Treatment of Special Enforcement Matters, 74940-74955 [2020-25904]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 85, Number 227 (Tuesday, November 24, 2020)]
[Proposed Rules]
[Pages 74940-74955]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-25904]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 301

[REG-123652-18]
RIN 1545-BP01


Treatment of Special Enforcement Matters

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: This document contains proposed regulations to except certain 
partnership-related items from the centralized partnership audit regime 
that was created by the Bipartisan Budget Act of 2015, and sets forth 
alternative rules that will apply. The centralized partnership audit 
regime does not apply to a partnership-related item if the item 
involves a special enforcement matter described in these regulations. 
Additionally, these regulations propose changes to the regulations to 
account for changes to the Internal Revenue Code (Code). Finally, these 
proposed regulations also make related and clarifying amendments to the 
final regulations under the centralized partnership audit regime. The 
proposed regulations would affect partnerships and partners to whom 
special enforcement matters apply.

DATES: Written or electronic comments must be received by January 25, 
2021.

ADDRESSES: Commenters are strongly encouraged to submit public comments 
electronically. Submit electronic submissions via the Federal 
eRulemaking Portal at www.regulations.gov (indicate IRS and REG-123652-
18) by following the online instructions for submitting comments. Once 
submitted to the Federal eRulemaking Portal, comments cannot be edited 
or withdrawn. The IRS expects to have limited personnel

[[Page 74941]]

available to process public comments that are submitted on paper 
through mail. Until further notice, any comments submitted on paper 
will be considered to the extent practicable. The Department of the 
Treasury (Treasury Department) and the IRS will publish for public 
availability any comment submitted electronically, and to the extent 
practicable on paper, to its public docket. Send paper submissions to: 
CC:PA:LPD:PR (REG-123652-18), Room 5203, Internal Revenue Service, PO 
Box 7604, Ben Franklin Station, Washington, DC 20044.

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Jennifer M. Black of the Office of Associate Chief Counsel (Procedure 
and Administration), (202) 317-6834; and concerning submissions of 
comments and/or requests for a public hearing, Regina Johnson, (202) 
317-5177 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

    This document contains proposed amendments to the Procedure and 
Administration Regulations (26 CFR part 301) regarding special 
enforcement matters under section 6241(11) of the Code and the 
collection of amounts due under the centralized partnership audit 
regime pursuant to section 6241(7) of the Code. Section 6241(11) was 
enacted by section 206 of the Tax Technical Corrections Act of 2018, 
contained in Title II of Division U of the Consolidated Appropriations 
Act of 2018, Public Law 115-141 (TTCA). This document also contains 
several proposed amendments to the final regulations on the centralized 
partnership audit regime published in TD 9844 (84 FR 6468) on February 
27, 2019.
    Section 1101(a) of the Bipartisan Budget Act of 2015, Public Law 
114-74 (BBA) amended chapter 63 of the Code (chapter 63) by removing 
former subchapter C of chapter 63 effective for partnership taxable 
years beginning after December 31, 2017. Former subchapter C of chapter 
63 contained the unified partnership audit and litigation rules enacted 
by the Tax Equity and Fiscal Responsibility Act of 1982, Public Law 97-
248 (TEFRA) that were commonly referred to as the TEFRA partnership 
procedures or simply, TEFRA. Section 1101(b) of the BBA removed 
subchapter D of chapter 63 and amended chapter 1 of the Code (chapter 
1) by removing part IV of subchapter K of chapter 1, rules applicable 
to electing large partnerships, effective for partnership taxable years 
beginning after December 31, 2017. Section 1101(c) of the BBA replaced 
the TEFRA partnership procedures and the rules applicable to electing 
large partnerships with a centralized partnership audit regime that 
determines adjustments and, in general, determines, assesses, and 
collects tax at the partnership level. Section 1101(g) of the BBA set 
forth the effective dates for these statutory amendments, which are 
effective generally for returns filed for partnership taxable years 
beginning after December 31, 2017. On December 18, 2015, section 1101 
of the BBA was amended by the Protecting Americans from Tax Hikes Act 
of 2015, Public Law 114-113 (PATH Act). The amendments under the PATH 
Act are effective as if included in section 1101 of the BBA, and 
therefore, subject to the effective dates in section 1101(g) of the 
BBA.
    Enacted on March 23, 2018, the TTCA made a number of technical 
corrections to the centralized partnership audit regime, including 
adding sections 6241(11) (regarding the treatment of special 
enforcement matters) and 6232(f) (regarding the collection of the 
imputed underpayment and other amounts due from partners of the 
partnership in the event the amounts are not paid by the partnership) 
to the Code. The amendments to subchapter C of chapter 63 included in 
the TTCA are effective as if included in section 1101 of the BBA, and 
therefore, subject to the effective dates in section 1101(g) of the 
BBA.
    On January 2, 2018, the Treasury Department and the IRS published 
in the Federal Register (82 FR 28398) final regulations under section 
6221(b) providing rules for electing out of the centralized partnership 
audit regime (TD 9829).
    On August 9, 2018, the Treasury Department and the IRS published in 
the Federal Register (83 FR 39331) final regulations under section 6223 
providing rules relating to partnership representatives and final 
regulations under Sec.  301.9100-22 providing rules for electing into 
the centralized partnership audit regime for taxable years beginning on 
or after November 2, 2015, and before January 1, 2018. Corresponding 
temporary regulations under Sec.  301.9100-22T were also withdrawn (TD 
9839).
    On February 27, 2019, the Treasury Department and the IRS published 
in the Federal Register (84 FR 6468) final regulations implementing 
sections 6221(a), 6222, and 6225 through 6241 of the centralized 
partnership audit regime (TD 9844).
    Under section 6241(11), in the case of partnership-related items 
involving special enforcement matters, the Secretary of the Treasury or 
his delegate (Secretary) may prescribe regulations providing that the 
centralized partnership audit regime (or any portion thereof) does not 
apply to such items and that such items are subject to special rules as 
the Secretary determines to be necessary for the effective and 
efficient enforcement of the Code. For purposes of section 6241(11), 
the term ``special enforcement matters'' means: (1) Failure to comply 
with the requirements of section 6226(b)(4)(A)(ii) (regarding the 
requirement for a partnership-partner or S corporation partner to 
furnish statements or compute and pay an imputed underpayment); (2) 
assessments under section 6851 (relating to termination assessments of 
income tax) or section 6861 (relating to jeopardy assessments of 
income, estate, gift, and certain excise taxes); (3) criminal 
investigations; (4) indirect methods of proof of income; (5) foreign 
partners or partnerships; and (6) other matters that the Secretary 
determines by regulation present special enforcement considerations.

Explanation of Provisions

    On January 14, 2019, the IRS published in the Internal Revenue 
Bulletin Notice 2019-06, 2019-03 IRB 353 (Notice 2019-06), informing 
taxpayers that the Treasury Department and the IRS intended to propose 
regulations addressing two special enforcement matters under section 
6241(11). These regulations propose the rules addressed in Notice 2019-
06 and several other rules regarding special enforcement matters under 
section 6241(11).
    These regulations also propose several changes to regulations 
finalized in TD 9844 to provide clarity regarding certain provisions. 
Changes are required to the regulations finalized in TD 9844 to address 
the treatment of chapter 1 taxes, penalties, additions to tax, 
additional amounts, and any imputed underpayments previously reported 
by the partnership adjusted as part of an examination under the 
centralized partnership audit regime to correspond to the addition of 
proposed Sec.  301.6241-7(g), which is discussed in part 5.F of this 
Explanations of Provisions. Additional edits are proposed to modify the 
rules implementing section 6241(7) regarding the treatment of 
adjustments when a partnership ceases to exist to account for the 
addition of section 6232(f) to the Code. Finally, minor clarifying 
edits are proposed.
    In addition to the changes listed above, certain regulations have 
been reordered or renumbered, typographical

[[Page 74942]]

errors have been corrected, and nonsubstantive editorial changes have 
been made.

1. Election Out of the Centralized Partnership Audit Regime

    Certain partnerships may elect out of the centralized partnership 
audit regime under section 6221(b). Section 301.6221(b)-1 provides the 
rules for electing out of the centralized partnership audit regime, 
including determining whether a partnership is eligible to elect out of 
the centralized partnership audit regime. A partnership is eligible to 
make an election out if it has 100 or fewer partners for the taxable 
year, each partner in the partnership is an eligible partner, the 
election is timely made in the manner prescribed by the Secretary, and 
the partnership notifies its partners of the election in the manner 
prescribed by the Secretary. Section 301.6221(b)-1(b)(2)(i) generally 
provides that a partnership has 100 or fewer partners if the 
partnership is required to furnish 100 or fewer statements under 
section 6031(b) for the taxable year. As part of determining whether a 
partnership has 100 or fewer partners, section 6221(b)(2)(A) and Sec.  
301.6221(b)-1(b)(2)(ii) require a partnership with a partner that is an 
S corporation (as defined in section 1361(a)(1)) to take into account 
each statement required to be furnished by the S corporation to its 
shareholders under section 6037(b) for the taxable year of the S 
corporation ending with or within the partnership's taxable year.
    Eligible partners are those persons prescribed in section 
6221(b)(1)(C) and Sec.  301.6221(b)-1(b)(3)(i). Under Sec.  
301.6221(b)-1(b)(3)(ii)(D) a partner is not an eligible partner if the 
partner is a ``disregarded entity described in Sec.  301.7701-
2(c)(2)(i).'' Proposed Sec.  301.6221(b)-1(b)(3)(ii)(D) changes 
``disregarded entity described in Sec.  301.7701-2(c)(2)(i)'' to ``a 
wholly-owned entity disregarded as separate from its owner for Federal 
income tax purposes'' and would include, for example, a qualified REIT 
subsidiary (as defined in section 856(i)(2)) or grantor trust. This 
change is made to be consistent with the description of a disregarded 
entity used elsewhere in the regulations under the centralized 
partnership audit regime. See, e.g., Sec. Sec.  301.6225-2; 301.6226-3; 
301.6241-1.
    The proposed regulations also add Sec.  301.6221(b)-1(b)(3)(ii)(G), 
which addresses partnerships with qualified subchapter S subsidiaries 
(QSubs) as partners to remove any ambiguity regarding whether a 
partnership with a QSub as a partner can elect out of the centralized 
partnership audit regime. A QSub is defined in section 1361(b)(3)(B) as 
any domestic corporation that is not an ineligible corporation (as 
defined in section 1361(b)(2)) if 100 percent of the stock of such 
corporation is held by an S corporation and the S corporation elects to 
treat such corporation as a QSub. See Sec.  1.1361-4(a)(1). However, 
section 1361(b)(3)(A) provides that, ``[e]xcept as provided in 
regulations prescribed by the Secretary, for purposes of this title'' 
(that is, the Code): (i) A corporation that is a QSub is not treated as 
a separate corporation, and (ii) all assets, liabilities, and items of 
income, deduction, and credit, of a QSub are treated as assets, 
liabilities, and such items (as the case may be) of its parent S 
corporation. Further, section 1361(b)(3)(E) provides that, except to 
the extent provided by the Secretary, the rules of section 1361(b)(3) 
do not apply with respect to the provisions of part III of subchapter A 
of chapter 61 of the Code (relating to information reporting). That is, 
a QSub is treated as a separate corporation for information reporting 
purposes. See Sec.  1.1361-4(a)(9). Section 6031(b), one of the 
provisions of part III of subchapter A of chapter 61, provides that 
each partnership required to file a return must furnish to each person 
who is a partner or who holds an interest in the partnership as a 
nominee for another person at any time during a partnership taxable 
year a copy of the information required to be shown on the return as 
may be required by regulations. Thus, if a QSub is treated as a partner 
in a partnership, then under section 6031(b) the partnership is 
required to furnish a statement containing its return information to 
the QSub.
    Notice 2019-06 states that partnership structures with QSubs as 
partners present special enforcement concerns because allowing a 
partnership with a QSub partner to elect out of the centralized 
partnership audit regime would enable a partnership to elect out in 
situations where there are over 100 ultimate taxpayers. If a 
partnership elects out of the centralized partnership audit regime, any 
adjustments must be made in examinations of the ultimate taxpayers who 
own interests in the partnership. To limit the number of examinations 
the IRS must conduct, Congress determined that only partnerships with 
100 or fewer partners could elect out of the centralized partnership 
audit regime. Section 6221(b). In addition, under section 6221(b), 
partnerships with partners that are flow-through entities, except for 
partners that are S corporations, are ineligible to elect out of the 
centralized partnership audit regime. For partnerships with S 
corporation partners, the shareholders of the S corporation partner are 
counted in determining if the partnership has 100 or fewer partners. 
Section 6221(b)(2)(A). Accordingly, if such partnerships elect out of 
the centralized partnership audit regime, this will generally result in 
there being less than 101 ultimate taxpayers to potentially examine. 
However, as described above, if partnerships with QSubs as partners are 
eligible to elect out, this may result in the IRS having to examine 
more than 100 ultimate taxpayers for a particular partnership.
    For example, in contrast to S corporations, if a QSub was an 
eligible partner for purposes of section 6221, because a QSub is not an 
S corporation, the special rules for S corporations under section 
6221(b)(2)(A) and Sec.  301.6221(b)-1(b)(2)(ii) would not apply to a 
QSub partner. These special rules require the partnership to count the 
number of statements required to be furnished by the S corporation 
partner in determining if the partnership has 100 or fewer partners for 
the taxable year. Therefore, in a situation where a partnership that 
has a QSub as a partner and 99 other individual partners for purposes 
of section 6031(b), the stock of the S corporation that wholly owned 
the stock of the QSub could be owned by well over 100 ultimate 
taxpayers who satisfy the requirements of section 1361(b)(1)(A) 
(limiting the number of shareholders of an S corporation to 100) by 
reason of section 1361(c)(1) (treating members of a family as one 
shareholder for purposes of section 1361(b)(1)(A)). Allowing such a 
partnership to elect out of the centralized partnership regime would 
clearly frustrate the efficiencies the regime was intended to create.
    To avoid this result and the attendant special enforcement 
concerns, Notice 2019-06 states that the Treasury Department and the 
IRS intend to propose regulations under section 6241(11)(B)(vi) 
providing that the ability to elect out of the centralized partnership 
audit regime under section 6221(b) generally does not apply to a 
partnership with a QSub as a partner. Notice 2019-06 states that the 
proposed regulations would apply a rule similar to the rules for S 
corporations under section 6221(b)(2)(A), which would require an S 
corporation holding the QSub stock to disclose the name and taxpayer 
identification number of each person with respect to whom the S 
corporation is required to furnish a statement under section 6037(b) 
for the taxable year of the S corporation ending with or within the 
partnership taxable year. Such statements are treated as if

