ALERT – Partnership Audit Rules Changing
As part of the Bipartisan Budget Act of 2015 (“BBA”), new IRS partnership audit rules become effective for partnership tax years which begin after December 31, 2017.
Under the new rules, audit adjustments made by the IRS to items of income, gain, loss, deductions or credits are required to be made at the partnership level with the partnership liable for any resulting underpayment of tax.
A partnership which does not elect out of the new audit rules must designate a partner or another U.S. person as the Partnership Representative
Under current partnership audit rules, these adjustments are all made at the partner level rather than at the partnership level. This represents a significant change.
Partnerships may elect out of the new rules if their only partners consist of individuals, estates of deceased partners or “S” or “C” corporations. (Note: It is unclear whether single member LLC are permissible partners and IRS guidance is anticipated on this issue.) They are required to issue no more than 100 Schedules K-1 and follow certain requirements as to the time and manner of making the election.
Also, under the new rules, additional taxes, penalties and interest arising from an audit are payable by the partnership. However, in lieu of the partnership paying the tax, a partnership may elect, within 45 days after receiving a notice of final partnership adjustments for an audited year, to furnish each partner in the reviewed year with a statement such as a revised Schedule K-1 of each partner’s share of each adjustment. The partner then self-assesses any added tax computed as if the adjustment had been properly reported for the reviewed year, but this assessment is reported and paid on the return for the year in which the revised Schedule K-1 is received.
A partnership which does not elect out of the new audit rules must designate a partner or another U.S. person as the Partnership Representative (Note: The Partnership Representative replaces the Tax Matters Partner). The Partnership Representative has sole authority to act on behalf of the partnership and may bind the partnership and all partners in IRS audits and in court proceedings (IRC §6223(b)).
Election out of the new audit rules is an annual election and this may be changed each year. The annual election is made on a timely filed return identifying the names and tax identification numbers of the partners and notifying each partner of the election.
Partnership agreements or operating agreement will need to be amended if election out is to be required, to require the partners of the reviewed years to reimburse the partnership for underpayments made by the partnerships in the adjustments year when the partners for the reviewed year and the adjustment year are different. Also, the procedures for selecting a Partnership Representative should be set forth in the amended partnership or operating agreement. There are other items that should be addressed in amending the partnership agreement and in the buy-sell agreements where Partnership interests are sold.
Of particular note, foreign partnerships are not included in the current changes, but the BBA and the Technical Corrections Act of 2016 propose that Treasury and the IRS will promulgate provisions for such foreign Partnership audits. (See H.R. 6439, §206(h)(10)(B)(v)).
To ensure the appropriate time necessary to evaluate the implications of this rules on a partnership and update partnership documents, as necessary, these matters should be addressed as soon as possible.
For further information, please contact Todd Douglas Hall, Esq., Partner, or B. Roland Freasier, Jr., Esq., at