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New Jersey Adapts to Federal Centralized Partnership Audit Rules

On December 22, 2022, Governor Murphy signed P.L.2022, c.133 (A4295/S2876) that eliminates the requirement to affirmatively make a New Jersey S corporation election; ends the New Jersey COVID-related extension for State tax assessments and refund interest and adapts New Jersey Partnership Audit Rules to the new federal partnership audit rules.

This article addresses New Jersey’s recent changes adapting its partnership audit rules to the new federal centralized partnership audit rules.

Background. The Bipartisan Budget Act of 2015, P.L. 114-74, made major changes in the federal income tax treatment of partnership audits. The law replaced the auditing and tax collection procedures for tax partnerships under the Tax Equity and Fiscal Responsibility Act of 1982 (“TEFRA”) and the electing large partnership rules with the centralized partnership audit regime. The centralized partnership audit regime, also referred to as “BBA” or “PBBA,” was generally effective for tax years beginning January 2018. Tax partnerships that file returns for tax years starting January 2018 must follow rules under the BBA.

Under the BBA, the IRS generally assesses and collects any understatement of tax (called an imputed underpayment or IU) at the partnership level. Partnerships may request to modify the IU and may elect to push out the adjustments underlying the IU instead of paying. Partnerships under the BBA must follow certain filing requirements including designating a partnership representative or, if eligible, elect out of the regime on a timely filed return.

The laws of most states, including New Jersey, do not allow for the direct assessment of income tax against partnerships because these entities are not considered taxpayers under state law. The BBA direct assessment model conflicts with this state tax treatment. To address this conflict, representatives of the Multistate Tax Commission (MTC), in conjunction with a number of business and professional associations developed a model uniform statute for state tax reporting adjustments to federal taxable income and federal partnership audit adjustments under the BBA regime.

New Jersey Adopts MTC Partnership Audit Model. The new law adopts the MTC’s Model Uniform Statute for Reporting Adjustments to Federal Taxable Income and Federal Partnership Audit Adjustments for purposes of the New Jersey Gross Income Tax Act (GIT) and Corporation Business Tax Act (CBT) and adapt New Jersey’s tax provisions to the new federal partnership audit regime that audits the partnership instead of auditing individual partners. The new law applies to any adjustments to a taxpayer’s federal taxable income on or after January 1, 2020.

Key Terms. The new law introduces a number of key terms related to federal partnership audits, including

• Audited Partnership “Audited partnership” means a partnership subject to a partnership level audit resulting in a federal adjustment.
• Federal Adjustment. “Federal adjustment” means a change to an item or amount determined under the federal Internal Revenue Code that is used by a taxpayer to compute tax owed under the “New Jersey Gross Income Tax Act,” N.J.S.54A:1-1 et seq., or Corporation Business Tax Act (1945), P.L.1945, c.162 (C.54:10A-1 et seq.), whether that change results from action by the Internal Revenue Service, including a partnership level audit, or the filing of an amended federal return, federal refund claim, or an administrative adjustment request by the taxpayer. A federal adjustment is positive to the extent that it increases State taxable income as determined under N.J.S.54A:5-1 or subsection (k) of section 4 of P.L.1945, c.162 (C.54:10A-4) and is negative to the extent that it decreases State taxable income as determined under N.J.S.54A:5-1 or subsection (k) of section 4 of P.L.1945, c.162 (C.54:10A-4).
• Final Federal Adjustment. “Final federal adjustment” means a federal adjustment after the final determination date for that federal adjustment has passed.
• Federal Adjustments Report. “Federal Adjustments Report” includes methods or forms required by N.J.S.54A:8-7 or section 13 of P.L.1945, c.162 (C.54:10A-13) for use by a taxpayer to report final federal adjustments, including an amended New Jersey tax return, information return, or a uniform multistate report.
• Final Determination Date “Final determination date” means the following:

1. Except as provided in b. and c. below, if the federal adjustment arises from an Internal Revenue Service audit or other action by the Internal Revenue Service, the final determination date is the first day on which no federal adjustments arising from that audit or other action remain to be finally determined, whether by Internal Revenue Service decision with respect to which all rights of appeal have been waived or exhausted, by agreement, or, if appealed or contested, by a final decision with respect to which all rights of appeal have been waived or exhausted. For agreements required to be signed by the Internal Revenue Service and the taxpayer, the final determination date is the date on which the last party signed the agreement.
2. For federal adjustments arising from an Internal Revenue Service audit or other action by the Internal Revenue Service, if the taxpayer filed as a member of a composite return Form NJ-1080(c) or as a member of a combined group filing a combined return for corporation business tax purposes, the final determination date means the first day on which no related federal adjustments arising from that audit remain to be finally determined, as described in a. above for the entire group.
3. If the federal adjustment results from filing an amended federal return, a federal refund claim, or an administrative adjustment request, or if it is a federal adjustment reported on an amended federal return or other similar report filed pursuant to 6225(c) of the federal Internal Revenue Code (26 U.S.C. s.6225(c)), the final determination date means the day on which the amended return, refund claim, administrative adjustment request, or other similar report was filed.

• Reviewed Year. “Reviewed year” means the taxable year of a partnership that is subject to a partnership level audit from which federal adjustments arise.

Reporting Federal Adjustments – Partnership Level Audit and Administrative Adjustment Request.

General Rule. The new law requires taxpayers, generally, to report and pay any GIT or CBT tax due with respect to final federal adjustments arising from an audit or other action by the IRS or reported by the taxpayer on a timely filed amended federal income tax return, or federal claim for refund by filing a Federal Adjustments Report with the Division of Taxation for the reviewed year and, if applicable, paying the additional tax no later than 180 days after the final determination date.

Partnership Level Audits and Administrative Adjustment Requests. The new law establishes special reporting and payment requirements for partnerships and partners regarding final federal adjustments arising from a partnership level audit or an administrative adjustment request.

Unless a partnership pays election, described below is made by the partnership, no later than 90 days after the final determination date, the partnership must:

• file a completed federal adjustments report, including other required information, with the Division;
• notify each of the partnership’s direct partners of their distributive share of the final federal adjustments including other information required by the Division;
• file an amended New Jersey Form 1065 and pay the amount required; and
• file an amended composite return for direct partners and pay the additional amount that would have been due had the final federal adjustments been reported properly as required.

No later than 180 days after the final determination date, each direct partner that is taxed under the GIT or CBT must

• file a Federal Adjustments Report reporting their distributive share of the adjustments reported to them by the partnership; and
• pay any additional amount of tax due as if final federal adjustments had been properly reported, plus any penalty and interest due.

State Partnership Representative. Under the federal partnership audit rules, a partnership is required to designate a partnership representative – the only person authorized to act on behalf of the partnership during a federal tax audit. The federal partnership representative will also act as the New Jersey state partnership representative unless the partnership designates in writing another person to act. State partnership representative for the reviewed year shall have the sole authority to act on behalf of the partnership, and the partnership’s direct partners and indirect partners shall be bound by those actions.

Partnership Pays Election. As a general rule, the new law requires final federal adjustments to be reported and taken into account by the partners of the tax partnership. However, the new law provides an irrevocable election for an audited partnership to pay tax attributable to the final federal adjustments.

No later than 90 days after the final determination date, the audited partnership must file a completed Federal Adjustments Report, including all information required by the Division of Taxation, and notify the Division that the partnership is making the irrevocable election to pay the tax on the adjustments in lieu of the tax otherwise due from the partnerships direct and indirect partners. The tax payment is due no later than 180 days after the final determination date.

An audited partnership not otherwise subject to any reporting or payment obligation to New Jersey that makes a partnership pays election consents to be subject to New Jersey laws related to reporting, assessment, payment, and collection of New Jersey tax calculated under the election.

The tax amount due from an electing partnership is the sum of tax calculated based on the various enumerated classes of partners comprising the partnership.

Direct Exempt Partners. The distributive share of final federal adjustments reported to a direct exempt partner not subject to tax is excluded from tax.

Direct Corporate Partners. The apportioned distributive share of final federal adjustments reported to a direct corporate partner is taxed at the highest Corporation Business Tax (CBT) rate. Apportionment is made under the CBT rules (N.J.S.A. 54:10A-6 through 54:10A-10; 54:10A-4.7 and 54:10A-15.6. through 54:10A-15.7)

GIT Nonresident Direct Partners. The final federal adjustments reported to nonresident direct partners subject to the Gross Income Tax (GIT) which constitute New Jersey source income under N.J.S.A. 54A:5-8(a)(3) are subject to tax at the highest GIT rate.

GIT Resident Direct Partners. The final federal adjustments reported to nonresident direct partners subject to the GIT are subject to tax at the highest GIT rate.