[[Page 74943]]

they were furnished by the partnership. See section 6221(b)(2)(A)(ii). 
Therefore, under Notice 2019-06, each statement furnished by the 
partnership to the S corporation, and by the S corporation to its 
shareholders, would be included in determining if the partnership has 
100 or fewer partners for the taxable year for purposes of the election 
out of the centralized partnership audit regime.
    In determining whether a QSub is an eligible partner under section 
6221(b), Notice 2019-06 cites to section 1361(a)(2), which provides 
that a corporation, other than an S corporation (as defined in section 
1361(b)(1)), is a C corporation. Comments to the centralized 
partnership audit regime and Notice 2019-06 revealed a lack of 
consensus regarding how section 1361 should be interpreted.
    A comment relating to rules for electing out of the centralized 
partnership audit regime requested guidance confirming that a partner's 
status as a QSub does not prevent a partnership from electing out of 
the centralized partnership audit regime based on the belief that 
current law under section 1361 treats a QSub as an eligible partner 
(that is, a C corporation) and so requires this result. Further, the 
comment stated that a QSub is not a disregarded entity as described in 
Sec.  301.7701-2(c)(2)(i) and even if a QSub is ignored for most 
Federal tax purposes, such treatment is afforded by section 
1361(b)(3)(A)(i) and not Sec.  301.7701-2(c)(2)(i). Section 301.7701-
2(c)(2)(i) provides that a business entity that has a single owner and 
is not a ``per se'' corporation under Sec.  301.7701-2(b) is 
disregarded as an entity separate from its owner. Thus, the comment 
concluded that a QSub could never be the type of disregarded entity 
that Treasury regulations identify as an ineligible partner.
    In contrast, another comment in response to Notice 2019-06 stated 
that Notice 2019-06 incorrectly states that, because a QSub is not an S 
corporation, it is a C corporation and therefore, an eligible partner 
under section 6221(b). The comment provided the rationale that, when a 
corporation makes a QSub election, it is treated under section 
1361(b)(3)(A) as if it liquidated into its parent S corporation and 
accordingly, no longer exists, for purposes of the Code, as a separate 
entity for Federal tax purposes (even though for state law purposes, 
such as limited liability, it still exists). Therefore, the comment 
stated that a QSub is not a partner under section 6221(b) and concluded 
that the parent S corporation is treated as the partner and that the S 
corporation, not the QSub, should provide its shareholder information 
to the partnership under section 6221(b)(2) for purposes of determining 
whether the partnership may elect out of the centralized partnership 
audit regime.
    Although Notice 2019-06 states that the proposed regulations would 
have applied a rule similar to the rules for S corporations under 
section 6221(b)(2)(A) to partnerships with a QSub as a partner, the 
Treasury Department and the IRS have reconsidered that approach. Under 
Sec.  301.6221(b)-1(b)(3)(ii), partnerships that have disregarded 
entities as partners may not elect out of the centralized partnership 
audit regime. QSubs are treated similarly to disregarded entities for 
most purposes under the Code in that both QSubs and disregarded 
entities do not file income tax returns but instead report their items 
of income and loss on the returns of the person who wholly owns the 
entity. Thus, as described earlier in this part and in Notice 2019-06, 
the Treasury Department and the IRS have determined that partnership 
structures with QSubs as partners present special enforcement concerns 
because allowing a partnership with a QSub partner to elect out of the 
centralized partnership audit regime would enable a partnership to 
elect out in situations where there are over 100 ultimate taxpayers, 
thereby frustrating the efficiencies the regime was intended to create. 
To make clear to taxpayers that a QSub cannot be used to facilitate the 
election out of the centralized partnership audit regime by a 
partnership with greater than 100 ultimate taxpayers, the Treasury 
Department and the IRS have determined it is necessary for the proposed 
regulations to address such a special enforcement concern by treating 
QSubs as ineligible partners for purposes of section 6221. Accordingly, 
proposed Sec.  301.6221(b)-1(b)(3)(ii)(G) provides that a QSub is not 
an eligible partner for purposes of making an election out of the 
centralized partnership audit regime under section 6221(b). Therefore, 
if a QSub is a partner in a partnership and required to be furnished a 
statement by the partnership under section 6031(b), that partnership 
will not be eligible to make an election under section 6221(b) to elect 
out of the centralized partnership audit regime.

2. Imputed Underpayments, Chapter 1 Taxes, Penalties, Additions to Tax, 
and Additional Amounts

    If the IRS adjusts a partnership's chapter 1 taxes, penalties, 
additions to tax, or similar amounts utilizing the centralized 
partnership audit regime, there must be a mechanism for including these 
amounts in the imputed underpayment and accounting for these amounts if 
the partnership elects to push out the adjustments under section 6226. 
In addition, there must also be a mechanism to account for any 
adjustments to a previously determined imputed underpayment. 
Accordingly, these proposed rules apply to the calculation of the 
imputed underpayment during an IRS examination and to adjustments to 
the imputed underpayment as calculated by the partnership. For example, 
the rules apply to the filing of an administrative adjustment request 
(AAR) when the partnership-partner computes and pays an imputed 
underpayment. For proposed changes related to Sec.  301.6241-3, see 
part 4, Cease to Exist.
A. Inclusion of Adjustments to an Imputed Underpayment and the 
Partnership's Chapter 1 Taxes, Penalties, Additions to Tax, or 
Additional Amounts in an Imputed Underpayment
    Section 301.6225-1 provides rules for how to calculate the imputed 
underpayment. First, all adjustments are placed into groups of similar 
adjustment types and netted appropriately, resulting in net positive or 
negative adjustments (as described in Sec.  301.6225-1(e)(4)(i)). Most 
net positive adjustments to items of income, gain, loss, and deduction 
are then added together to create a total netted partnership adjustment 
and a tax rate is then applied. That amount is then increased or 
decreased by any adjustments to credits. Credits are not included in 
earlier steps of the imputed underpayment calculation because credits 
generally adjust a taxpayer's amount of tax owed on a dollar-for-dollar 
basis after a tax rate has been applied. If adjustments to credits were 
taken into account as part of the total netted partnership adjustment 
before the tax rate was applied, the value of the credits would be 
reduced by the tax rate applied and, because of that reduction, would 
no longer operate as an increase or decrease in tax on a dollar-for-
dollar basis.
    Proposed Sec.  301.6225-1 modifies the final regulations under 
Sec.  301.6225-1 to provide a mechanism for including the partnership's 
chapter 1 taxes, penalties, additions to tax, or additional amounts, as 
well as any adjustment to a previously determined imputed underpayment 
(chapter 1 liabilities), in the calculation of the imputed 
underpayment. Under proposed Sec.  301.6225-1(c)(3), any adjustments to 
the partnership's chapter 1 liabilities

[[Page 74944]]

