Reducing a BBA Imputed Underpayment: How Modification Under IRC 6225(c) Works

The number on the notice of proposed partnership adjustment is going to look wrong. Often it is, at least in the sense that it overstates what your partners would really owe. The imputed underpayment is built to be blunt. Modification is the tool for sanding it down.

But modification is not automatic, it is not informal, and it runs on a hard deadline. Here is how it works under IRC Section 6225(c) and Treas. Reg. 301.6225-2.

Why the starting number is so high

Under IRC 6225(b), the IRS computes the imputed underpayment by netting the partnership adjustments and applying the highest rate of tax in effect for the reviewed year under IRC 1 or IRC 11. Adjustments that reallocate an item from one partner to another are not allowed to reduce the imputed underpayment, and decreases that could be limited in a partner's hands may be left out. The result ignores who your partners actually are. For the computation itself, see the imputed underpayment explained.

Modification lets the partnership show the IRS facts about the partners that justify a smaller number.

The ground rules

• Only the partnership representative may request modification. Treas. Reg. 301.6225-2(a) says so directly.
• 270 days from the NOPPA. IRC 6225(c)(7) and Treas. Reg. 301.6225-2(c)(3)(i) require everything to be submitted within 270 days after the NOPPA is mailed, unless the IRS grants an extension. An extension must be requested before the period runs out, under Treas. Reg. 301.6225-2(c)(3)(ii).
• The IRS must approve it. IRC 6225(c)(8) says a modification is made only upon IRS approval.
• The partnership must prove it. Under Treas. Reg. 301.6225-2(c)(2)(i), the IRS will deny a request if the partnership fails to provide the information the IRS determines is necessary, or if any required payment is not made on time.
• Modification changes the bill, not the adjustments. Treas. Reg. 301.6225-2(b)(1) says a modification has no effect on the partnership adjustments themselves. It can also increase the imputed underpayment, not just reduce it.

IRM 4.31.13.8 says the request is made on Form 8980, Partnership Request for Modification of Imputed Underpayments Under IRC Section 6225(c), and that the modification forms must be submitted electronically through the BBA Online Form Submission Service portal.

The main types of modification

1. Amended returns by partners

This is the most powerful option and the most demanding. Under IRC 6225(c)(2)(A), if one or more partners file returns for the taxable year that includes the end of the reviewed year (and any later year whose tax attributes are affected), take into account all adjustments properly allocable to them, and pay the tax due with those returns, the imputed underpayment is computed without their share.

Treas. Reg. 301.6225-2(d)(2)(ii)(A) requires full payment: tax, penalties, additions to tax, additional amounts, and interest. Partial payment does not qualify. IRM 4.31.13.8 says each participating partner signs Form 8982, an affidavit submitted with the modification package.

Two features make this work for older years:

• IRC 6225(c)(2)(D) says the normal assessment and refund statutes in IRC 6501 and IRC 6511 do not apply to those returns and payments. A closed year for the partner is not a barrier.
• IRC 6225(c)(2)(E) makes the resulting tax attribute adjustments binding on the partner for later years. Getting that wrong is treated as a consistency failure under IRC 6222.

2. The alternative procedure to amended returns

IRC 6225(c)(2)(B) and Treas. Reg. 301.6225-2(d)(2)(x) let the partnership submit, on behalf of a partner, the information and payment that an amended return would have required, without the partner filing an actual amended return. The partner must agree to adjust its tax attributes. This is often simpler logistically, but the payment requirement is the same.

One trap applies to both procedures. If an adjustment reallocates an item from one partner to another, IRC 6225(c)(2)(C) allows the modification only if every partner affected by the reallocation participates.

3. Tax-exempt partners

Under IRC 6225(c)(3), the imputed underpayment can be computed without the portion of the adjustment allocable to a partner that would not owe tax because of its tax-exempt status. IRM 4.31.13.8 lists Form 8983 as the certification of tax-exempt status submitted with the package.

4. Lower tax rates

IRC 6225(c)(4) allows a lower rate for the portion of an adjustment allocable to a C corporation partner, or to an individual partner for capital gains and qualified dividends. An S corporation is treated as an individual for this purpose. The rate cannot go below the highest rate in effect for that type of income and taxpayer, as Treas. Reg. 301.6225-2(d)(4) explains.

5. Other modifications

Treas. Reg. 301.6225-2(d) also covers:

• Specified passive activity losses of publicly traded partnerships, under IRC 6225(c)(5).
• Changing the number and composition of imputed underpayments, such as moving adjustments into different groupings.
• Partners that are qualified investment entities.
• Closing agreements with the partnership or a partner.
• Tax treaty benefits for foreign partners.
• Other modifications the IRS finds accurate and appropriate.

When several modifications are requested, Treas. Reg. 301.6225-2(b)(1) applies them in a set order: first those that remove adjustments from the computation, then changes to the number and composition of imputed underpayments, then rate changes.

How modification affects the timeline

Modification can extend the IRS's time to finish the case. Under IRC 6235(a)(2), the IRS has until 270 days (plus any agreed extension) after everything required for the modification has been submitted. Treas. Reg. 301.6235-1(b)(2) treats the submission as complete on the earlier of the end of the modification period or the date that period ends by waiver. An incomplete submission does not change that date. The full picture is in the BBA statute of limitations.

The partnership can end the window early by signing Form 8981. IRM 4.31.13.10.1 cautions that once the IRS countersigns it, no further modifications can be submitted. Do not sign it until every request you intend to make is in.

After the IRS decides

IRM 4.31.13.8.2 says the IRS communicates its determination with Letter 5975 and Form 15027, and the partnership representative has 10 days from the letter's issuance date to respond. The representative may sign to agree, or request an Appeals conference if the partnership disagrees with the determination. If there is no response, the IRS moves to the notice of final partnership adjustment. See BBA audit notices and the timeline.

Modification or push-out?

Modification and the push-out election under IRC 6226 are different tools. Modification reduces what the partnership pays. The push-out, elected within 45 days after the final notice, shifts the adjustments to the reviewed year partners, with interest computed at a rate 2 percentage points higher than the normal underpayment rate under IRC 6226(c)(2). Which one fits depends on who the partners are, whether they can pay now, and whether they are still around. Compare the push-out mechanics in the push-out election under Section 6226.

On an administrative adjustment request, the menu is shorter. Treas. Reg. 301.6227-2(a)(2) allows only certain modifications on an AAR, and amended return modifications are not among them.

Practical steps the day the NOPPA arrives

1. Calendar the 270-day deadline and the date by which an extension must be requested.
2. Pull the reviewed year partner list, including each partner's type: individual, C corporation, S corporation, tax-exempt, foreign, or pass-through.
3. Identify which partners can file amended returns or use the alternative procedure, and whether they can pay in full.
4. Check for reallocation adjustments that require every affected partner to participate.
5. Assemble the partnership agreement and ownership history. Treas. Reg. 301.6225-2(c)(2)(ii) says the IRS may require it.

If your partnership has a NOPPA with an imputed underpayment, the Law Offices of Darrin T. Mish, P.A. in Tampa, Florida can review which modifications may apply and what proof the IRS will expect. Call 813-229-7100.

The IRS starts with the highest rate on purpose. The 270 days are your chance to argue with it.