Tiered Partners. The final federal adjustments reported to tiered partners subject to tax by an electing partnership is (i) the portion of final federal adjustments subject to sourcing to New Jersey under N.J.S.A. 54A;5-8(a)(3) which is sourced to New Jersey plus (ii) amount of such adjustments which is of a type that it would not be subject to sourcing to New Jersey by a nonresident partner under N.J.S.A. 54A;5-8(c) minus (iii) the portion of the amount determined in (ii) that can be established, under regulation issued by the Division, to be properly allocable to nonresident indirect partners or other partners not subject to tax on the adjustments; or that can be excluded under the modified reporting and payment method describe below. The determined amount is subject to tax at the highest GIT tax rate. A “tiered partner” is a partner that is a partnership or other entity not taxed as a C corporation.

The new law provides that direct and indirect partners of an audited partnership that are tiered partners, and all of the partners of those tiered partners that are subject to the CBT or GIT are subject to the general reporting and payment requirements and tiered partners may make the election to a partnership pays election or utilize an approved alternative reporting and payment method.

Subject to regulations adopted by the Division of Taxation, tiered partners or their partners must make required reports and payments no later than 90 days after the time for filing and furnishing statements to tiered partners and their partners as established under IRC 6226.

The Division of Taxation is authorized to adopt procedures under which an audited partnership or tiered partner may enter into an agreement with the Division to utilize an alternative reporting and payment method. Application for approval of an alternative reporting and payment method must be made by the audited partnership or tiered partner within the time for making the partnership pays election.

The tax due from an electing partnership will be subject to statutory interest and penalties.

The direct partners or indirect partners may not take any deduction or credit for tax paid by the electing partnership or claim a refund.

Taxes paid by an audited partnership or tied partnership to another state or local taxing jurisdiction may be claimed as a resident credit for tax of another state under the rules of N.J.S.A. 54A:4-1.

If an electing partnership or tiered partner fails to timely make any required report or payment, the Division of Taxation may assess direct partners or indirect partners for taxes owed, using the best information available.

Estimated New Jersey Tax Payments During the Course of a Federal Audit. A taxpayer that expects to owe additional tax as a result of a pending federal partnership level audit may make estimated tax payments, as prescribed by the Division of Taxation, before the due date of the Federal Adjustments Report. The Division will credit any estimated payments against any tax liability ultimately found to be due under the report and any payments made will limit the accrual of further statutory interest on that amount. If the estimated tax payments exceed the final tax liability and statutory interest ultimately determined to be due, the taxpayer is entitled to a refund or credit for the excess, provided the taxpayer files a Federal Adjustments Report or claim for refund or credit of tax no later than one year following the final determination date.

Statute of Limitations. Under the new law, the Division may assess additional tax, interest, and penalties attributable to final federal audit adjustments, including a partnership level audit, or reported by the taxpayer on an amended federal income tax return or as part of an administrative adjustment request.

Timely Reported Federal Adjustments. If a taxpayer files with the division a Federal Adjustments Report or an amended New Jersey Form 1065 or amended New Jersey CBT return as required no later than 180 days after the final determination date, the Division may assess any tax related liabilities arising from those federal adjustments if the Division issues a notice of the assessment to the taxpayer no later than (i) the expiration of the generally applicable limitations period or (ii) one-year following the date of filing with the Division of the Federal Adjustments Report.

Untimely Reported Federal Adjustments. If a taxpayer fails to file with the Division a Federal Adjustments Report within 180 days of the final determination date or if the Federal Adjustments Report omits final federal adjustments or understates the correct amount of tax owed, the Division may assess any tax related liabilities arising from those federal adjustments if the Division issues a notice of the assessment to the taxpayer no later than (i) the expiration of the generally applicable limitations period, (ii) two-years following the date of filing with the Division of the Federal Adjustments Report or (iii) absent fraud, the expiration of the six-year period following the final determination date.

Claims for Refund or Credits of Tax Arising from Final Federal Adjustments. Except for final federal adjustments required to be reported for federal purposes under the Internal Revenue Code, a taxpayer may file a claim for a refund or credit of the overpayment of the tax arising from federal adjustments made by the IRS before the later of (i) the expiration of the last day for filing a claim for refund or credit of New Jersey tax, including any extensions; or (ii) one year from the date a Federal Adjustments Report was due to the Division, including any extensions.