will be placed in the credit grouping and treated similarly to credit 
adjustments for purposes of calculating the imputed underpayment. 
Adjustments to these amounts are placed into the credit grouping 
because, similar to credits, they change the amount the partnership 
owes on a dollar-per-dollar basis. Multiplying these adjustments to 
chapter 1 liabilities by a tax rate after the amount has been 
calculated would be inappropriate because, like credits, these amounts 
increase or decrease the amount owed on a dollar-per-dollar basis. If 
these chapter 1 liabilities were included with the other partnership 
adjustments, they would be multiplied by a tax rate, which would 
inappropriately reduce the amount of the partnership's chapter 1 
liabilities. Thus, treating adjustments to chapter 1 liabilities 
similarly to credit adjustments allows for appropriate increases or 
decreases to the imputed underpayment.
    The proposed addition to Sec.  301.6225-1(d)(2)(ii) provides that a 
decrease in a chapter 1 liability is treated as a negative adjustment. 
Because Sec.  301.6225-1(d)(2)(iii) provides that a positive adjustment 
is any adjustment that is not a negative adjustment as defined in Sec.  
301.6225-1(d)(2)(ii), the proposed addition to the definition of a 
negative adjustment has the result of making an increase in a chapter 1 
liability a positive adjustment. Because Sec.  301.6225-1(e)(4) defines 
net positive adjustments and net negative adjustments with respect to 
the definitions of positive and negative adjustments, the proposed 
addition to Sec.  301.6225-1(d)(2)(ii) affects those definitions as 
well.
    In general, net positive adjustments are used to calculate the 
imputed underpayment, and net negative adjustments are adjustments that 
do not result in an imputed underpayment as described in Sec.  
301.6225-1(f). An exception to that rule is the treatment of credit 
adjustments. Both net positive and net negative adjustments to credits 
may be included in the calculation of the imputed underpayment to 
increase or decrease the imputed underpayment amount after the tax rate 
is applied to other adjustments. See Sec.  301.6225-1(b)(1)(v) and 
(e)(3)(ii). If a net negative adjustment applied to the imputed 
underpayment reduces the amount of the imputed underpayment to zero or 
below zero, the imputed underpayment adjustments are treated as 
adjustments that do not result in an imputed underpayment under Sec.  
301.6225-1(f)(1)(ii). These adjustments would then be taken into 
account by the partnership on the adjustment year return pursuant to 
Sec.  301.6225-3 or by the reviewed year partners pursuant to Sec.  
301.6226-3.
    This rule does not operate well, however, when the adjustment that 
has reduced the imputed underpayment below zero is a net negative 
adjustment to chapter 1 liabilities because the chapter 1 liabilities 
at issue are adjustments to the liability of the partnership, not the 
partners, and they are thus neither properly allocated to the partners 
after they are reported on the partnership's next filed return nor 
properly pushed out to the partners under section 6226. These amounts 
could be used to offset another chapter 1 liability of the partnership, 
but partnerships may not have those types of items on their returns 
each year because partnerships are often not liable for tax under 
chapter 1. Treating these amounts similarly to other adjustments could 
result in an amount reported on the partnership's return that would not 
result in an overpayment to the partnership and for which there may not 
be an item to offset in the adjustment year. Accordingly, for 
partnerships to take advantage of a net negative adjustment to these 
chapter 1 liabilities, a special rule is required.
    The proposed addition to Sec.  301.6225-1(e)(3)(ii), along with 
proposed Sec.  301.6225-1(f)(1)(ii) and (f)(3), provides two special 
rules for the treatment of a net negative adjustment to chapter 1 
liabilities. Under the first rule, a net negative adjustment to a 
credit is normally treated as an adjustment that does not result in an 
imputed underpayment under Sec.  301.6225-1(f)(1)(i), unless the IRS 
makes a determination to have it offset the imputed underpayment. The 
proposed addition to Sec.  301.6225-1(e)(3)(ii) states that a net 
negative adjustment to one of the chapter 1 liabilities is not an 
adjustment described in Sec.  301.6225-1(f).
    The second rule creates an exception to Sec.  301.6225-1(f)(1)(ii), 
which provides that if the calculation of the imputed underpayment 
under Sec.  301.6225-1(b)(1) results in a number that is zero or less 
than zero, the partnership adjustments associated with that calculation 
are treated as adjustments that do not result in an imputed 
underpayment. Proposed Sec.  301.6225-1(f)(3) provides a new method for 
calculating the imputed underpayment if the imputed underpayment 
calculation results in zero or less than zero and includes a net 
negative adjustment to one of the chapter 1 liabilities at issue. This 
new calculation provides that the imputed underpayment be recalculated 
using all partnership adjustments under Sec.  301.6225-1(b)(1) except 
for the net negative adjustments to the chapter 1 liabilities. Once 
that calculation is complete, if the imputed underpayment is a number 
greater than zero, the imputed underpayment may be reduced, but not 
below zero, using the net negative adjustment to the chapter 1 
liabilities at issue. If this happens, the adjustments that went into 
the calculation are not adjustments that do not result in an imputed 
underpayment because the partnership has effectively paid the imputed 
underpayment calculated on these adjustments through the application of 
the net negative adjustment to chapter 1 liabilities (or a portion 
thereof). Any remaining portion of the net negative adjustment to 
chapter 1 liabilities is not an adjustment that does not result in an 
imputed underpayment. If, however, the imputed underpayment is already 
zero or less than zero, the net negative adjustments to the chapter 1 
liabilities are not added back to the imputed underpayment calculation, 
and the net negative adjustments to the chapter 1 liabilities are not 
treated as adjustments that do not result in an imputed underpayment.
    If there is an additional amount of the net negative adjustment to 
chapter 1 liabilities that was not included in the imputed underpayment 
calculation (that is, there was excess after the imputed underpayment 
was reduced to zero or if the imputed underpayment was zero or less 
than zero regardless of the net negative adjustment to chapter 1 
liabilities), the partnership may be able to recoup that amount to 
offset a prior payment. For instance, if the adjustment related to an 
amount previously paid by the partnership, the partnership may file a 
claim for refund of the amount in accordance with section 6511. 
Alternatively, if the amount has not been previously paid by the 
partnership, the remaining net negative adjustment to a chapter 1 
liability will reduce the amount of chapter 1 tax, penalty, additional 
amount, addition to tax, or imputed underpayment owed by the 
partnership.
B. Exception to the Section 6226 Push Out Election
    Proposed Sec.  301.6226-2(g)(4) provides that a partnership that 
makes an election under section 6226 (sometimes called a ``push out 
election'') must pay any chapter 1 taxes, penalties, additions to tax, 
and additional amounts or the amount of any adjustment to an imputed 
underpayment at the time statements are furnished to its partners in 
accordance with Sec.  301.6226-2. Because these amounts are the 
partnership's liability, partnerships are not permitted to push out any

[[Page 74945]]

adjustments to these items when making the push out election.

3. Adjustments to Items That Are Not Items of Income, Gain, Loss, 
Deduction, or Credit

    The final regulations implementing section 6225 do not expressly 
explain how adjustments to items that are not items of income, gain, 
loss, deduction, or credit (collectively referred to as ``non-income 
items'') are taken into account (1) in the calculation of the imputed 
underpayment; (2) as adjustments that do not result in an imputed 
underpayment; or (3) if the partnership elects to push out the 
adjustments to its reviewed year partners. Examples of non-income items 
include the partnership's assets, liabilities, and capital accounts. 
Accordingly, amendments are proposed to the final regulations to 
clarify the treatment of adjustments to non-income items.
    Under section 6241(2)(A) and Sec.  301.6241-1(a)(6)(i), a 
partnership adjustment is any adjustment to a partnership-related item. 
Under section 6241(2)(B) and Sec.  301.6241-1(a)(6)(ii), a partnership-
related item is any item or amount that is relevant in determining the 
chapter 1 liability of any person that is reflected, or required to be 
reflected, on the partnership's return under section 6031 for the 
taxable year or required to be maintained in the partnership's books 
and records, any partner's distributive share of such items, and the 
imputed underpayment. Accordingly, adjustments to non-income items that 
meet this definition are partnership-related items. See, e.g., Sec.  
301.6241-1(a)(6)(ii)(C)-(E). Under Sec.  301.6225-1(a)(1), all 
partnership adjustments, including adjustments to non-income items, are 
taken into account in determining whether the adjustments result in an 
imputed underpayment.
    In some cases, adjustments to non-income items will be related to 
adjustments to items of income, gain, loss, deduction, or credit (for 
example, if an item was expensed that was required to be capitalized). 
Under Sec.  301.6225-1(b)(4), the IRS may treat an adjustment as zero 
solely for purposes of calculating an imputed underpayment if that 
adjustment is reflected in one or more partnership adjustments. 
Accordingly, the IRS could, if appropriate, treat an adjustment to a 
non-income item as zero solely for purposes of calculating the imputed 
underpayment if the effect of the adjustment is already reflected in an 
adjustment to an item of income, gain, loss, deduction, or credit. 
However, Sec.  301.6225-1(b)(4) only provides this authority to the 
IRS. Accordingly, an addition is proposed to Sec.  301.6225-1(b)(4) to 
provide that, generally, an adjustment to a non-income item that is 
related to, or results from, an adjustment to an item of income, gain, 
loss, deduction, or credit is treated as zero as part of the 
calculation of an imputed underpayment unless the IRS determines that 
the adjustment should be included in the imputed underpayment. This 
proposed addition not only clarifies the rule in Sec.  301.6225-1(b)(4) 
but also extends the rule in Sec.  301.6225-1(b)(4) to persons other 
than the IRS. Consequently, when filing an AAR a partnership may treat 
an adjustment to a non-income item as zero if the adjustment is related 
to, and the effect is reflected in, an adjustment to an item of income, 
gain, loss, deduction, or credit unless the IRS subsequently 
determines, in an examination of the AAR, that both adjustments should 
be included in the calculation of the imputed underpayment.
    As discussed in part 2.A of this Explanation of Provisions, Sec.  
301.6225-1(d)(2)(iii)(A) defines a ``positive adjustment'' as any 
adjustment that is not a negative adjustment. An adjustment to a non-
income item, by definition, is not an adjustment to an item of income, 
gain, loss, deduction, credit, or chapter 1 liability, therefore, and 
is a positive adjustment. However, as with any other adjustment, an 
adjustment to a non-income item may be an adjustment that does not 
result in an imputed underpayment, as defined in Sec.  301.6225-1(f), 
if the adjustment is included in a calculation that results in an 
amount that is zero or less than zero.
    Proposed Sec.  301.6225-3(b)(8) clarifies the rules for taking into 
account adjustments to non-income items if they are adjustments that do 
not result in an imputed underpayment. Under proposed Sec.  301.6225-
3(b)(8), a partnership takes into account adjustments to non-income 
items in the adjustment year by adjusting the item on its adjustment 
year return to be consistent with the adjustment (for example, in 
amount, character, or classification). However, this only applies to 
the extent the item would appear on the adjustment year return without 
regard to the adjustment. If the item already appears on the 
partnership's adjustment year return as a non-income item or the item 
appeared as a non-income item on any return of the partnership for a 
taxable year between the reviewed year and the adjustment year, the 
partnership does not create a new item on the partnership's adjustment 
year return. For example, if the adjustment results in the addition of 
a liability in the reviewed year but the partnership had reported the 
liability on its return for the year immediately following the reviewed 
year and the liability was paid off prior to the adjustment year, then 
the adjustment to the liability does not create a new liability in the 
adjustment year and the adjustment is disregarded when the partnership 
takes into account the adjustments that did not result in an imputed 
underpayment on its adjustment year return. Accordingly, the 
partnership takes into account the adjustment to the non-income item 
by, for example, changing the character or amount of the item on the 
adjustment year return consistent with the adjustment to the non-income 
item. Proposed Sec.  301.6225-3(d)(3) provides an example of the 
application of this rule.

4. Cease To Exist

    Section 6241(7) provides that if a partnership ceases to exist 
prior to the partnership adjustments taking effect, the adjustments are 
taken into account by the former partners of the partnership. To 
utilize the provisions of section 6241(7) the partnership must first 
have ceased to exist, as defined in proposed Sec.  301.6241-3(b), prior 
to the adjustments taking effect. In addition to the provisions of 
section 6241(7), if a partnership has ceased to exist, section 6232(f) 
provides rules that allow the IRS to assess a former partner for that 
partner's proportionate share of any amounts owed by the partnership 
under the centralized partnership audit regime.
A. When Partnership Adjustments Take Effect
    Section 301.6241-3(c) provides that the partnership adjustments 
take effect when there is full payment of the tax and other amounts 
owed as a result of the partnership adjustments. If the partnership 
ceases to exist prior to the amounts due being fully paid, the former 
partners must take into account the adjustments. This interpretation 
could potentially preclude the use of section 6232(f) because if there 
is an amount due from the partnership any determination that a 
partnership has ceased to exist will trigger the rules under section 
6241(7) as it would occur prior to the adjustments taking effect (i.e., 
full payment).
    Section 6232(f) expressly provides for rules that govern the use of 
section 6232(f) in situations when a partnership has ceased to exist. 
Accordingly, it would be inconsistent with the intent of Congress to 
define when the

