Chasing Waterfalls: Allocating Adjustments in a Push Out Election, Part 2
Posted on May 12, 2025
By Jenni Black
Jenni Black is a managing director in Citrin Cooperman’s national tax office and the practice leader of the tax procedure and controversy practice
In this post, Black examines complications that may arise in tiered partnerships when allocating adjustments in a push out election
JENNIBLACK
Under the centralized partnership audit regime enacted by the Bipartisan Budget Act of 2015, any adjustments to partnership-related items (PRIs) must be determined, and any tax attributable to those adjustments must be assessed and collected, at the partnership level, unless BBA provides for an exception.1 One of the exceptions to when the tax attributable to partnership adjustments must be assessed and collected at the partnership level is if the partnership makes an election under section 6226 (or section 6227 in the case of administrative adjustment requests (AARs)) to “push out” the adjustments to its partners from the reviewed year.2 In part one of my article, I discussed allocating adjustments to partners on push out statements and what “in the same manner” means.3
In this part, I discuss why any of this matters, complications that may arise in tiered partnerships, and what happens if the pushed-out adjustments would change as they flowed through the tiers based on the facts and circumstances of upper-tier partnerships.
Why Does This Matter?
Before we get to that potential complication I promised you in part one of this article, let’s discuss why any of this matters You might be thinking to yourself, “It’s not clear, that’s fine; if it’s an audit, I’ll just ask the IRS to determine the allocations as part of the adjustments and if it’s an AAR, I will just make the changes as reallocation adjustments Ambiguity avoided ” And you would be right — for the source partnership.
When a pass-through partner (as defined in reg. section 301.6241-1(a)(5)) receives a push out statement, it must furnish its own push out statements to its partners or, if it does not furnish statements, pay an imputed underpayment (IU) calculated on the adjustments contained in the push out statement it received.4 The pass-through partner does not file its own AAR or amended return; it just furnishes and files statements (or pays)
If, as discussed in part one of this article, “in the same manner” means that adjustments must be allocated to partners using the exact same percentage as on the original return, a pass-through partner would not have the ability to change the allocations like the source partnership would. The allocation of a partnership’s items is a PRI that can only be determined or adjusted at the partnership level under BBA 5 If a pass-through partner must allocate the adjustments using the exact same percentage as on the original return, changing this allocation would require an adjustment to a PRI. A pass-through partner cannot change its own PRIs when it furnishes push out statements to its partners The only ways to adjust PRIs under BBA are through an exam or an AAR As the passthrough partner does not file an AAR in response to receiving a push out statement and it isn’t under exam, there would be no way to allocate the adjustments in a different manner (i e , it could not create its own reallocation adjustments or ask the IRS to determine its allocations (as its PRIs are not at issue in an exam of the audited partnership)) The pass-through partner might be able to file its own AAR to reallocate the pushed out adjustments independently of furnishing the push out statements but only if the time to do so under section 6227(c) had not expired (and, let’s be honest, by the time we get to this point, it’s likely closed) 6 But this seems inefficient Another consideration — as mentioned, the only way to adjust PRIs under BBA is through an exam or an AAR. If the passthrough partner is itself a BBA partnership, would requiring the pass-through partner to allocate its items using the same percentage, even if the adjustments would be allocated differently under the same method, constitute an adjustment to the pass-through partner’s PRIs without going through an exam or AAR?
However, if, as discussed in part one of this article, “in the same manner” means using the same methodas on the original return, a pass-through partner could allocate the adjustments in the push out statement using the same method it did originally (even if the pass-through partner is not using the exact same percentages), which would not be an adjustment As explained above, this interpretation is consistent with the general BBA framework.
