an increase to income or gain, a notional item of 
income or gain is created in an amount equal to the partnership 
adjustment.
    (iii) Increase in expense or loss. In the case of a partnership 
adjustment that is an increase to an expense or a loss, a notional item 
of an expense or loss is created in an amount equal to the partnership 
adjustment.
    (iv) Decrease in income or gain. In the case of a partnership 
adjustment that is a decrease to income or gain, a notional item of 
expense or loss is created in an amount equal to the partnership 
adjustment.
    (v) Decrease in expense or loss. In the case of a partnership 
adjustment that is a decrease to an expense or to a loss, a notional 
item of income or gain is created in an amount equal to the partnership 
adjustment.
    (vi) Credits. If a partnership adjustment reflects a net increase 
or net decrease in credits as determined under Sec.  301.6225-1(d), the 
partnership may have one or more notional items of income, gain, loss, 
or deduction that reflects the change in the item that gives rise to 
the credit, and those items are treated as items in paragraph 
(b)(3)(ii), (iii), (iv), or (v) of this section. For example, if a 
partnership adjustment is to a credit, a notional item of deduction may 
be created when appropriate. See section 280C.
    (4) Situations in which notional items are not created--(i) In 
general. In the case of a partnership adjustment described in this 
paragraph (b)(4), or when the creation of a notional item would 
duplicate a specified tax attribute or an actual item already taken 
into account, notional items are not created. Nevertheless, in these 
situations specified tax attributes are adjusted for the partnership 
and its reviewed year partners or their successors (as defined in Sec.  
1.704-1(b)(i)(viii)(b) of this chapter) in a manner that is consistent 
with how the partnership adjustment would have been taken into account 
under the partnership agreement in effect for the reviewed year taking 
into account all facts and circumstances. See Sec.  1.704-
1(b)(2)(iii)(f)(4) of this chapter for rules for allocating the 
expenditure for an imputed underpayment in these circumstances.
    (ii) Adjustments for non-section 704(b) items. Notional items are 
not created for a partnership adjustment that does not derive from 
items that would have been allocated in the reviewed year under section 
704(b). See paragraph (e) of this section, Example 5.
    (iii) Section 705(a)(2)(B) expenditures. Notional items are not 
created for a partnership adjustment that is a change of an item of 
deduction to a section 705(a)(2)(B) expenditure.
    (iv) Tax-exempt income. Notional items are not created for a 
partnership adjustment to an item of income of a partnership exempt 
from tax under subtitle A of the Code.
    (5) Allocation of the notional items. Notional items are allocated 
to the reviewed year partners or their successors under Sec.  1.704-
1(b)(4)(xi) of this chapter.
    (6) Effect of notional items--(i) In general. The partnership 
creates notional items of income, gain, loss, deduction, or credit in 
order to make appropriate adjustments to specified tax attributes. See 
paragraph (e) of this section, Example 1.
    (ii) Partner capital accounts. For purposes of capital accounts 
determined and maintained in accordance with Sec.  1.704-1(b)(2) of 
this chapter, a notional item of income, gain, loss, deduction or 
credit is treated as an item of income, gain, loss, deduction or credit 
(including for purposes of determining book value). Similar adjustments 
may be appropriate for partnerships that do not determine and maintain 
capital accounts in accordance with Sec.  1.704-1(b)(2) of this 
chapter.
    (iii) Partner's basis in its interest--(A) In general. Except as 
otherwise provided, the basis of a partner's interest in a partnership 
is adjusted (but not below zero) to reflect any notional item allocated 
to the partner by treating the notional item as an item described in 
section 705(a).
    (B) Special basis rules. The basis of a partner's interest in a 
partnership is not adjusted for any notional items allocated to the 
partner--
    (1) When a partner that is not a tax-exempt entity (as defined in 
Sec.  301.6225-2(d)(3)(iii)) is a successor under Sec.  1.704-
1(b)(1)(viii)(b) of this chapter to a reviewed year tax-exempt partner 
(as defined in Sec.  301.6225-2(d)(3)(iii)), to the extent that the IRS 
approved a modification under Sec.  301.6225-2 because the tax-exempt 
partner was not subject to tax; or
    (2) When the notional item would be allocated to a successor that 
is related

[[Page 4879]]