[[Page 74946]]

adjustments take effect in a way that precludes the use of section 
6232(f) when a partnership has ceased to exist. Therefore, proposed 
Sec.  301.6241-3 amends Sec.  301.6241-3(b) to provide that a 
partnership adjustment takes effect when the adjustments become finally 
determined as described in Sec.  301.6226-2(b)(1); when the partnership 
and IRS enter into a settlement agreement regarding the adjustment; or, 
for adjustments reflected in an AAR, when the AAR is filed. After this 
amendment, the rules under section 6241(7) would apply prior to the 
adjustments taking effect and the rules under section 6232(f) would 
apply once the adjustments have taken effect.
    As a result of this change, the proposed regulations contain 
additional conforming changes to other provisions in Sec.  301.6241-3. 
Proposed Sec.  301.6241-3(b)(1)(ii) was modified to provide that a 
partnership ceases to exist if the IRS determines that the partnership 
does not have the ability to pay in full any amount that the 
partnership may become liable for under the centralized partnership 
audit regime. Previously, Sec.  301.6241-3(b)(1)(ii) provided that the 
partnership ceases to exist if the IRS determines that the partnership 
does not have the ability to pay any amounts due under the centralized 
partnership audit regime. As proposed Sec.  301.6241-3 only applies 
prior to the adjustments becoming finally determined, the partnership 
would not have an amount due under the centralized partnership audit 
regime at that time. Because the partnership would not have an amount 
due, Sec.  301.6241-3 is incompatible with section 6232(f). 
Accordingly, proposed Sec.  301.6241-3 reconciles section 6232(f) with 
section 6241(7) in a way that gives meaning to both sections.
    Additionally, proposed Sec.  301.6241-3 would remove Sec.  
301.6241-3(b)(2). Section 301.6241-3(b)(2) provides situations for when 
the IRS will not determine that a partnership ceases to exist. Under 
Sec.  301.6241-3(b)(2), the IRS would not make such determination if 
the partnership has a valid election under section 6226 in effect, if a 
pass-through partner receives a statement under section 6226 and 
furnishes statements to its partners, or if the partnership has not 
paid any amount due under the centralized partnership audit regime, but 
was able to pay such amount. As all these exceptions cover situations 
where the partnership adjustments have already been finally determined, 
this provision is no longer necessary. Similarly, Sec.  301.6241-
3(c)(2) regarding partial payments by the partnership is also proposed 
to be removed because it is impossible to have an amount due until 
after the adjustments become finally determined. Accordingly, after the 
changes introduced by proposed Sec.  301.6241-3, there would be nothing 
upon which to make a partial payment before the adjustments take 
effect.
    Finally, Sec.  301.6241-3(e)(2)(ii) is proposed to be modified to 
provide that statements under Sec.  301.6241-3 must be furnished to the 
former partners and filed with the IRS no later than 60 days after the 
later of the date the IRS notifies the partnership that it has ceased 
to exist or the date the adjustments take effect, as described in Sec.  
301.6241-3(c). Section 301.6241-3(e)(2)(ii) provides that statements 
must be furnished no later than 30 days after the date the IRS notifies 
the partnership that the partnership has ceased to exist. Now, with the 
proposed change to when adjustments take effect, the IRS may determine 
that a partnership has ceased to exist prior to the date the 
adjustments become finally determined. To prevent confusion, statements 
should not be issued until the adjustments become final. Section 
301.6241-3(e)(2)(ii) is proposed to be adjusted accordingly. The 
proposed change from 30 days to 60 days for furnishing statements is 
intended to conform the rules for statements in Sec.  301.6241-3 with 
those in Sec.  301.6226-2.
B. Former Partners
    As described previously, if a partnership ceases to exist prior to 
the adjustments taking effect, the former partners of the partnership 
must take the adjustments into account. Section 301.6241-3(d) defines 
former partners as the partners from the adjustment year of the 
partnership or, if there were no adjustment year partners, the partners 
from the partnership taxable year for which a final partnership return 
is filed. Proposed Sec.  301.6241-3(d) modifies the definition of 
former partners to be partners of the partnership during the last 
taxable year for which a partnership return or AAR was filed or the 
most recent persons determined to be the partners of the partnership in 
a final determination (for example, final court decision, defaulted 
notice of final partnership adjustment (FPA), or settlement agreement). 
As discussed previously, proposed Sec.  301.6241-3 applies prior to the 
adjustments taking effect. Because the adjustment year does not exist 
until the adjustments become final, proposed Sec.  301.6241-3 would not 
apply after that point. Accordingly, the definition of former partners 
is modified to reflect the partners that are the partners of the 
partnership before the partnership adjustments take effect.
    Finally, the examples under Sec.  301.6241-3(f) are modified to 
reflect the changes to Sec.  301.6241-3 previously described in this 
Explanation of Provisions.

5. Miscellaneous Amendments to Regulations Finalized in TD 9844

    In addition to the amendments described above, two other 
miscellaneous clarifications to the regulations finalized in TD 9844 
are being proposed in these regulations.
    First, under Sec.  301.6225-2(d)(2)(vi)(A), as part of a request 
for modification of an imputed underpayment a pass-through partner may 
file an amended return, take into account its share of the partnership 
adjustments, and determine and pay an amount calculated in the same 
manner as the amount computed under Sec.  301.6226-3(e)(4)(iii). In 
calculating the amount due under Sec.  301.6225-2(d)(2)(vi)(A), a pass-
through partner may, as described in Sec.  301.6225-2(d)(2)(vi)(B), 
take into account any modifications approved with respect to its direct 
and indirect partners. Under Sec.  301.6226-3(e)(4)(iii), a pass-
through partner calculates an imputed underpayment on its allocable 
share of the adjustments, taking into account any modifications 
approved with respect to its direct and indirect partners. Accordingly, 
Sec.  301.6225-2(d)(2)(vi)(B) is redundant in that, under Sec.  
301.6225-2(d)(2)(vi)(A), a pass-through partner computes the amount due 
by reference to Sec.  301.6226-3(e)(4)(iii), which also allows a pass-
through partner to take into account modifications approved with 
respect to its direct and indirect owners when computing its amount 
due. Therefore, the proposed regulations propose to remove Sec.  
301.6225-2(d)(2)(vi)(B) as in the final regulations and replace it as 
described below. Also, additional language is added to the end of Sec.  
301.6225-2(d)(2)(vi)(A) by the proposed regulations to clarify the 
reference to Sec.  301.6226-3(e)(4)(iii) for the needs of a 
partnership-partner pursuing modification under section 6225.
    Section 301.6225-2(d)(2)(vi)(A) is silent as to how the pass-
through partner would take into account any adjustments that do not 
result in an imputed underpayment. Under Sec.  301.6226-3(e)(4)(v), a 
pass-through partner who pays an imputed underpayment takes into 
account any adjustments that did not result in an imputed underpayment 
in accordance with Sec.  301.6225-3 in the taxable year of the pass-
through partner that includes the date the imputed underpayment is 
paid. Under Sec.  301.6226-3(e)(4)(v), if

[[Page 74947]]

there are only adjustments that do not result in an imputed 
underpayment, the pass-through partner takes into account those 
adjustments in the taxable year of the pass-through partner that 
includes the date the statement under section 6226 is furnished to that 
pass-through partner.
    The Treasury Department and the IRS have determined that a pass-
through partner that pays an amount as part of an amended return 
submitted for purposes of modifying an imputed underpayment should take 
into account any adjustments that do not result in an imputed 
underpayment in the taxable year the amount is paid by the pass-through 
partner. However, unlike under Sec.  301.6226-3(e)(4)(v), a pass-
through partner should not be able to take adjustments that do not 
result in an imputed underpayment into account as part of a request for 
modification unless the partnership pays an amount on the corresponding 
adjustments that resulted in an imputed underpayment. If there are 
solely adjustments that do not result in an imputed underpayment, those 
adjustments should be subject to modification by the ultimate taxpayers 
who reported the original amounts and not by any new partners of the 
pass-through partner. Accordingly, proposed Sec.  301.6225-
3(d)(2)(vi)(B) provides that a pass-through partner that is paying an 
amount as part of an amended return filed during modification takes 
into account any adjustments that do not result in an imputed 
underpayment in the taxable year of the pass-through partner that 
includes the date the payment is made. This provision, however, does 
not apply if no payment is made by the partnership because no payment 
is required.
    Finally, under Sec.  301.6225-3(b)(1), a partnership adjustment 
that does not result in an imputed underpayment is taken into account 
as a reduction in non-separately stated income or as an increase in 
non-separately stated loss for the adjustment year. However, not all 
adjustments that do not result in an imputed underpayment are negative 
adjustments. For example, adjustments may not result in an imputed 
underpayment because, after the application of adjustments to credits, 
the imputed underpayment is zero or less than zero. In those cases, it 
would be inappropriate for a positive adjustment to reduce non-
separately stated income or increase non-separately stated loss. 
Accordingly, the proposed change to Sec.  301.6225-3(b)(1) clarifies 
that adjustments that do not result in an imputed underpayment, except 
as provided in Sec.  301.6225-3(b)(2) through (7), can increase or 
decrease non-separately stated income or loss, as appropriate, 
depending on whether the adjustment is to an item of income or loss.

6. Special Enforcement Matters

    Proposed Sec.  301.6241-7(a) provides the general rule that the 
partnership-related items described in proposed Sec.  301.6241-7 
involve special enforcement matters.
A. Partnership-Related Item Components of Non-Partnership-Related Items
    Section 6221(a) requires that any adjustment to a partnership-
related item must be determined at the partnership level under the 
centralized partnership audit regime, except to the extent otherwise 
provided in subchapter C of chapter 63. Section 6241(2)(B) defines a 
partnership-related item as any item or amount with respect to the 
partnership which is relevant in determining the tax liability of any 
person under chapter 1, including any distributive share of such an 
item or amount.
    Generally, adjusting partnership-related items in a centralized 
proceeding at the partnership level is the most efficient way to 
determine adjustments to partnership-related items. Under the 
centralized partnership audit procedures, the IRS can then efficiently 
assess and collect any tax associated with the adjustments. Requiring 
the IRS to adjust certain partnership-related items at the partnership 
level in a centralized proceeding, however, would interfere with the 
efficient enforcement of the Code. These circumstances present special 
enforcement considerations.
    Specifically, the Treasury Department and the IRS have determined 
that special enforcement considerations are presented where the 
partnership's treatment of a partnership-related item on its return or 
in its books and records is based in whole, or in part, on information 
provided by a person other than the partnership. In these 
circumstances, it is more efficient for the IRS and the partner if the 
IRS makes an adjustment to a partnership-related item during an 
examination of the partner rather than opening a separate examination 
of the partnership to first adjust the partnership-related item at 
issue in the examination of the partner. It also is likely that the 
partnership is not in the best position to substantiate the information 
upon which the partnership's treatment of that partnership-related item 
is based and may not have detailed or adequate records regarding the 
information. In situations in which the number of partners potentially 
impacted by an adjustment is limited, adjusting the partnership-related 
items in direct examinations of those partners does not raise 
inefficiency or inconsistency concerns that the centralized partnership 
audit regime is designed to alleviate. As a result, it may be a more 
efficient use of both IRS and taxpayer resources to examine and adjust 
that partnership-related item in an examination of the person who 
provided this information. The IRS anticipates making these adjustments 
in cases in which the adjustments are likely only relevant to a single 
partner or a small group of partners and are unlikely to involve items 
that are allocable to all partners generally or that impact the 
partnership as a whole.
    For example, if a partner contributes a non-depreciable asset to a 
partnership in exchange for a partnership interest, any issues 
regarding the basis in the asset may be more easily identified in an 
examination of the partner who contributes the asset than in an 
examination of the partnership. Because the asset is not depreciable 
the partnership does not take any depreciation deductions with respect 
to the asset. Proper deductions are likely to be the focus of an 
examination of the partnership, but the basis of the asset is not until 
the partnership disposes of the asset. In contrast, the contribution of 
the asset itself is a partnership-related item, and the basis of the 
asset that is contributed is taken into account in determining the 
partner's basis in the partnership interest (not a partnership-related 
item). The partner's basis in the partnership interest may affect the 
ability of the partner to claim a distributive share of deductions or 
losses or the computation of gain or loss the partner would recognize 
on the sale of the partnership interest, items that are commonly 
reviewed in an examination of a partner. These types of partnership-
related items are therefore more likely to be identified during 
examinations of a single partner or a small group of partners, not 
during an examination of the partnership alone.
    The ability to adjust certain partnership-related items at the 
partner level under these circumstances should be beneficial to 
partnerships and partners, as well as the IRS. For partnerships, this 
special rule alleviates the need to open an examination of the 
partnership under the centralized partnership audit procedures solely 
to adjust the partnership-related items based on information provided 
by the partner who is already independently under examination. This 
relieves the partnership from having to expend

