Under the default provisions of the centralized partnership audit procedures enacted by the Bipartisan Budget Act of 2015 (BBA), a partnership is liable for tax (imputed underpayment or IU) resulting from partnership adjustments. In lieu of paying the IU, a partnership can elect to have the partners for the year being adjusted (the reviewed year) take the adjustments into account and pay the resulting tax. A partnership making a pushout election reports each partner’s allocable share of adjustments by filing Form 8986, “Partner’s Share of Adjustment(s) to Partnership-Related Item(s) (Required Under Sections 6226 and 6227)” with the IRS and furnishing a copy of the form to the partner.
Since the BBA was enacted, the IRS has increased the number of partnerships audited. The number of partnerships filing AARs to adjust already-filed partnership returns also has increased. Partners receiving Form 8986 are required to take the adjustments into account in accordance with the rules under IRC Sections 6226 and 6227.
Crowe observation
As a result of the increased number of partnerships filing AARs, more adjustments are being pushed out and more partners are receiving Forms 8986.
Taking Form 8986 adjustments into account
The rules for taking BBA partnership adjustments into account are different depending on whether the partner is a pass-through partner or a non-pass-through partner. Generally, a pass-through partner is a partner that is a partnership, S corporation, nongrantor trust, or estate of a decedent. Other partners, including individuals and C corporations, are non-pass-through partners.
Pass-through partners. Pass-through partners receiving a Form 8986 must determine whether taking the adjustments into account results in an IU. Generally, pass-through partners can either pay the IU resulting from taking the adjustments into account or push out the adjustments to their reviewed year partners. In the case of an AAR, adjustments that do not result in an IU – generally taxpayer favorable adjustments – must be pushed out to the reviewed year partners.
Pass-through partners are required to file a Form 8985, “Pass-Through Statement – Transmittal/Partnership Adjustment Tracking Report (Required Under Sections 6226 and 6227),” with the IRS to report whether they are paying the IU or pushing out the adjustments. If the pass-through partner is pushing out the adjustments, it also must file Form 8986s with the IRS and furnish copies to the reviewed year partners. A pass-through partner has until the extended return due date of the adjustment year for the partnership that filed the AAR or that is being audited to pay the IU or push out the adjustments. That date is identified in box F of Part II of Form 8986. If a pass-through partner pays the IU, no further reporting or payment is required for adjustments included in the IU calculation.
Non-pass-through partners. Generally, non-pass-through partners take the adjustments into account in the reviewed year and, if applicable, any year after the reviewed year and before the reporting year (intervening year) by preparing a pro forma return(s). The Form 8986 recipient does not amend any of its returns. Instead, the non-pass-through partner reports the total of the change in tax for the reviewed year and each affected intervening year on its income tax return for the reporting year by attaching a Form 8978, “Partner’s Additional Reporting Year Tax,” and Schedule A (Form 8978), “Partner’s Additional Reporting Year Tax (Schedule of Adjustments),” to the return. Tax due as a result of taking the adjustments into account is treated as additional Chapter 1 tax of the partner in the reporting year.
For example, assume that in 2023 a calendar year partnership with two individual partners (who also use a calendar year for tax purposes) pushes out adjustments to the partnership’s 2021 Form 1065, “U.S. Return of Partnership Income,” to its partners and timely files and furnishes Form 8986s. The reviewed year is 2021 and the reporting year is 2023. The partners generally would prepare a pro forma 2021 Form 1040, “U.S. Individual Income Tax Return,” to determine the change in tax as a result of taking the adjustments into account in that year. If the adjustments taken into account for 2021 result in a change in tax attributes that affects 2022, the partner generally would also prepare a pro forma return for 2022. Each partner reports the total change in their tax liability for 2021 and 2022 (plus interest and penalties as applicable) on Form 8978 attached to the partner’s 2023 Form 1040.
Although adjustments from multiple Form 8986s received in a reporting year generally can be reported on a single Form 8978, a taxpayer must attach a separate Form 8978 to its income tax return for each Form 8986 reporting adjustment from a BBA audit.
A partner that receives multiple Form 8986s in a reporting year might have to attach several Form 8978s to its income tax for the reporting year.
Looking ahead
Form 8986s tend to be sent at year-end to direct partners of the partnership filing the AAR. However, pass-through partners often will send their Form 8986s to their partners at the same time they are sending their partners the Form K-1s for the reporting year. It will be important to focus on the date in box F of Part II of the Form 8986 to determine the correct reporting year. Taxpayers receiving Form 8986s for the 2023 reporting year should provide the form to their tax return preparer as soon as possible so proper reporting can be done within the required time frame.