(within the meaning of sections 267(b) or 707(b)) to the reviewed year 
partner, the successor acquired its interest from the reviewed year 
partner in a transaction (or series of transactions) in which not all 
gain or loss is recognized during an administrative adjustment 
proceeding with respect to the partnership's reviewed year under 
subchapter C of chapter 63, and a principal purpose of the interest 
transfer (or transfers) was to shift the economic burden of the imputed 
underpayment among the related parties.
    (c) Determining a partner's share of an expenditure for any payment 
required to be made by a partnership under subchapter C of chapter 63. 
Payment by a partnership of any amount required to be paid under 
subchapter C of chapter 63 as described in Sec.  301.6241-4(a) is 
treated as an expenditure described in section 705(a)(2)(B). Rules for 
determining whether the economic effect of an allocation of these 
expenses is substantial are provided in Sec.  1.704-1(b)(2)(iii)(f) of 
this chapter and rules for determining whether an allocation of these 
expenses is deemed to be in accordance with the partners' interests in 
the partnership are provided in Sec.  1.704-1(b)(4)(xii) of this 
chapter.
    (d) Adjusting tax attributes for a partnership adjustment that does 
not result in an imputed underpayment. The rules under subchapter K 
apply in the case of a partnership adjustment that does not result in 
an imputed underpayment. See Sec.  301.6225-3(c). Accordingly, tax 
attributes (as defined in Sec.  301.6241-1(a)(10)) are adjusted under 
those rules. An item arising from a partnership adjustment that does 
not result in an imputed underpayment (as defined in Sec.  301.6225-
1(c)(2)) is allocated under Sec.  1.704-1(b)(4)(xiii) of this chapter.
    (e) Examples. The following examples illustrate the rules of this 
section. For purposes of these examples, unless otherwise stated, 
Partnership is subject to the provisions of subchapter C of chapter 63, 
Partnership and its partners are calendar year taxpayers, all partners 
are U.S. persons, and the highest rate of income tax in effect for all 
taxpayers is 40 percent for all relevant periods.

    Example 1.  (i) In 2019, A, B, and C are individuals that form 
Partnership. A contributes Whiteacre, which is unimproved land with 
an adjusted basis of $400 and a fair market value of $1000, and B 
and C each contribute $1000 in cash. The partnership agreement 
provides that all income, gain, loss, and deduction will be 
allocated in equal \1/3\ shares among the partners. The partnership 
agreement also provides that the partners' capital accounts will be 
determined and maintained in accordance with Sec.  1.704-1(b)(2)(iv) 
of this chapter, distributions in liquidation of the partnership (or 
any partner's interest) will be made in accordance with the 
partners' positive capital account balances, and any partner with a 
deficit balance in his capital account following the liquidation of 
his interest must restore that deficit to the partnership (as 
provided in Sec.  1.704-1(b)(2)(ii)(b)(2) and (3) of this chapter).
    (ii) Upon formation, Partnership has the following assets and 
capital accounts:

--------------------------------------------------------------------------------------------------------------------------------------------------------
                                           Partnership
                                              basis           Book            Value                        Outside basis       Book            Value
--------------------------------------------------------------------------------------------------------------------------------------------------------
Cash...................................          $2,000          $2,000          $2,000               A             $400          $1,000          $1,000
Whiteacre..............................             400           1,000           1,000               B            1,000           1,000           1,000
                                         ..............  ..............  ..............                C           1,000           1,000           1,000
                                        ----------------------------------------------------------------------------------------------------------------
    Totals.............................           2,400           3,000           3,000  ...............           2,400           3,000           3,000
--------------------------------------------------------------------------------------------------------------------------------------------------------

    (iii) In 2019, Partnership makes a $120 payment for Asset that 
it treats as a deductible expense on its partnership return.