[[Page 74948]]

resources during an examination for items related primarily to the 
partner who provided the information.
    This rule allows those partners whose non-partnership-related items 
are being adjusted during an examination of their return to more fully 
control and participate in any adjustments or determinations that need 
to be made to partnership-related items that underlie or affect the 
non-partnership-related item that is being adjusted. Further, after 
adjustments to certain partnership-related items impacting a single 
partner or a small group of partners are made there are cases in which 
it may not be necessary to adjust any other partnership-related item of 
the partnership, and an examination at the partnership level would be 
unnecessary. Adjusting these partnership-related items (or portions 
thereof) outside of subchapter C of chapter 63 also allows the IRS to 
effectively and efficiently focus on a single partner or a small group 
of partners with respect to a limited set of partnership-related items 
without unduly burdening the partnership.
    Therefore, under proposed Sec.  301.6241-7(b), the IRS may 
determine that subchapter C of chapter 63 does not apply to an 
adjustment or determination of a partnership-related item if an 
adjustment or determination of that partnership-related item is part 
of, or underlies, an adjustment to a non-partnership-related item 
during an examination of a person other than the partnership. However, 
this rule only applies if the treatment of the partnership-related item 
on the return of the partnership (or in its books and records) is based 
in whole or in part on information provided by the person under 
examination. Accordingly, if the IRS determines that subchapter C of 
chapter 63 (of a portion thereof) does not apply, the IRS may adjust, 
or make determinations regarding, partnership-related items that 
underlie, or are part of adjustments or determinations regarding a non-
partnership-related item of the person under examination. Proposed 
Sec.  301.6241-7(b)(2) provides an example that illustrates this 
provision.
B. Termination and Jeopardy Assessments
    Section 6241(11)(B)(ii) provides that assessments under section 
6851 (relating to termination assessments of income tax) or section 
6861 (relating to jeopardy assessments of income, estate, gift, and 
certain excise taxes) are special enforcement matters. Consequently, 
the Secretary may prescribe rules under which subchapter C of chapter 
63 (or a portion thereof) does not apply to partnership-related items 
allocable to a partner or indirect partner subject to a termination or 
jeopardy assessment and those partnership-related items are subject to 
special rules as is necessary for the effective and efficient 
enforcement of the Code. Section 6241(11)(A).
    In termination and jeopardy assessment situations, the IRS makes an 
immediate assessment against a taxpayer to collect tax where the 
collection of tax is in jeopardy. In these special circumstances, the 
IRS needs to be able to make a full assessment of any amounts 
determined to be owed or risk being unable to collect tax in the 
future.
    To address this special enforcement matter, proposed Sec.  
301.6241-7(c) provides that for any taxable year of a partner or 
indirect partner for which an assessment of income tax under section 
6851 or section 6861 is made, the IRS may adjust any partnership-
related item with respect to such partner or indirect partner as part 
of making that assessment without regard to subchapter C of chapter 63. 
When making a termination or jeopardy assessment against a partner or 
indirect partner, the IRS will be able to protect the government's 
interest quickly with respect to a particular partner or indirect 
partner without having to conduct a proceeding under subchapter C of 
chapter 63 at the partnership level.
C. Criminal Investigations
    Section 6241(11)(B)(iii) provides that criminal investigations 
constitute a special enforcement matter. As such, the Secretary may 
prescribe rules under which subchapter C of chapter 63 (or a portion 
thereof) does not apply to partnership-related items with respect to a 
taxpayer subject to criminal investigation and these partnership-
related items are subject to special rules as is necessary for the 
effective and efficient enforcement of the Code. Section 6241(11)(A). 
The IRS needs to preserve flexibility in addressing potential 
adjustments so as to not interfere with criminal investigations.
    To address this special enforcement matter, proposed Sec.  
301.6241-7(d) provides that the IRS may adjust any partnership-related 
item with respect to any partner or indirect partner for any taxable 
year of a partner or indirect partner for which the partner or indirect 
partner is under criminal investigation without regard to subchapter C 
of chapter 63.
D. Indirect Methods of Proof
    Section 6241(11)(B)(iv) provides that indirect methods of proof of 
income constitute a special enforcement matter. As such, the Secretary 
may prescribe rules under which subchapter C of chapter 63 (or a 
portion thereof) does not apply to partnership-related items with 
respect to a taxpayer whose income is subject to an indirect method of 
proof and these partnership-related items are subject to special rules 
as is necessary for the effective and efficient enforcement of the 
Code. Section 6241(11)(A).
    When using an indirect method of proving a person's income, the IRS 
may not be able to determine whether the income is derived from 
partnership-related items of a partnership subject to the centralized 
partnership audit regime. Accordingly, the IRS must be able to 
determine a person's income without determining whether any of the 
income identified using an indirect method of proof are partnership-
related items that must be adjusted under the centralized partnership 
audit regime. Requiring the IRS to determine what amount of income 
identified using an indirect method of proof is attributable to a 
partnership-related item would frustrate the administration of the Code 
by making it nearly impossible to utilize an indirect method of proof 
because the source of the specific income is generally not readily 
apparent when an indirect method of proof is being utilized.
    To address this special enforcement matter, proposed Sec.  
301.6241-7(e)(1) provides that the IRS may adjust any partnership-
related item as part of a determination of any deficiency (or portion 
thereof) of the partner or indirect partner that is based on an 
indirect method of proof without regard to subchapter C of chapter 63.
E. Controlled Partnerships and the Partner's Period of Limitations
    Under section 6221, any adjustments to partnership-related items 
must be made at the partnership level. Section 6235 sets the period of 
limitations in which those adjustments to partnership-related items 
must be made. Although the items of a partnership are reported on the 
partnership's return, a partnership itself does not pay income tax. See 
section 701. The true tax impact and completeness of the partnership's 
reporting may not be apparent except by reviewing the partners' returns 
that report the partnership-related items. Additionally, in allocating 
resources and determining whether to open an examination, the IRS may 
identify issues either by reviewing the partners' returns or the 
partnership's return. Certain partnership issues may only become 
apparent at a future date or during an examination of a partner,

[[Page 74949]]

which can frustrate the IRS's ability to allocate resources and examine 
taxpayers timely, especially in situations where the partnership 
structure includes many related and controlled entities.
    Many partnerships, through many related and controlled entities, 
are ultimately controlled by a single or small number of individuals. 
The ultimate tax impact of the partnership's reporting would not be 
evident until the items were traced through a network of entities until 
they reach the single, or small group, of ultimate taxpayers. Many of 
these structures are examined as a group or as part of an examination 
of the controlling individual. In these situations, the existence of 
the partnership or the ultimate tax impact may not be known until the 
period of limitations on making adjustments to the partnership has 
expired, even though the controlling taxpayer may still be under 
examination. In those cases, the most efficient way to examine the 
partnership's reporting might be as part of a consolidated examination 
or during the examination of the controlling individual. In these 
cases, all of the related and controlled entities and their 
transactions can be considered together, benefiting both the IRS and 
the taxpayer by eliminating the need for separate examinations. These 
situations also present special enforcement considerations.
    Specifically, the Treasury Department and the IRS have determined 
that special enforcement considerations are presented when the period 
of limitations on making adjustments to the partnership has expired for 
a taxable year but a controlling partner's period of limitations on 
assessment of chapter 1 tax has not expired or where the partner has 
voluntarily agreed to extend the period of limitation. When examining a 
partner that has control of a partnership through multiple tiered 
entities it may not be evident that an adjustment to an item on the 
controlling partner's return requires an adjustment to a partnership-
related item until the controlling partner's interest is finally traced 
to a partnership. It may not be possible for this tracing to be 
completed before the period of limitations to make adjustments to the 
partnership has expired. In these circumstances, it is necessary for 
the effective and efficient enforcement of the Code to make adjustments 
or determinations regarding partnership-related items at the partner 
level during an examination of the controlling partner who has an open 
period to assess chapter 1 tax with respect to that item or amount. The 
same principles apply with respect to a partner who has consented to 
extend the period of limitations.
    Under proposed Sec.  301.6241-7(f), the IRS may only make 
adjustments or determinations as to partnership-related items without 
regard to subchapter C of chapter 63 if the partner has control of the 
partnership or if the partner has voluntarily agreed to extend his or 
her period of limitations on making assessments under section 6501. The 
extension agreement must expressly provide that the partner is 
extending the time to adjust and assess any tax attributable to 
partnership-related items for the taxable year.
    To determine if a direct or indirect partner has control of the 
partnership, proposed Sec.  301.6241-7(f)(1) incorporates the rules 
under sections 267(b) and 707(b). Accordingly, a direct or indirect 
partner will be deemed to be in control of the partnership if the 
partner is related to the partnership under sections 267(b) or 707(b).
F. Penalties and Taxes Imposed on the Partnership Under Chapter 1
    Except as otherwise provided under subchapter C of section 63, 
under section 6221(a), adjustments to partnership-related items and the 
applicability of any penalty, addition to tax, or additional amount 
that relates to an adjustment to partnership-related items must be 
determined at the partnership level. To be a partnership-related item, 
the item must be relevant in determining the tax liability of any 
person under chapter 1. Section 6241(2)(B)(i); Sec.  301.6241-
1(a)(6)(iv). A tax, penalty, addition to tax, or additional amount that 
is imposed on, and which is the liability of, the partnership under 
chapter 1 could qualify as a partnership-related item that would need 
to be adjusted under the centralized partnership audit regime.
    The purpose of the centralized partnership audit regime is to 
create a centralized and efficient means of examining partnerships 
instead of examining partners. This purpose would not be served if 
these chapter 1 taxes and penalties were adjusted in an examination 
under this regime because these taxes and penalties are imposed on the 
partnership itself and are not the liability of the partners. As a 
liability of the partnership, these chapter 1 penalties and taxes are 
incompatible with the centralized partnership audit regime, which is 
designed to approximate the chapter 1 liability on the adjustments that 
would have been owed by the partners, not the partnership. On the other 
hand, when a liability is owed by the partnership itself, the 
partnership's exact liability should be determined and paid by that 
partnership. As such, the centralized partnership audit regime is 
generally not compatible with chapter 1 penalties and taxes imposed on 
partnerships. However, there could be situations where an adjustment to 
a chapter 1 tax or penalty owed by the partnership would be more 
appropriately adjusted at the partnership level, such as when the 
adjustment relates to, or results from, other adjustments being made at 
the partnership level. Accordingly, for the reasons stated above, the 
Treasury Department and the IRS have determined that special 
enforcement considerations are presented where a tax, penalty, addition 
to tax, or additional amount is imposed on, and is the liability of, a 
partnership under chapter 1.
    Therefore, under proposed Sec.  301.6241-7(g), the IRS may 
determine that the centralized partnership audit regime does not apply 
to any taxes, penalties, additions to tax, or additional amounts 
imposed on a partnership under chapter 1 and to any determination made 
to determine whether the partnership meets the requirements for the tax 
or penalty, addition to tax, or additional amount. Accordingly, these 
taxes and penalties may be determined outside the centralized 
partnership audit regime in the same manner as they would be determined 
and imposed for entities not subject to the centralized partnership 
audit regime, such as corporations. Additionally, if the IRS is 
determining any chapter 1 tax or penalty imposed on the partnership 
outside of the centralized partnership audit regime, the IRS may also 
adjust any partnership-related item, outside of the centralized 
partnership audit regime, as part of any determination necessary to 
determine the amount and applicability of the chapter 1 tax or penalty. 
This rule does not apply to determinations surrounding the actual 
payment of the chapter 1 tax or penalty, such as whether the payment is 
deductible and any determinations regarding how the payment must be 
allocated amongst the partners. For the rules for when a chapter 1 tax 
or penalty is determined under the centralized partnership audit 
regime, see part 2 of this Explanation of Provisions.
G. Determining That Subchapter C of Chapter 63 Does Not Apply
    Proposed Sec.  301.6241-7(h)(1) provides that if the IRS determines 
that all or some of the rules under the centralized partnership audit 
regime do not apply to a partnership-related item (or portion