Unadjusted Items
Now for that complication I promised you
When a partnership pushes out the adjustments to its partners, it does just that — it pushes out adjustments But what if applying the waterfall would create adjustments to other items not being adjusted? For example, a waterfall provision could provide that if income is $9 million or less, then all income is allocated to the limited partners But, if income exceeds $9 million, then 90 percent of all income is allocated to the limited partners and 10 percent of all income is allocated to the general partner Using this hypothetical waterfall provision, the partnership reported $9 million in ordinary income, all of which, in accordance with the partnership agreement, was allocated to its limited
partners. The IRS audits the partnership and determines the partnership omitted $2 million in capital gain If the $2 million in capital gain had been reported on the original return, $8 1 million of ordinary income and $1.8 million of capital gain would have been allocated to the limited partners (with the general partner being allocated the balance) If the partnership elects to push out, what does it put on the statements it furnishes to its partners? With regard to the $2 million capital gain adjustment, because it was not reported on the original return, under reg section 301 6226-2(f)(1)(ii) it will be allocated under rules that apply to partnership allocations, including in accordance with the partnership agreement Therefore, it would seem as if the $2 million capital gain adjustment would be allocated 90 percent to the limited partners and 10 percent to the general partners. But the $9 million in ordinary income that was allocated to the limited partners on the original return was not adjusted in the audit and only adjustments are included on push out statements 7
In this example, the partnership could ask the IRS to also adjust the ordinary income allocation. If not, the ordinary income would remain as originally allocated (all $9 million to the limited partners).8 However, this does not fix this problem if it occurs for a pass-through partner. As discussed above, a pass-through partner does not file an AAR (or amended return) when it receives a push out statement; it just furnishes its own statements or makes a payment. So, what if the adjustment would have affected how the pass-through partner would have allocated other items? Using the example above, let’s assume that the upper-tier partnership agreement contains the waterfall provision. Using the terms of the previous example, when the pass-through partner receives a push out statement reflecting an additional $2 million in capital gain it would have, if everything was reported correctly to begin with, allocated its ordinary income differently than it did on its original return, to account for the waterfall. But, in this case, regardless of whether “in the same manner” means the same percentage or the same method, the pass-through partner cannot adjust the allocation of its ordinary income without filing its own AAR, even though it is affected by the adjustment to the capital gain 9
OtherPass-Through PartnerFacts and Circumstances
Another tricky situation is when a pass-through partner’s facts and circumstances impact the amount of the adjustment at the pass-through partner level. Let’s take an example. On its original return for Year 1, LTP allocated $100 ordinary loss to UTP. UTP had an outside basis of $100 in LTP, so it includes the $100 ordinary loss in the Schedule K-1s it furnishes to its partners, resulting in UTP now having a basis in LTP of zero. Two years later, LTP files an AAR, increasing the amount of its ordinary loss for Year 1, which requires it to push out the adjustments to its partners. UTP receives a push out statement from LTP increasing the ordinary loss allocable to UTP by $50 to $150. If LTP had reported its ordinary loss correctly to begin with, UTP would have included $100 of ordinary loss on the Schedule K-1s it furnished to its partners and suspended the remaining $50 loss. But now UTP has received a push out statement and the regulations tell it to furnish statements to its partners reflecting their share of the adjustments 10 But what is their share of the adjustments?
In this case, is UTP supposed to furnish statements to its partners, reflecting zero adjustments and noting that the increase in ordinary loss is suspended?11 Or is it supposed to furnish statements allocating the additional $50 even though the loss would be limited if UTP reported it on its original return? This doesn’t exactly implicate the “in the same manner” and other allocation rules previously
discussed so much as what the underlying adjustments should be on the statements UTP furnishes. The answer is: It’s not addressed (Wait, aren’t I supposed to have the answers to all BBA questions?) The regulations do not address whether or how pass-through partner facts and circumstances impact the push out statements a pass-through partner is required to furnish In this example, the adjustment was an adjustment that does not result in an IU so it can only be pushed out, but what if it wasn’t? Would the pass-through partner risk being liable for an IU if it didn’t include the adjustment on the statements it furnished?
My BBA-Spidey Sense(TM) tells me the pass-through partner should only flow through the adjustments as it would have if the items had been reported correct to begin with. As I mentioned previously, BBA is a procedural regime that does not impact substantive tax results. If a pass-through partner was required to flow through the adjustments as is, without considering its facts and circumstances that would impact the amount of the adjustments, this would change substantive tax as it would give the pass-through partner’s partners an item they would not normally have gotten. But I’m just saying what I think the answer should be.12 While there is nothing in the Internal Revenue Code or regulations that would give this answer, my view is not completely unsupported by the regulations. Reg. section 301.6226-3(e)(6) provides rules for pass-through partners subject to chapter 1 tax. Under reg. section 301.6226-3(e)(6), if a pass-through partner would normally have paid chapter 1 tax on any of the adjusted items, it must still pay that chapter 1 tax and it would only include, on the push out statements it furnishes, the adjustments it would have included on the Schedule K-1s it furnishes if the item had been reported correctly to begin with.13 This rule retains the “natural order” of substantive tax — the pass-through partner pays the tax it would have owed and its partners do not receive items they would not have gotten if the items had been reported correctly to begin with Although this rule only applies to pass-through partners that are subject to chapter 1 tax, it evidences the desire to retain the normal substantive tax rules when a partnership is pushing out the adjustments to its partners. If a pass-through partner adjusts the adjustments to reflect its own facts and circumstances, it likewise retains the normal substantive tax rules.
