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CARES Quirk for Partnerships Caused by Unique Audit Challenges

Posted on May 6, 2020

Recently enacted business interest deduction rules for partnerships were guided by administrative hurdles and the need to get partners much-needed money as quickly as possible, according to a lawyer who helped draft the coronavirus relief legislation.

The special rules under section 163(j) in the Coronavirus Aid, Relief, and Economic Security (CARES) Act (P.L. 116-136) were meant to free up cash for ailing businesses, but because of the “rough justice in the name of liquidity” that Congress used when creating the rules, some businesses that operate as partnerships might receive less cash than other types of companies, said Monisha Santamaria, legislation counsel with the Joint Committee on Taxation.

However, in some cases, the partnership changes may be more generous, added Santamaria, who spoke May 5 on a webcast sponsored by the American Bar Association Section of Taxation.

Santamaria added that the partnership-specific section 163(j) items in the law were necessary in part because partnerships under the centralized audit regime couldn’t file amended returns. Instead, those partnerships had to file administrative adjustment requests, which wouldn’t provide partners with an immediate benefit.

The IRS has since provided several rounds of filing relief for businesses, including partnerships, even allowing some subject to the audit regime to file amended returns.

The CARES Act made changes to the limits imposed under the Tax Cuts and Jobs Act on the ability of businesses to deduct interest expense.

Under the TCJA, the deduction for business interest expenses under section 163(j) was limited to the sum of interest income, 30 percent of adjusted taxable income, and floor plan financing interest. The CARES Act raised the net business interest deduction limit from 30 percent of ATI to 50 percent for tax years beginning in 2019 or 2020. For tax years beginning in 2020, businesses may elect to compute the interest expense limitation based on their 2019 ATI, which will likely be higher because of the economic downturn.

That generally means that if a taxpayer has ATI of $100 in 2019 and $50 in 2020, the net interest deduction limitation is $50 for both years.

But the section 163(j) changes are more complex for partnerships.

Under the CARES Act, partnership business interest deductions are still limited to 30 percent of ATI for 2019. However, if a partner gets suspended excess interest expense allocated to them in 2019, 50 percent of that suspended interest will be treated as freed up in 2020.

The other 50 percent of that suspended interest carryover in 2020 is still subject to the section 163(j) carryover limits, meaning it is deductible only when the partner gets an allocation of excess taxable income or excess business interest income.

For example, for a partnership that has $100 of ATI in 2019 and $100 of interest expense, the deduction is limited to $30, and $70 is carried forward to 2020 as excess interest. In 2020 the partner could deduct $35 of the excess amount, but the remaining $35 would be subject to the partner excess interest income rules, as usual.

Santamaria said that another reason behind the special partnership rules was to avoid making partnerships redo the complicated 11-step allocation process from the proposed regulations released in 2018.

“The idea of making partnerships redo their 11-step process and making partners redo partner-level computations while most of the country is working from home just seemed not fun,” Santamaria said.

But according to Glenn Dance of Holthouse Carlin & Van Trigt LLP, practitioners who do partnership tax compliance wouldn’t have considered it a monumental undertaking to redo the 11-step process because it’s built into a computer model.

Dance told Tax Notes he believes the decision to prevent partnerships from claiming the additional deductions in 2019 must have been because there was an objection somewhere in the process on the need for some partnerships to reissue their 2019 Schedules K-1, which were sent out before the end of March.

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