[[Page 74950]]

thereof) under the rules described in paragraphs (b) (partnership-
related items underlying adjustments to non-partnership-related items), 
(c) (termination and jeopardy assessments), (d) (criminal 
investigations), (e) (indirect methods of proof of income), (f) 
(controlled partnerships and extensions of the partner's period of 
limitations), or (g) (penalties and taxes imposed on the partnership 
under chapter 1), then the IRS will notify, in writing, the taxpayer to 
whom the adjustments are being made. The Treasury Department and the 
IRS request comments on the timing of notices to be provided under 
proposed Sec.  301.6241-7(h)(1) including comments regarding whether 
the timing should be different based on the specific provision that is 
applicable.
    Proposed Sec.  301.6241-7(h)(2) provides that any final decision 
with respect to any partnership-related item adjusted outside of the 
centralized partnership audit regime is not binding on the partnership, 
any partner, or any indirect partner that is not a party to the 
proceeding because there is no provision which would make them liable 
for any adjustments in a proceeding to which they are not a party.
H. Coordination With Adjustments Made at the Partnership Level
    If the IRS makes adjustments to partnership-related items in an 
examination of a person other than the partnership and adjustments are 
made to the same partnership-related items in an examination of the 
partnership, there is a potential for the same adjustments to be 
subject to tax at both the partner and partnership level. Proposed 
Sec.  301.6241-7(i) sets forth a rule that would prevent taxing the 
same partnership-related item twice. Under this rule, if a deficiency 
is calculated or an adjustment is proposed by the IRS that includes 
amounts based on adjustments to partnership-related items and the 
person can establish that specific amounts included within the 
deficiency or adjustment were previously taxed to the partner in one of 
two sets of circumstances, the amounts will not be included in the 
deficiency or adjustment.
    First, the partner or indirect partner can exclude amounts 
previously taken into account by the partner or indirect partner under 
the centralized partnership audit regime. For example, the partner 
could demonstrate that the amounts were taken into account through an 
amended return modification, the alternative to amended return 
modification, or through a push out election.
    Second, a partner can exclude amounts included in an imputed 
underpayment that was paid by a partnership (or pass-through partner) 
in which the partner was a reviewed year partner or indirect partner. 
The amounts included as part of an imputed underpayment may only be 
excluded from the deficiency or adjustment if the amount included in 
the imputed underpayment exceeds the amount reported by the partnership 
to the partner (for example, on a Schedule K-1 or statement under 
section 6227) or is otherwise included in the deficiency or adjustment 
determined by the IRS (for example, as part of the deficiency based on 
a means other than an indirect method of proof). In other words, a 
partner may only exclude amounts included in an imputed underpayment 
paid by a partnership if the partner was taxed on the original amounts 
reported by the partnership to the partner. This puts the partner in 
parity with other partners in the partnership that are not subject to a 
special rule. Those partners are required to report consistently with 
the statements furnished by the partnership to the partner and are not 
taxed on any additional amounts included in an imputed underpayment 
paid by a partnership.
I. Applicability Dates
    If this proposed rule is finalized, the revisions to the 
regulations finalized in TD 9829 and TD 9844 will be applicable on 
November 20, 2020.
    Proposed Sec.  301.6241-7(j) provides the applicability dates for 
the rules contained in proposed Sec.  301.6241-7. Proposed Sec.  
301.6241-7(j) provides that, except for the rules contained in proposed 
Sec.  301.6241-7(b) (partnership-related items that underlie non-
partnership-related items), the rules contained in proposed Sec.  
301.6241-7 apply to partnership taxable years ending after November 20, 
2020, or any examination or investigation beginning after [DATE THE 
FINAL RULE IS FILED FOR PUBLIC INSPECTION AT THE OFFICE OF THE FEDERAL 
REGISTER]. Proposed Sec.  301.6241-7(j) provides that the rules 
contained in proposed Sec.  301.6241-7(b) apply to partnership taxable 
years beginning after December 20, 2018, or to any examinations or 
investigations beginning after [DATE THE FINAL RULE IS FILED FOR PUBLIC 
INSPECTION AT THE OFFICE OF THE FEDERAL REGISTER].
    Section 7805(b)(7) permits the Secretary to allow taxpayers to 
elect to apply a regulation retroactively. Accordingly, proposed Sec.  
301.6241-7(j) contains a provision that provides that, notwithstanding 
the applicability dates provided in proposed Sec.  301.6241-7(j), the 
IRS and a partner may agree to apply any provision of proposed Sec.  
301.6241-7 to any taxable year of a partner that corresponds to a 
partnership taxable year that is subject to the centralized partnership 
audit regime.

Special Analyses

    This regulation is not subject to review under section 6(b) of 
Executive Order 12866 pursuant to the Memorandum of Agreement (April 
11, 2018) between the Treasury Department and the Office of Management 
and Budget regarding review of tax regulations.
    In accordance with the Regulatory Flexibility Act (5 U.S.C. 601 et 
seq.) it is hereby certified that this proposed rule will not have a 
significant economic impact on a substantial number of small entities.
    The proposed rules directly affect any partnership subject to the 
centralized partnership audit regime under subchapter C of chapter 63. 
As all partnerships are subject to the centralized partnership audit 
regime unless they make a valid election out of the regime, the 
proposed rules are expected to affect a substantial number of small 
entities. However, the IRS has determined that the economic impact on 
small entities affected by the proposed rule would not be significant.
    The proposed rules under Sec.  301.6241-7 implement section 
6241(11) and allow the IRS, for partnership-related items that involve 
special enforcement matters, to provide that the centralized 
partnership audit regime (or a portion thereof) does not apply to such 
partnership-related items and that such items are subject to special 
rules as is necessary for the efficient and effective enforcement of 
the Code. As such, except for one circumstance, the proposed rules 
provide for certain situations where partnership-related items may be 
adjusted outside of the centralized partnership audit regime. In all 
but one of these situations, if the rules in proposed Sec.  301.6241-7 
were utilized, then the adjustments would be made to partners of the 
partnership, rather than the partnership itself and, thus, utilizing 
the proposed rules would not have an impact on small entities. 
Additionally, many small entities may be eligible to elect out of the 
centralized partnership audit regime under section 6221(b). 
Accordingly, if a small entity is eligible to elect out, they may 
choose to elect out of the regime at which point the rules contained in 
proposed

[[Page 74951]]

Sec.  301.6241-7 would be inapplicable to those entities.
    Finally, the proposed rules under Sec.  301.6241-7 address the 
process for conducting an examination and do not have a significant 
economic impact on small entities as the rules do not affect entities' 
substantive tax, such as the requirement to include items in income or 
the deductibility of items. The proposed rules promulgated under other 
Code sections simply clarify sections of regulations previously 
published. Accordingly, any significant economic impact on small 
entities will result from the application of the substantive tax 
provisions and will not be as a result of the procedural rules 
contained in proposed Sec.  301.6241-7.
    The Secretary hereby certifies that the proposed rule will not have 
a significant economic impact on a substantial number of small 
entities. The Treasury Department and the IRS invite comment from 
members of the public about potential impacts on small entities.
    Pursuant to section 7805(f) of the Code, this notice of proposed 
rulemaking has been submitted to the Chief Counsel for the Office of 
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 www.irs.gov.

Comments and Requests for Public Hearing

    Before these proposed amendments to the regulations are adopted as 
final regulations, consideration will be given to comments that are 
submitted timely to the IRS as prescribed in the preamble under the 
ADDRESSES section. The Treasury Department and the IRS request comments 
on all aspects of the proposed regulations. Any electronic comments 
submitted, and to the extent practicable any paper comments submitted, 
will be made available at www.regulations.gov or upon request.
    A public hearing will be scheduled if requested in writing by any 
person who timely submits electronic or written comments. Requests for 
a public hearing are also encouraged to be made electronically. If a 
public hearing is scheduled, notice of the date and time for the public 
hearing will be published in the Federal Register. Announcement 2020-4, 
2020-17 I.R.B 1, provides that until further notice, public hearings 
conducted by the IRS will be held telephonically. Any telephonic 
hearing will be made accessible to people with disabilities.

Drafting Information

    The principal author of these proposed regulations is Jennifer M. 
Black of the Associate Chief Counsel (Procedure and Administration). 
However, other personnel from the Treasury Department and the IRS 
participated in the development of the proposed regulations.

List of Subjects in 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 part 301 is proposed to be amended as follows:

PART 301--PROCEDURE AND ADMINISTRATION

0
Par. 1. The authority citation for part 301 is amended by adding 
entries in numerical order to read in part as follows:

    Authority:  26 U.S.C. 7805.
* * * * *
    Section 301.6221(b)-1 also issued under sections 6221 and 6241.
* * * * *
    Section 301.6241-7 also issued under section 6241.
* * * * *
0
Par. 2. Section 301.6221(b)-1 is amended by revising paragraphs 
(b)(3)(ii)(D) and (F), adding paragraph (b)(3)(ii)(G), and adding a 
sentence to the end of paragraph (f) to read as follows:


Sec.  301.6221 (b)-1  Election out for certain partnerships with 100 or 
fewer partners.

* * * * *
    (b) * * *
    (3) * * *
    (ii) * * *
    (D) A wholly owned entity disregarded as separate from its owner 
for Federal income tax purposes,
* * * * *
    (F) Any person who holds an interest in the partnership on behalf 
of another person, or
    (G) A qualified subchapter S subsidiary, as defined in section 
1361(b)(3)(B).
* * * * *
    (f) * * * Notwithstanding the preceding sentence, paragraph 
(b)(3)(ii)(D), (F), and (G) of this section are applicable on November 
20, 2020.


Sec.  301.6223-1  [Amended]

0
Par. 3. Section 301.6223-1 is amended by removing ``B'' and ``B's'' and 
adding ``PR'' and ``PR's'' in its place, respectively, wherever either 
appears in Examples 1 and 2 in paragraph (e)(8).
0
Par. 4. Section 301.6225-1 is amended:
0
1. By revising the paragraph (b)(3) subject heading;
0
2. By adding a sentence to the end of paragraph (b)(4);
0
3. By adding a sentence to the end of paragraph (c)(3);
0
4. By revising paragraph (d)(2)(ii);
0
5. By removing reserved paragraph (d)(3)(iii)(C);
0
6. By adding a sentence to the end of paragraph (e)(3)(ii);
0
7. By revising paragraph (f)(1)(ii);
0
8. By adding paragraph (f)(3);
0
9. By adding paragraphs (h)(13) and (14); and
0
10. By adding a sentence to the end of paragraph (i)(1).
    The revisions and additions read as follows:


Sec.  301.6225-1  Partnership adjustment by the Internal Revenue 
Service.