In sum, none of the rules discussed in this article (parts one and two) are clear I think there is at least a decent argument that a partnership allocates adjustments to its partners “in the same manner” under reg. section 301.6226-2(f) when it uses the same method to allocate the adjustments as it used when it allocated the items originally, even if the percentage would differ from the percentage on the original return. This keeps the allocation in line with what it would have been if the items were reported correctly to begin with, which is the general goal of push out.14 In that same vein, I think a pass-through partner should be able to apply its own facts and circumstances to the adjustments when it furnishes its push out statements, and not just when it is also liable for chapter 1 tax Push out (under section 6226 or 6227) is intended to (generally) replicate what would have happened if the items had been reported correctly to begin with. The IRS should consider clarifying these issues to give partnerships guidance for when they prepare their push out statements While I realize that hoping for regulations anytime soon is like hoping I will hit the Powerball so I can retire, I (in my humble opinion) think these clarifications can be done through the forms and instructions.
FOOTNOTES
1 IRC section 6221(a).
2 The reviewed year is the tax year to which the adjustment relates. IRC section 6225(d)(1); reg. section 301.6241-1(a)(8).
3 TaxNotes Federal, May 12, 2025, p. XXX.
4 Reg. section 301.6226-3(e).
5 IRC section 6241(2)(B)(ii); reg. section 301.6241-1(a)(6)(ii)(B).
6 The ability to do this is not addressed in the Internal Revenue Code or regulations. If the regulations require the pass-through partner to allocate the adjustments using the same percentage as it did originally, it’s unclear whether the pass-through partner can file an AAR to change the allocations from those in the regulations (but see whether this would be an adjustment to a PRI). Perhaps this is another reason why it may make more sense for “in the same manner” to refer to the same method as used on the original return, instead of the same percentages.
7 An election to push out adjustments is made with respect to an IU IRC section 6226(a)(1); reg section 301 6226-1(a)-(c) With the exception of adjustments that do not result in an IU, only adjustments that are included in the IU to which the election relates are included on the push out statements Reg section 301 6226-2(e); seealsoreg section 301 6226-1(b)(2)
8 Obviously, if the partnership is filing an AAR, it can adjust the ordinary income at the same time it is adjusting the capital gain. In an exam, the partnership could not self-help and file an AAR to adjust the ordinary income because an AAR cannot be filed once the IRS has issued a notice of administrative proceeding. IRC section 6227(c) (flush language).
9 If “in the same manner” means using the same percentage, all of the capital gain adjustment would be allocated to the limited partners in this example. While this may not be how it would have been allocated if the items had been reported correctly to begin with, it does provide a method to allocate the adjustment that does not create any “loose ends” (i.e., the need to change the allocation of other items not adjusted).
10 See reg. section 301.6226-3(e)(3); 301.6227-3(c).
11 If the increase in loss for Year 1 is now suspended, UTP may also have to file an AAR (or amended return, whichever is appropriate) for a year after Year 1, if UTP is allocated income from LTP in a subsequent year which would allow UTP to utilize the suspended loss
12 To be clear, I think, in this example, the answer should be that the partnership suspends the additional $50 loss, as it would have if the loss had been correctly reported on its original return. If the loss could have been used in a subsequent year the partnership could file an AAR to utilize the
suspended loss or it would continue to carry it forward to be used in the future, just as it would have if the total loss was reported on its original return
13 The taxpaying pass-through partner could also choose to pay an IU on all the adjustments contained in the push out statement furnished to it. Reg. section 301.6226-3(e)(6).
14 SeeIRC section 6226(b)(2) (calculating the partner’s increase or decrease in chapter 1 tax by reference to the amount of tax the partner would have paid if the adjusted item was taken into account in the year to which it relates).