--------------------------------------------------------------------------------------------------------------------------------------------------------
                                           Partnership
                                              basis           Book            Value                        Outside basis       Book            Value
--------------------------------------------------------------------------------------------------------------------------------------------------------
Cash...................................          $1,880          $1,880          $1,880               A             $360            $960          $1,000
Whiteacre..............................             400           1,000           1,000               B              960             960           1,000
Asset..................................               0               0             120                C             960             960           1,000
                                        ----------------------------------------------------------------------------------------------------------------
    Totals.............................           2,280           2,880           3,000  ...............           2,280           2,880           3,000
--------------------------------------------------------------------------------------------------------------------------------------------------------

    (iv) Partnership does not file an AAR for 2020. The IRS 
determines in 2021 (the adjustment year) that Partnership's $120 
expenditure was not allowed as a deduction in 2019 (the reviewed 
year), but rather was the acquisition of an asset for which cost 
recovery deductions are unavailable. Accordingly, the IRS makes a 
partnership adjustment that disallows the entire $120 deduction, 
which results in an imputed underpayment of $48 ($120 x 40 percent). 
Partnership does not request modification under Sec.  301.6225-2. 
Partnership pays the $48 imputed underpayment.
    (v) Partnership first determines its tax attribute adjustments 
resulting from the partnership adjustment by applying paragraph (b) 
of this section. Pursuant to paragraph (b)(2)(i) of this section, 
Partnership must re-state the basis and book value of Asset to $120. 
Further, pursuant to paragraph (b)(3)(ii) of this section, a $120 
notional item of income is created. The $120 item of notional income 
is allocated in equal shares ($40) to A, B, and C in 2021 under 
Sec.  1.704-1(b)(4)(xi) of this chapter. Accordingly, in 2021 
Partnership increases the capital accounts of A, B, and C by $40 
each, and increases A, B, and C's outside bases by $40 each under 
paragraph (b)(5)(ii) and (iii) of this section, respectively.
    (vi) As described in paragraph (c) of this section, 
Partnership's payment of the $48 imputed underpayment is treated as 
an expenditure described in section 705(a)(2)(B) under Sec.  
301.6241-4. Under Sec.  1.704-1(b)(4)(xii) of this chapter, 
Partnership determines each partner's properly allocable share of 
this expenditure in 2021 by allocating the expenditure in proportion 
to the allocations of the notional item to which the expenditure 
relates. Accordingly, each of A, B, and C have a properly allocable 
share of $16 each, which is the same proportion (\1/3\ each) in 
which A, B, and C share the $120 item of notional income. Thus, A, B 
and C's capital accounts are each decreased by $16 in 2021 and A, B 
and C's outside bases are each decreased by $16 in 2021. The 
allocation of the expenditure under the partnership agreement has 
economic effect under Sec.  1.704-1(b)(2)(ii) of this chapter and, 
because the allocation of the expenditure is determined in 
accordance with Sec.  1.704-1(b)(2)(iii)(f) of this chapter, the 
economic effect of these allocations is deemed to be substantial.
    (vii) The payment is also reflected by a $48 decrease in 
partnership cash for book purposes under Sec.  1.704-1(b)(4)(ii) of 
this

[[Page 4880]]

chapter. Therefore, in 2021, A's basis in Partnership is $384 and 
his capital account is $984. B and C each have a basis and capital 
account of $984.

--------------------------------------------------------------------------------------------------------------------------------------------------------
                                           Partnership
                                              basis           Book            Value                        Outside basis       Book            Value
--------------------------------------------------------------------------------------------------------------------------------------------------------
Cash...................................          $1,832          $1,832          $1,832               A             $384            $984            $984
Whiteacre..............................             400           1,000           1,000               B              984             984             984
Asset..................................             120             120             120                C             984             984             984
                                        ----------------------------------------------------------------------------------------------------------------
    Totals.............................           2,352           2,952           2,952  ...............           2,352           2,952           2,952
--------------------------------------------------------------------------------------------------------------------------------------------------------