* * * * *
    (b) * * *
    (3) Adjustments to items for which tax has been collected under 
chapters 3 and 4 of the Internal Revenue Code (Code). * * *
    (4) * * * If an adjustment to an item of income, gain, loss, 
deduction, or credit is related to, or results from, an adjustment to 
an item that is not an item of income, gain, loss, deduction, or 
credit, the adjustment to the item that is not an item of income, gain, 
loss, deduction, or credit will generally be treated as zero solely for 
purposes of calculating the imputed underpayment unless the IRS 
determines that the adjustment should be included in the imputed 
underpayment.
* * * * *
    (c) * * *
    (3) * * * Each adjustment to any tax, penalty, addition to tax, or 
additional amount for the taxable year for which the partnership is 
liable under chapter 1 of the Code (chapter 1) and each adjustment to 
an imputed underpayment calculated by the partnership is placed in the 
credit grouping.
* * * * *
    (d) * * *
    (2) * * *

[[Page 74952]]

    (ii) Negative adjustment. A negative adjustment is any adjustment 
that is a decrease in an item of income; a partnership adjustment 
treated under paragraph (d)(2)(i) of this section as a decrease in an 
item of income; an increase in an item of credit; a decrease in an item 
of tax, penalty, addition to tax, or additional amount for which the 
partnership is liable under chapter 1; or a decrease to an imputed 
underpayment calculated by the partnership for the taxable year.
* * * * *
    (e) * * *
    (3) * * *
    (ii) * * * A net negative adjustment to a tax, penalty, addition to 
tax, or additional amount for which the partnership is liable under 
chapter 1 or an adjustment to any imputed underpayment calculated by 
the partnership for the taxable year is not an adjustment described in 
paragraph (f) of this section.
* * * * *
    (f) * * *
    (1) * * *
    (ii) The calculation under paragraph (b)(1) of this section results 
in an amount that is zero or less than zero, unless paragraph (f)(3) of 
this section applies.
* * * * *
    (3) Exception to treatment as an adjustment that does not result in 
an imputed underpayment--(i) Application of this paragraph (f)(3). If 
the calculation under paragraph (b)(1) of this section results in an 
amount that is zero or less than zero due to the inclusion of a net 
negative adjustment to a tax, penalty, addition to tax, or additional 
amount for which the partnership is liable under chapter 1 or an 
adjustment to any imputed underpayment calculated by the partnership 
for the taxable year, this paragraph (f)(3) applies, and paragraph 
(f)(1) of this section does not apply except as provided in paragraph 
(f)(3)(ii)(C) of this section.
    (ii) Recalculation if paragraph (f)(3) of this section applies--(A) 
In general. If this paragraph (f)(3) applies, the imputed underpayment 
is recalculated under paragraph (b)(1) of this section without regard 
to a net negative adjustment to a tax, penalty, addition to tax, or 
additional amount for which the partnership is liable under chapter 1 
or an adjustment to any imputed underpayment calculated by the 
partnership for the taxable year. The net negative adjustment that was 
excluded from the imputed underpayment recalculation is then treated in 
one of two ways under paragraphs (f)(3)(ii)(B) and (C) of this section 
depending on the results of the recalculation.
    (B) Recalculation is greater than zero. If the result of the 
recalculation under paragraph (f)(3)(ii) of this section is greater 
than zero, the IRS may apply the portion of the net negative 
adjustment(s) that was excluded from the recalculation to reduce the 
imputed underpayment to zero, but not below zero. In this case, the 
imputed underpayment is zero but the adjustments included in the 
recalculation and the remaining net negative adjustment(s) excluded 
from the recalculation under paragraph (f)(3)(ii)(A) of this section 
are not adjustments that do not result in an imputed underpayment 
subject to treatment as described in paragraph (f)(2) of this section. 
See paragraph (h)(13) of this section (Example 13).
    (C) Recalculation is zero or less than zero. If the result of the 
recalculation under paragraph (f)(3)(ii) of this section is zero or 
less than zero, the adjustments included in the recalculation are 
treated as adjustments that do not result in an imputed underpayment 
under paragraph (f)(1)(ii) of this section. The net negative 
adjustment(s) that was excluded from the recalculation is not an 
adjustment that does not result in an imputed underpayment subject to 
treatment as described in paragraph (f)(2) of this section. See 
paragraph (h)(14) of this section (Example 14).
* * * * *
    (h) * * *
    (13) Example 13. The IRS initiates an administrative proceeding 
with respect to Partnership's 2019 partnership return and makes 
adjustments as follows: Net positive adjustment of $100 ordinary 
income, net negative adjustment of $20 in credits, and a net negative 
adjustment of $25 to a chapter 1 tax liability of the partnership. The 
IRS determines that the net negative adjustment in credits should be 
taken into account in the calculation of the imputed underpayment in 
accordance with paragraph (b)(1)(v) of this section. Pursuant to 
paragraph (b)(1) of this section, the $100 net positive adjustment to 
ordinary income is multiplied by 40 percent (highest tax rate in 
effect), which results in $40. The adjustments in the credits grouping 
are then applied, which include the adjustment to credits and the 
adjustment to the chapter 1 tax liability. Applying the credits results 
in an amount less than zero as described in paragraph (f)(3)(i) of this 
section ($40-$20-$25 = -$5). Pursuant to paragraph (f)(3)(ii) of this 
section, the imputed underpayment is recalculated without regard to the 
adjustment to the chapter 1 tax liability, resulting in a recalculation 
amount greater than zero as described in paragraph (f)(3)(ii)(B) of 
this section ($40-$20 = $20). Pursuant to paragraph (f)(3)(ii)(B) of 
this section, the IRS may apply a portion of the adjustment to chapter 
1 tax liability to reduce the recalculation to zero but not below zero. 
In this case, the recalculation amount would be reduced to zero using 
$20 of the $25 adjustment to chapter 1 tax liability. Because the 
imputed underpayment was reduced to zero, pursuant to paragraph 
(f)(3)(ii)(B), the adjustments that went into the recalculation are not 
adjustments that do not result in an imputed underpayment. These 
adjustments are the $100 adjustment to ordinary income and the $20 
adjustment to credits. The remaining $5 adjustment to the chapter 1 tax 
liability of the partnership is an adjustment that is treated as 
described in paragraph (e)(3)(ii) of this section and is therefore not 
taken into account on the partnership's adjustment year return.
    (14) Example 14. The facts are the same as in paragraph (h)(13) of 
this section (Example 13), but the negative adjustment to credits is 
$50 instead of $20. Applying the credits results in an amount less than 
zero as described in paragraph (f)(3)(i) of this section ($40-$50-$25 = 
-$35). Pursuant to paragraph (f)(3)(ii) of this section, the imputed 
underpayment is recalculated without regard to the adjustment to the 
chapter 1 tax liability, resulting in a recalculation amount less than 
zero as described in paragraph (f)(3)(ii)(C) of this section ($40-$50 = 
-$10). Pursuant to paragraph (f)(3)(ii)(C) of this section, the 
partnership adjustments resulting in the -$10 recalculation amount are 
adjustments that do not result in an imputed underpayment treated in 
accordance with paragraph (f)(1)(ii) of this section, and the $25 
adjustment to chapter 1 tax liability is not treated as such an 
adjustment and is therefore not taken into account on the partnership's 
adjustment year return.
    (i) * * *
    (1) * * * Notwithstanding the preceding sentence, paragraphs 
(b)(4), (c)(3), (d)(2)(ii), (d)(3)(iii)(C), (e)(3)(ii), (e)(3)(iii)(B), 
(f)(1)(ii), (f)(3), and (h)(13) and (14) of this section are applicable 
on November 20, 2020.
0
Par. 5. Section 301.6225-2 is amended:
0
1. In paragraph (d)(2)(vi)(A), by removing the period and the end of 
the paragraph and adding in its place ``, by treating any approved 
modifications and partnership adjustments allocable to the

[[Page 74953]]

pass-through partner as items reflected on the statement furnished to 
the pass-through partner.'';
0
2. By revising paragraph (d)(2)(vi)(B); and
0
3. By adding a sentence to the end of the paragraph (g)(1).
    The additions and revisions read as follows:


Sec.  301.6225-2  Modification of imputed underpayment.

* * * * *
    (d) * * *
    (2) * * *
    (vi) * * *
    (B) Adjustments that do not result in an imputed underpayment. If a 
pass-through partner takes into account its share of the adjustments by 
paying an amount described in paragraph (d)(2)(vi)(A) of this section 
and there are any adjustments that do not result in an imputed 
underpayment (as defined in Sec.  301.6225-1(f)), those adjustments are 
taken into account by the pass-through partner in accordance with Sec.  
301.6225-3 in the taxable year of the pass-through partner that 
includes the date the payment described in paragraph (d)(2)(iv)(A) of 
this section is paid. This paragraph does not apply if, after making 
the calculation described in paragraph (d)(2)(iv)(A) of this section, 
no amount exists and therefore no payment is required under paragraph 
(d)(2)(iv)(A) of this section.
* * * * *
    (g) * * *
    (1) * * * Notwithstanding the preceding sentence, paragraph 
(d)(2)(vi)(B) of this section is applicable on November 20, 2020.
0
Par. 6. Section 301.6225-3 is amended:
0
1. In paragraph (b)(1) by removing ``a reduction in non-separately 
stated income or as an increase in non-separately stated loss'' and 
adding in its place ``part of non-separately stated income or loss'';
0
2. By adding paragraphs (b)(8) and (d)(3); and
0
3. By adding a sentence to the end of paragraph (e)(1).
    The additions read as follows:


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

* * * * *
    (b) * * *
    (8) Adjustments to items that are not items of income, gain, loss, 
deduction, or credit. The partnership takes into account an adjustment 
that does not result in an imputed underpayment that resulted from an 
adjustment to an item that is not an item of income, gain, loss, 
deduction, or credit by adjusting the item on its adjustment year 
return but only to the extent the item would appear on the adjustment 
year return without regard to the adjustment. If the item is already 
reflected on the partnership's adjustment year return as an item that 
is not an item of income, gain, loss, deduction, or credit, or in any 
year between the reviewed year and the adjustment year, a partnership 
should not create a new item in the amount of the adjustment on the 
partnership's adjustment year return.
* * * * *
    (d) * * *
    (3) Example 3. On its partnership return for the 2020 taxable year, 
Partnership placed Asset into service, reporting that Asset, a non-
depreciable asset, had a basis of $100. During an administrative 
proceeding with respect to Partnership's 2020 taxable year, the IRS 
determines that Asset has a basis of $90 instead of $100. The IRS also 
determines that Partnership has a negative adjustment to credits of $4. 
There are no other adjustments for the 2020 partnership taxable year. 
Under paragraph (d)(2) of this section, the adjustment to the basis of 
an asset is not an adjustment to an item of income. Therefore, the $10 
adjustment to the basis of Asset is treated as a $10 positive 
adjustment. The IRS determines that the net negative adjustment to 
credits should be taken into account as part of the calculation of the 
imputed underpayment. The total netted partnership adjustment is $10, 
which, after applying the highest rate and decreasing the product by 
the $4 adjustment to credits results in an imputed underpayment of $0. 
Accordingly, both adjustments are adjustments that do not result in an 
imputed underpayment under paragraph (f) of this section. The 
adjustment year is 2022 and Partnership still owns Asset. Under 
paragraph (b)(8) of this section, the partnership takes into account 
the $10 adjustment to Asset on its 2022 return by reducing its basis in 
Asset by $10.
    (e) * * *
    (1) * * * Notwithstanding the preceding sentence, paragraphs (b)(8) 
and (d)(3) of this section are applicable on November 20, 2020.
* * * * *
0
Par. 7. Section 301.6226-2 is amended by removing ``Internal Revenue'' 
from the paragraph (g)(3) subject heading, adding paragraph (g)(4), and 
adding a sentence to the end of paragraph (h)(1).
    The additions read as follows:


Sec.  301.6226-2  Statements furnished to partners and filed with the 
IRS.

* * * * *
    (g) * * *
    (4) Liability for chapter 1 taxes and penalties. A partnership that 
makes an election under Sec.  301.6226-1 with respect to an imputed 
underpayment must pay any taxes, penalties, additions to tax, 
additional amounts, or the amount of any adjustments to any imputed 
underpayment calculated by the partnership that is determined under 
subchapter C of chapter 63 for which the partnership is liable under 
chapter 1 of the Code or subchapter C of chapter 63 at the time the 
partnership furnishes statements to its partners in accordance with 
paragraph (b) of this section. Any adjustments to such items are not 
included in the statements the partnership furnishes to its partners or 
files with the IRS under this section.
    (h) * * *
    (1) * * * Notwithstanding the prior sentence, paragraph (c)(1) of 
this section is applicable on November 20, 2020.
* * * * *
0
Par. 8. Section 301.6241-3 is amended:
0
1. By revising paragraph (b)(1)(ii);
0
2. By removing paragraph (b)(2);
0
3. By redesignating paragraphs (b)(3) and (4) as paragraphs (b)(2) and 
(3) respectively; and
0
4. By revising paragraphs (c), (d), (e)(2)(ii), (f)(1) and (2), and 
(g).
    The revisions read as follows:


Sec.  301.6241-3  Treatment where a partnership ceases to exist.

