FAQ: Administrative adjustment requests for partnership tax returns

ARTICLE | May 09, 2024

Authored by RSM US LLP

Administrative adjustment request (AAR) filings have become more common since the IRS clarified it would increase enforcement efforts involving entities taxed as partnerships. Those efforts are compelling many taxpayers to further scrutinize their filing positions—not only due to increased audit risk but also heightened emphasis on partnership issues during due diligence in sale processes.

Filing an AAR to revise a previously filed tax return may be time-consuming, complicated and susceptible to error, especially for intricately tiered structures. Fortunately, tax technology can help you file more efficiently and accurately.

Here are answers to some frequently asked questions about AARs:

What is an AAR, and why would I need to file one?

Starting in 2018, the AAR process replaced amended returns as the only available method to correct or adjust previously filed federal income tax returns for most partnerships.

This change was intended to simplify the amended return process, as it often does not require the ultimate partners to file amended returns. However, it is quite complex and increases risks that the partnerships themselves may be subject to tax—often far exceeding the tax that would have otherwise been borne by its partners.

What makes an AAR different from an amended return?

In an AAR, the default treatment of a change is assessment of tax on the partnership itself. This tax is assessed at the highest individual or corporate rate, and it can apply to any item changed on the return, including non-income items. Partner-level attributes, including loss carryovers, are not available to decrease this tax.

However, a partnership can choose to “push out” changes to its partners. Once these push-out changes make their way to a taxpaying entity, such as a C corporation or individual, that partner computes what the change in their tax would have been and pays the tax with the return in the year they receive the so-called push-out statement. This push-out process is the only method to benefit from a reduction in tax—the partnership itself cannot seek a refund.

How does this AAR process affect funds or other tiered partnerships?

To ensure taxes are paid if the push-out method is elected, any pass-through, such as an upper-tier partnership or S corporation, that receives a push-out statement has a fixed amount of time to either pay the tax itself or push it out to the next partner. Generally, that time period is the extended due date for the year in which they receive the statement.

What is the risk for upper-tier partnerships if they do not follow the push-out process for AAR forms received from lower tiers or portfolio companies?

If an upper-tier partnership does not push out changes it receives from a lower-tier entity, such as a portfolio company, it can be subject to taxes far exceeding those that would be paid by the partners.

For example, assume that a portfolio company has historically operated with losses, and most limited partners in a fund two tiers above have substantial suspended passive losses. The portfolio company files an AAR increasing income in a prior year.

If the full push out is followed, the AAR process becomes ministerial—no taxes are likely due. However, if one of the partnerships in the tiered structure fails to follow the process, it would be liable for tax on the change at the highest individual or corporate rate.

How can tax technology help with pushing out AARs?

Tax technology solutions can simplify the allocation of adjustments in intricate tiered structures and automate reporting requirements. Once your structure is loaded into a tax technology solution, the initial push-out statement from the lowest-tier entity can be input into the tiered structure, and a push-out statement package for each pass-through partner in the structure can be generated in moments.

Without leveraging partnership tax automation to adhere to the required AAR calculations, what should I expect from the process?

The process without using tax technology can be time-consuming and prone to error, requiring manual input at each tier of your fund structure.

The pass-through partner would allocate each adjustment to the partners and prepare the push-out statements for filing with the IRS. In a tiered structure, this process would be repeated until the push-out statements reach a taxpaying partner or the adjustments leave the structure.