    Example 2.  (i) The facts are the same as in Example 1 of this 
paragraph (e), except the IRS approves modification under Sec.  
301.6225-2(d)(3) with respect to A, which is a tax-exempt entity, 
and under Sec.  301.6225-2(d)(4) with respect to C, which is a 
corporation subject to a tax rate of 35%. These modifications reduce 
Partnership's overall imputed underpayment from $48 to $30.
    (ii) As in Example 1 of this paragraph (e), Partnership 
determines its tax attribute adjustments resulting from the 
partnership adjustment by applying paragraph (b) of this section. 
Pursuant to paragraph (b)(3)(ii) of this section, a $120 notional 
item of income is created. The $120 item of notional income is 
allocated in equal shares ($40) to A, B, and C in 2021 under Sec.  
1.704-1(b)(4)(xi) of this chapter. Accordingly, in 2021 Partnership 
increases the capital accounts of A, B, and C by $40 each, and 
increases A, B, and C's outside bases by $40 each under paragraph 
(b)(5) (ii) and (iii) of this section, respectively.
    (iii) However, the modifications affect how Partnership must 
allocate the imputed underpayment expenditure among A, B, and C in 
2021 (the adjustment year) pursuant to Sec.  1.704-1(b)(2)(iii)(f) 
of this chapter. Specifically, Partnership allocates the $30 
expenditure in 2021 in proportion to the allocation of the notional 
item to which it relates (which is \1/3\ each as in Example 1 of 
this paragraph (e)), but it must also take into account 
modifications attributable to each partner. Accordingly, B's 
allocation is $16 (its share of the imputed underpayment, for which 
no modification occurred), and A and C have properly allocable 
shares of $0 and $14, respectively (their shares, taking into 
account modification). Thus, A's capital account is decreased by $0, 
B's capital account is decreased by $16, and C's capital account is 
decreased by $14 in 2021 and their respective outside bases are 
decreased by the same amounts in 2021.
    (iv) The payment is also reflected by a $30 decrease in 
partnership cash for book purposes. Therefore, in 2021, A's basis in 
Partnership is $400 and his capital account is $1000, B's basis and 
capital account are both $984, and C's basis and capital account are 
both $986.

--------------------------------------------------------------------------------------------------------------------------------------------------------
                                           Partnership
                                              basis           Book            Value                        Outside basis       Book            Value
--------------------------------------------------------------------------------------------------------------------------------------------------------
Cash...................................          $1,850          $1,850          $1,850               A             $400          $1,000          $1,000
Whiteacre..............................             400           1,000           1,000               B              984             984             984
Asset..................................             120             120             120                C             986             986             986
                                        ----------------------------------------------------------------------------------------------------------------
    Totals.............................           2,370           2,970           2,970  ...............           2,370           2,970           2,970
--------------------------------------------------------------------------------------------------------------------------------------------------------

    Example 3.  The facts are the same as in Example 1 of this 
paragraph (e). However, in 2020, C transfers its entire interest in 
Partnership to D (an individual) for cash. Under Sec.  1.704-
1(b)(2)(iv)(l) of this chapter, C's capital account carries over to 
D. In 2021, the year the IRS determines that Partnership's $120 
expense is not allowed as a deduction, D is C's successor under 
Sec.  1.704-1(b)(1)(viii)(b)(2) of this chapter with respect to 
specified tax attributes and the payment of the imputed underpayment 
treated as an expenditure under section 705(a)(2)(B).
    Example 4.  The facts are the same as in Example 1 of this 
paragraph (e), except that the partnership agreement provides that 
the section 705(a)(2)(B) expenditure for imputed underpayments made 
by the partnership are specially allocated to A (all other items 
continue to be allocated in equal shares). Accordingly, in 2021, the 
section 705(a)(2)(B) expenditure is allocated entirely to A, which 
reduces its capital account by $120, which has economic effect under 
Sec.  1.704-1(b)(2)(ii) of this chapter. However, the economic 
effect of this allocation is not substantial under Sec.  1.704-
1(b)(2)(iii)(a) of this chapter because it is not allocated in the 
manner described in Sec.  1.704-1(b)(2)(iii)(f) of this chapter. The 
allocation will also not be deemed to be in accordance with the 
partners' interests in the partnership under Sec.  1.704-1(b)(3)(ix) 
of this chapter because it is not allocated pursuant to the rules 
under Sec.  1.704-1(b)(4)(xii) of this chapter.
    Example 5.  (i) In 2019, Partnership has two partners, A and B. 
Both A and B have a $0 basis in their interests in Partnership. 
Further, Partnership has a $200 liability as defined in Sec.  1.752-
1(a)(4) of this chapter. The liability is treated as a nonrecourse 
liability as defined in Sec.  1.752-1(a)(2) of this chapter so that 
A and B both are treated as having a $100 share of the liability 
under Sec.  1.752-3 of this chapter. In 2021 (the adjustment year), 
the IRS determines that the liability was inappropriately classified 
as a nonrecourse liability, should have been classified as a 
recourse liability as defined in Sec.  1.752-1(a)(1) of this 
chapter, and that A should have no share of the recourse liability 
under Sec.  1.752-2 of this chapter. As a result of the liability 
misclassification, the IRS assesses an imputed underpayment of $40 
($100 x 40%) resulting from the $100 decrease in A's share of 
partnership liabilities under Sec. Sec.  1.752-1(c) and 1.731-
1(a)(1)(i) of this chapter. Partnership does not request 
modification under Sec.  301.6225-2. Partnership pays the $40 
imputed underpayment.
    (ii) Pursuant to paragraph (b)(4)(ii) of this of this section, 
notional items are not created with respect to this partnership 
adjustment. Instead, under paragraph (b)(4)(i) of this section, 
specified tax attributes are adjusted in a manner that is consistent 
with how the partnership adjustment would have been taken into 
account under the partnership agreement in effect for the reviewed 
year taking into account all facts and circumstances. In this case, 
no specified tax attributes are adjusted.
    (iii) However, because A would have borne the economic burden of 
the partnership adjustment if the partnership and its partners had 
originally reported in a manner consistent with the partnership 
adjustment, the $40 imputed underpayment section 705(a)(2)(B) 
expenditure is allocated to A under Sec.  1.704-1(b)(2)(iii)(f)(4) 
of this chapter.