* * * * *
    (b) * * *
    (1) * * *
    (ii) The partnership does not have the ability to pay, in full, any 
amount that may be due under the provisions of subchapter C of chapter 
63 for which the partnership is or may become liable. For purposes of 
this section, a partnership does not have the ability to pay if the IRS 
determines that the partnership is currently not collectible based on 
the information the IRS has at the time of such determination.
* * * * *
    (c) Partnership adjustment takes effect. For purposes of this 
section, a partnership adjustment under subchapter C of chapter 63 
takes effect when the adjustment becomes finally determined as 
described in Sec.  301.6226-2(b)(1); when the partnership and the IRS 
enter into a settlement agreement regarding the adjustment; or, for 
adjustments appearing on an administrative adjustment request (AAR), 
when the request is filed.

[[Page 74954]]

    (d) Former partners--(1) In general. Except as described in 
paragraph (d)(2) of this section, the term former partners means the 
partners of the partnership during the last taxable year for which a 
partnership return under section 6031 or AAR was filed for such 
partnership or the most recent persons determined to be partners of the 
partnership in a final determination (for example, a defaulted notice 
of final partnership adjustment, final court decision, or settlement 
agreement) binding upon the partnership.
    (2) Partnership-partner ceases to exist. If any former partner is a 
partnership-partner that the IRS has determined ceased to exist, the 
former partners for purposes of this section are the partners of such 
partnership-partner during the last partnership taxable year for which 
a partnership return of the partnership-partner under section 6031 or 
AAR was filed or the most recent persons determined to be partners of 
the partnership-partner in a final determination (for example, a 
defaulted notice of final partnership adjustment, final court decision, 
or settlement agreement) binding upon the partnership-partner.
    (e) * * *
    (2) * * *
    (ii) The partnership must furnish statements to the former partners 
and file the statements with the IRS no later than 60 days after the 
later of the date of the notification to the partnership that the IRS 
has determined that the partnership has ceased to exist or the date the 
adjustment takes effect, as described in paragraph (c) of this section.
* * * * *
    (f) * * *
    (1) Example 1. The IRS initiates a proceeding under subchapter C of 
chapter 63 with respect to the 2020 partnership taxable year of 
Partnership. During 2023, in accordance with section 6235(b), 
Partnership extends the period of limitations on adjustments under 
section 6235(a) until December 31, 2025. However, on July 31, 2024, 
Partnership terminates within the meaning of section 708(b)(1). Based 
on the prior termination under section 708(b)(1), the IRS determines 
that Partnership ceased to exist, as defined in paragraph (b) of this 
section, on September 16, 2024. On February 1, 2025, the IRS mails 
Partnership a notice of final partnership adjustment (FPA) that 
determines partnership adjustments that result in a single imputed 
underpayment. Partnership does not timely file a petition under section 
6234 and does not make a valid election under section 6226. Partnership 
files its final return of partnership income on October 15, 2024 
listing A and B, both individuals, as the partners for its final 
taxable year ending July 31, 2024. Accordingly, under paragraph (d)(1) 
of this section, A and B are former partners. Therefore, A and B are 
required to take their share of the partnership adjustments determined 
in the FPA into account under paragraph (e) of this section.
    (2) Example 2. The IRS initiates a proceeding under subchapter C of 
chapter 63 with respect to the 2020 partnership taxable year of P, a 
partnership. G, a partnership that has an election under section 
6221(b) in effect for the 2020 taxable year, is a partner of P during 
2020 and for every year thereafter. On February 3, 2025, the IRS mails 
P an FPA that determines partnership adjustments that result in a 
single imputed underpayment. P does not timely file a petition under 
section 6234 and does not make a timely election under section 6226. On 
March 21, 2025, the IRS determines that P has ceased to exist because P 
did not make an election under section 6226, P is currently not 
collectible, and the IRS does not expect P will be able to pay any 
imputed underpayment. G terminated under section 708(b)(1) on December 
31, 2024. On March 3, 2025, the IRS determines that G ceased to exist 
in 2024 for purposes of this section in accordance with paragraph (b) 
of this section. J and K, individuals, were the only partners of G 
during 2024. Therefore, under paragraph (d)(2) of this section, J and 
K, the partners of G during G's 2024 partnership taxable year, are the 
former partners of G for purposes of this section. Therefore, J and K 
are required to take into account their share of the adjustments 
contained in the statement furnished by P to G in accordance with 
paragraph (e) of this section.
    (g) Applicability date. This section applies to any determinations 
made after November 20, 2020.
0
Par. 9. Section 301.6241-7 is added to read as follows:


Sec.  301.6241-7  Treatment of special enforcement matters.

    (a) Items that involve special enforcement matters. In accordance 
with section 6241(11)(B) of the Internal Revenue Code (Code), the 
partnership-related items (as defined in Sec.  301.6241-1(a)(6)(ii)) 
described in this section have been determined to involve special 
enforcement matters.
    (b) Partnership-related items underlying non-partnership-related 
items--(1) In general. The Internal Revenue Service (IRS) may determine 
that the rules of subchapter C of chapter 63 of the Code (subchapter C 
of chapter 63) do not apply to an adjustment to a partnership-related 
item of a partnership if--
    (i) An examination is being conducted of a person other than the 
partnership;
    (ii) A partnership-related item is adjusted, or a determination 
regarding a partnership-related item is made, as part of, or 
underlying, an adjustment to a non-partnership-related item of the 
person whose return is being examined; and
    (iii) The treatment of the partnership-related item on the return 
of the partnership under section 6031(b) or in the partnership's books 
and records is based in whole or in part on information provided by the 
person whose return is being examined.
    (2) Example. The following example illustrates the provisions of 
paragraph (b) of this section. For purposes of this example, the 
partnership has no liabilities, is subject to subchapter C of chapter 
63, and the partnership and partner each has a calendar year taxable 
year. On June 1, 2018, A acquires an interest in Partnership by 
contributing Asset to Partnership in a section 721 contribution 
(Contribution). Partnership claims a basis in Asset of $50 under 
section 723 equal to A's purported adjusted basis in Asset as of June 
1, 2018, based on information A provided to Partnership. There is no 
activity in Partnership that gives rise to any other partnership-
related items between June 1, 2018 and June 2, 2019. On June 2, 2019, A 
sells A's interest in Partnership to B for $100 in cash and reports a 
gain of $50 based on A's purported adjusted basis in Partnership of $50 
under section 722 (reflecting solely A's purported adjusted basis in 
Asset immediately prior to the Contribution). The IRS opens an 
examination of A and determines that A's adjusted basis in Asset 
immediately prior to the Contribution should have been $30 instead of 
the $50 claimed by A. As a result, A's basis in Asset immediately prior 
to the Contribution is reduced from $50 to $30 and A's adjusted basis 
in A's interest in Partnership under section 722 is reduced from $50 to 
$30. Because A's adjusted basis in A's interest in Partnership is 
reduced to $30, the total gain from the sale of A's interest in 
Partnership is increased to $70 ($50 as originally reported plus $20 as 
adjusted by the IRS). The amount of Partnership's adjusted basis in 
Asset, which is the property transferred by A in the Contribution, is 
based on information provided by A to Partnership; the adjustment to 
A's pre-

[[Page 74955]]

Contribution adjusted basis in Asset, which is a non-partnership-
related item, results in an adjustment to the adjusted basis of the 
property (that is, Asset) transferred to Partnership in the 
Contribution, which is a partnership-related item; and the Contribution 
underlies the adjustment to A's basis in A's interest Partnership, 
which is a non-partnership-related item. As a result, the IRS may 
determine that the rules of subchapter C of chapter 63 do not apply to 
the Contribution and may adjust, during an examination of A, the 
Contribution as it relates to the adjusted basis in Asset transferred 
in the Contribution.
    (c) Termination and jeopardy assessment. For any taxable year of a 
partner or indirect partner for which an assessment of income tax under 
section 6851 or section 6861 is made, the IRS may adjust any 
partnership-related item with respect to such partner or indirect 
partner as part of making an assessment of income tax under section 
6851 or section 6861 without regard to subchapter C of chapter 63.
    (d) Criminal investigations. For any taxable year of a partner or 
indirect partner for which the partner or indirect partner is under 
criminal investigation, the IRS may adjust any partnership-related item 
with respect to such partner or indirect partner without regard to 
subchapter C of chapter 63.
    (e) Indirect methods of proof of income. The IRS may adjust any 
partnership-related item as part of a determination of any deficiency 
(or portion thereof) of the partner or indirect partner that is based 
on an indirect method of proof of income without regard to subchapter C 
of chapter 63.
    (f) Controlled partnerships and extensions of the partner's period 
of limitations. If the period of limitations under section 6235 on 
making partnership adjustments has expired for a taxable year, the IRS 
may adjust any partnership-related item that relates to any item or 
amount for which the partner's period of limitations on assessment of 
tax imposed by chapter 1 of the Code (chapter 1) has not expired for 
the taxable year of the partner or indirect partner, without regard to 
subchapter C of chapter 63 if--
    (1) The direct or indirect partner is deemed to have control of a 
partnership if such partner is related to the partnership under 
sections 267(b) or 707(b); or
    (2) Under section 6501(c)(4), the direct or indirect partner 
agrees, in writing, to extend the partner's section 6501 period of 
limitations on assessment for the taxable year but only if the 
agreement expressly provides that the partner is extending the time to 
adjust and assess any tax attributable to partnership-related items for 
the taxable year.
    (g) Penalties and taxes imposed on the partnership under chapter 1. 
The IRS may adjust any tax, penalties, additions to tax, or additional 
amounts imposed on, and which are the liability of, the partnership 
under chapter 1 without regard to subchapter C of chapter 63. The IRS 
may also adjust any partnership-related item, without regard to 
subchapter C of chapter 63, as part of any determinations made to 
determine the amount and applicability of the tax, penalty, addition to 
tax, or additional amount being determined without regard to subchapter 
C of chapter 63. Any determinations under this paragraph (g) will be 
treated as a determination under a chapter of the Code other than 
chapter 1 for purposes of Sec.  301.6241-6.
    (h) Determination that subchapter C of chapter 63 does not apply--
(1) Notification. If the IRS determines, in accordance with paragraph 
(b), (c), (d), (e), (f), or (g) of this section, that some or all of 
the rules under subchapter C of chapter 63 do not apply to any 
partnership-related item (or portion thereof), then the IRS will 
notify, in writing, the taxpayer to whom the adjustments are being 
made.
    (2) Effect on adjustments made under subchapter C of chapter 63. 
Any final decision with respect to any partnership-related item 
adjusted in a proceeding not under subchapter C of chapter 63 is not 
binding on any person that is not a party to the proceeding.
    (i) Coordination with adjustments made at the partnership level. 
This section will not apply to the extent the partner can demonstrate 
adjustments to partnership-related items included in the deficiency or 
an adjustment by the IRS were--
    (1) Previously taken into account under subchapter C of chapter 63 
by the person being examined; or
    (2) Included in an imputed underpayment paid by a partnership (or 
pass-through partner) for any taxable year in which the partner was a 
reviewed year partner or indirect partner but only if the amount 
included in the deficiency or adjustment exceeds the amount reported by 
the partnership to the partner that was either reported by the partner 
or indirect partner or is otherwise included in the deficiency or 
adjustment determined by the IRS.
    (j) Applicability date--(1) In general. Except for paragraph (b) of 
this section, this section applies to partnership taxable years ending 
after November 20, 2020, or any examination or investigation begun 
after November 20, 2020. Notwithstanding the preceding sentence, any 
provision of this section except for paragraph (b) of this section may 
apply to any taxable year of a partner that relates to a partnership 
taxable year subject to subchapter C of chapter 63 that ended before 
November 20, 2020, upon agreement between the partner under examination 
and the IRS.
    (2) Partnership-related items underlying non-partnership-related 
items. Paragraph (b) of this section applies to partnership taxable 
years beginning after December 20, 2018, or any examination or 
investigation begun after November 20, 2020. Notwithstanding the 
preceding sentence, paragraph (b) of this section may apply to any 
taxable year of a partner that relates to a partnership taxable year 
subject to subchapter C of chapter 63 that ended before December 20, 
2018, upon agreement between the partner under examination and the IRS.

Sunita Lough,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 2020-25904 Filed 11-20-20; 11:15 am]
BILLING CODE 4830-01-P