IRS Allows BBA Partnerships to File Amended Returns; Update on California’s Treatment of CARES Act Tax Provisions
IRS Allows BBA Partnerships to File Amended Returns; Update on California’s Treatment of CARES Act Tax Provisions
April 10, 2020
On April 8, 2020, both the Internal Revenue Service and the California Franchise Tax Board provided additional guidance regarding recent changes to some Federal and State tax laws in response to the COVID-19 crisis.
IRS Guidance - Amended Income Tax Returns for BBA Partnerships
Most entities that are treated as partnerships for income tax purposes are now subject to the centralized partnership audit rules enacted as part of the Bipartisan Budget Act of 2015 (the “BBA”, hence “BBA Partnerships”). On April 8, 2020, the IRS issued Revenue Procedure 2020-23, which allows BBA Partnerships to file amended federal income tax returns to take advantage of the new tax provisions in the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act, to take advantage of any other tax benefits that might be available to them, and to claim cash refunds for prior years.
As described in our April 3, 2020, Client Alert, the CARES Act contains tax provisions that are intended to provide economic relief to businesses and individuals in response to the COVID-19 crisis. These provisions include an increase in the amount of excess business losses a non-corporate taxpayer can deduct for taxable years 2018, 2019 and 2020, an allowance for the carryback of net operating losses arising in 2018, 2019 and 2020, and a modification of the limitation on deductible business interest expenses for taxable years 2019 and 2020.
The BBA, which went into effect on January 1, 2018, provides for a centralized partnership audit regime that determines, assesses, and collects tax at the entity level. See our prior Client Alert on this for more information. As part of this regime, BBA Partnerships are generally unable to file amended income tax returns. Instead, a BBA Partnership must file an Administrative Adjustment Request (“AAR”) in the current taxable year in order to account for a reduction in the partnership’s income for a prior year. A successful AAR results only in a nonrefundable credit against taxes owed in the current taxable year, and not a tax refund in respect of the prior year. Therefore, the BBA would normally prevent a BBA Partnership from deriving any economic benefit from many of the new CARES Act provisions until it files its 2020 federal income tax return (which would likely occur in 2021). This process would significantly delay the relief provided in the CARES Act. It might even be the case that a BBA Partnership would not be able to take advantage of these CARES Act provisions at all, if, for example, it has no net income in 2020 to absorb a tax credit in respect of a “new” 2019 (or earlier) deduction.
Fortunately, the IRS recognized this problem and issued Revenue Procedure 2020-23. Under the Revenue Procedure, a BBA Partnership that, prior to April 8, 2020, filed a Form 1065 (U.S. Return of Partnership Income) for taxable years beginning in 2018 or 2019 and furnished all required Schedules K-1 may file amended partnership returns and furnish corresponding Schedules K-1 before September 30, 2020. The amended returns may take into account tax changes brought about by the CARES Act as well as any other tax attributes to which the BBA Partnership is entitled under the law.
To take advantage of the option to file an amended return, a BBA Partnership must file a Form 1065 (with the “Amended Return” box checked) and furnish corresponding amended Schedules K-1. The BBA Partnership must clearly indicate the application of the Revenue Procedure on the amended return by writing “FILED PURSUANT TO REV PROC 2020-23” at the top of the amended return and attaching a statement with the same notation to each Schedule K-1 sent to its partners. The partnership may file electronically or by mail, but the IRS noted that filing electronically may allow for faster processing of the return.
It may not be in the interest of every BBA Partnership or its current partners to file amended returns. In some situations, an AAR could be the better option. BBA Partnerships and partners should consult with their tax advisors to determine the best course of action for them.
There remain open questions as to what a BBA Partnership can amend on its prior year returns to address the changes outlined in the CARES Act. For example, a BBA Partnership that previously avoided the Tax Cuts and Jobs Act (“TCJA”) limits on deducting business interest by electing to be treated as a “real property trade or business” might now wish to revisit that election. This is especially true in light of the CARES Act “fix” for “qualified improvement property”, which now permits such property to be immediately expensed (with retroactive effect). An election to be treated as a “real property trade or business” is normally irrevocable, but, with the CARES Act change, there is pressure to permit a complementary additional fix to the TCJA to allow the election to be reversed.
FTB Guidance – CARES Act Updates in California
On April 8, 2020, the Franchise Tax Board updated its COVID-19 FAQ Page to address certain aspects of the CARES Act and how they apply for California income tax purposes. Below are the updated questions and answers posted by the Franchise Tax Board.
Are the payments that individuals receive from the federal government (i.e., $1,200 [$2,400 for individuals filing a joint return] and $500 per qualifying child) under the recently enacted federal CARES Act subject to California income tax?
No, these payments are not subject to California income tax.
Is the emergency increase in unemployment compensation benefits (in the amount of $600 per week) that individuals receive under the recently enacted federal CARES Act subject to California income tax?
No, these payments are not subject to California income tax.
Are the modifications for net operating losses (NOLs) in the recently enacted federal CARES Act applicable for California income and franchise tax purposes?
No, these modifications for NOLs do not apply for California income and franchise tax purposes.
Does California conform to the federal early withdrawal penalty waivers for distributions from qualified retirement accounts under the recently enacted federal CARES Act?
Yes, the federal early withdrawal penalty waivers for distributions from qualified retirement accounts under the federal CARES Act also applies for California income tax purposes.
Additional FAQs can be found at the Franchise Tax Board’s website at https://www.ftb.ca.gov/about-ftb/newsroom/covid-19/help-with-covid-19.html.