    (f) Applicability date--(1) In general. Except as provided in 
paragraph (f)(2) of this section, this section applies to partnership 
taxable years beginning after December 31, 2017.
    (2) Election under Sec.  301.9100-22T in effect. This section 
applies to any partnership taxable year beginning after November 2, 
2015 and before January 1, 2018 for which a valid election under Sec.  
301.9100-22T is in effect.
0
Par. 8. Section 301.6226-4 is added to read as follows:

[[Page 4881]]

Sec.  301.6226-4   Effect of a partnership adjustment on tax attributes 
of partnerships and their partners.

    (a) Adjustments to tax attributes--(1) In general. When a 
partnership adjustment (as defined in Sec.  301.6241-1(a)(6)) is taken 
into account by the reviewed year partners (as defined in Sec.  
301.6241-1(a)(9)) or affected partners (as described in Sec.  301.6226-
3(e)(3)(i)) pursuant to an election made by a partnership under Sec.  
301.6226-1, the partnership and its reviewed year partners or affected 
partners must adjust their tax attributes (as defined in Sec.  
301.6241-1(a)(10)) in accordance with the rules in this section.
    (2) Application to pass-through partners and indirect partners. To 
the extent a pass-through partner (as defined in Sec.  301.6241-
1(a)(5)) pays an amount computed in the same manner as an imputed 
underpayment under Sec.  301.6226-3(e)(4)(iii) (paying partnership), 
the paying partnership and its affected partners (as defined in Sec.  
301.6226-3(e)(3)(i)) or their successors must make adjustments to their 
tax attributes in accordance with the rules in Sec.  301.6225-4.
    (3) Allocation of partnership adjustments. Partnership adjustments 
are allocated to the reviewed year partners or affected partners under 
Sec.  1.704-1(b)(4)(xiv) of this chapter.
    (b) Adjusting tax attributes when an election under section 6226 is 
made. For partnership adjustments that are taken into account by the 
reviewed year partners or affected partners because an election is made 
under Sec.  301.6226-1, each partner's share of the partnership 
adjustments are determined under Sec.  301.6226-2(f). Accordingly, the 
reviewed year partners or affected partners must take into account 
items of income, gain, loss, deduction or credit with respect to their 
share of the partnership adjustments as reflected on the statements 
described in Sec.  301.6226-2 or Sec.  301.6226-3(e)(3) (pushed-out 
items) in the reporting year (as defined in Sec.  301.6226-3(a)). 
Similarly, partnerships adjust tax attributes affected by reason of a 
pushed-out item in the adjustment year (as defined in Sec.  301.6241-
1(a)(1)), but these adjustments are calculated with respect to each 
year beginning with the reviewed year (as defined in Sec.  301.6241-
1(a)(8)), followed by any subsequent taxable years, concluding with the 
adjustment year (as defined in Sec.  301.6241-1(a)(1)).

    (c) Example. The following example illustrates the rules of this 
section. For purposes of this example, Partnership is subject to the 
provisions of subchapter C of chapter 63 of the Internal Revenue Code, 
Partnership and its partners are calendar year taxpayers, all partners 
are U.S. persons, and the highest rate of income tax in effect for all 
taxpayers is 40% for all relevant periods.

    Example.  (i) In 2021, J, K and L form Partnership by each 
contributing $500 in exchange for partnership interests that share 
all items of income, gain, loss and deduction in identical shares. 
Partnership immediately purchases Asset on January 1, 2021 for 
$1500, which it depreciates using the straight-line method with a 
10-year recovery period beginning in 2021 ($150) so that each 
partner has a $50 distributive share of the depreciation, resulting 
in an outside basis of $450 for each partner. Accordingly, at the 
end of 2022, J, K and L have an outside basis and capital account of 
$400 each ($500 less $50 of their respective allocable shares of 
depreciation in 2021 and $50 in 2022).

--------------------------------------------------------------------------------------------------------------------------------------------------------
                                           Partnership
                                              basis           Book            Value                        Outside basis       Book            Value
--------------------------------------------------------------------------------------------------------------------------------------------------------
Asset..................................          $1,200          $1,200          $1,500               J             $400            $400            $500
                                         ..............  ..............  ..............               K              400             400             500
                                         ..............  ..............  ..............               L              400             400             500
                                        ----------------------------------------------------------------------------------------------------------------
    Totals.............................           1,200           1,200           1,500  ...............           1,200           1,200           1,500
--------------------------------------------------------------------------------------------------------------------------------------------------------

    (ii) The IRS initiates an administrative proceeding with respect 
to Partnership's 2021 taxable year (reviewed year) in 2023 
(adjustment year) and determines that Asset should have been 
depreciated with a 20-year recovery period beginning in 2021, 
resulting in a $75 partnership adjustment that results in an imputed 
underpayment. The IRS does not initiate an administrative proceeding 
with respect to Partnership's 2022 taxable year, and Partnership 
does not file an administrative adjustment request for that taxable 
year. Partnership makes an election under Sec.  301.6226-1 with 
respect to the imputed underpayment. Therefore, J, K and L each are 
furnished a statement described in Sec.  301.6226-2 by Partnership 
reflecting the $25 income adjustment for 2021. Pursuant to Sec.  
301.6226-2(e)(6), the statement furnished by Partnership to J, K, 
and L also reflects a $25 income adjustment to the 2022 intervening 
year.
    (iii) Tax attributes must be adjusted to reflect the $75 pushed-
out item of income that is taken into account in equal shares ($25) 
by J, K, and L with respect to 2021. Specifically, J, K and L's 
outside bases and capital accounts must be increased $25 each with 
respect to the 2021 tax year. Additionally, tax attributes must be 
adjusted with respect to 2022, as an intervening year. Specifically, 
J, K and L must increase their outside bases and capital accounts by 
$25 each with respect to the 2022 tax year. As a result, J, K and L 
each have an outside basis and capital account of $425 ($400 minus 
$25 of depreciation for 2023 plus $25 of income realized with 
respect to 2021 plus $25 of income realized with respect to 2022). 
Asset's basis and book value must also be changed in 2023. Thus, 
after adjusting tax attributes to take into account the election 
under Sec.  301.6225-1 and taking into account other activities of 
Partnership in 2023, accounts are stated as follows:

--------------------------------------------------------------------------------------------------------------------------------------------------------
                                           Partnership
                                              basis           Book            Value                        Outside basis       Book            Value
--------------------------------------------------------------------------------------------------------------------------------------------------------
Asset..................................          $1,275          $1,275          $1,500               J             $425            $425            $500
                                         ..............  ..............  ..............               K              425             425             500
                                         ..............  ..............  ..............               L              425             425             500
                                        ----------------------------------------------------------------------------------------------------------------
    Totals.............................           1,275           1,275           1,500  ...............           1,275           1,275           1,500
--------------------------------------------------------------------------------------------------------------------------------------------------------

    (d) Applicability date--(1) In general. Except as provided in 
paragraph (d)(2) of this section, this section applies to partnership 
taxable years beginning after December 31, 2017.
    (2) Election under Sec.  301.9100-22T in effect. This section 
applies to any partnership taxable year beginning after November 2, 
2015 and before January 1,

[[Page 4882]]

2018 for which a valid election under Sec.  301.9100-22T is in effect.

Kirsten Wielobob,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 2018-01989 Filed 2-1-18; 8:45 am]
 BILLING CODE 4830-01-P