Partnership Audit Regime Rules Ahead: With all the new tax law issues to address, one of the provisions from way back in 2015 is going to affect the tax filings and responsibilities associated with partnerships starting in year 2018.
The Bipartisan Budget Act of 2015 (BBA) established a new audit regime for partnerships that changes audit procedures by allowing the IRS to assess and collect taxes at the partnership level. The new partnership audit rules will go into effect in 2018.
The BBA regime created new roles and responsibilities that could lead to disagreements among partners. Many of these disagreements can be avoided by carefully reviewing and revising the partnership agreement.
In the past, partnership audits were governed by the so-called Tax Equity and Fiscal Responsibility Act (TEFRA) audit rules. Under the TEFRA rules, partnership items are audited and adjusted only in partnership-level proceedings. Once adjustments are made, each partner made the adjustments to his or her return and paid any resulting taxes, penalties, and interest.
For tax years beginning after 2017, the TEFRA audit procedures are replaced by the BBA regime. Under this regime, adjustments to a partnership’s items of income, gain, loss, deduction, or credit will be made at the partnership level. Any additional tax, penalty, or amount related to the tax will also be determined and collected at the partnership level unless the partnership elects an alternative payment process (also known as a push-out election).
If an audit results in additional taxes, the partnership must pay the imputed underpayment amount in the adjustment year-the year the adjustment is finally determined. Interest and penalties also will be payable by the partnership. This begs the question of whether the burden of such payments should fall on the current partners or those who partners in the tax year under audit were. Under the BBA, the partnership (and therefore, the current partners) is responsible for paying the assessment unless the partnership makes a push-out election (more on that later). This can lead to inequitable results and contention between prior and current partners. The partnership agreement should address how liabilities arising from an audit will be allocated between current and reviewed year partners.
Under the new rules, Partnerships will be required to designate a partnership representative. The partnership representative has the sole authority to act on behalf of the partnership in audits and other tax proceedings. The partnership representative doesn’t have to be a partner, but it must have a substantial presence in the U.S. If the partnership representative is an entity, the partnership must appoint a sole designated individualthrough whom the partnership representative will act.
The partnership representative has the sole authority to extend a statute of limitations, settle with the IRS, and initiate a lawsuit. Any defense not raised by the partnership representative is waived. This also means that the partnership representative will take on a high level of risk. Considering this, partnerships may have a difficult time finding someone willing to act as the representative. Partnerships may have to consider indemnifying or compensating the partnership representative.
Partnerships must designate a partnership representative separately for each taxable year on the tax return. Partnerships will need to amend their agreements to establish procedures for choosing, removing, and replacing the partnership representative. In addition, the partnership agreement should carefully outline the duties of the partnership representative.
Under the new audit regime, a partnership must pay the imputed underpayment amount resulting from an IRS audit unless it makes a push-out election. As the name suggests, a push-out election allows a partnership to push an adjustment out to the reviewed year partners. This shifts the liability away from the current partners to those who were partners in the year the adjusted item arose. A push-out election must be filed within 45 days of the date the Final Partnership Adjustment (FPA) is mailed to the partnership by the IRS. At a minimum, the partnership agreement should address whether the partnership representative is required to make a push-out election or the circumstances in which a push-out election will be made.
Partnerships with 100 or fewer partners can elect out of the new audit rules for any tax year, in which case the partnership and its partners will be audited under the general rules for individual taxpayers. The election is available only if each of the partners is an individual, a C or S corporation, a foreign entity that would be treated as a C corporation were it domestic, the estate of a deceased partner. Each election must be made on an annual basis and must include the name and tax identification number of each partner. Also, the partnership must notify each partner of the election within 30 days of making it. Once made, an election may not be revoked without the consent of the IRS.
Many small partnerships assume they will be able to elect out of the new audit procedures because they have 100 or fewer partners. However, the election isn’t available if one of the partners is a partnership or if any of the individual partners hold their ownership in a revocable living trust.
Partnership agreements of eligible partnerships should address whether an election out will be mandatory. In many situations, an election out will be preferable. However, partnerships looking to maintain flexibility in their partnership agreements should include provisions indicating how the decision to elect out will be made.
If you have questions, please contact John Csargo at firstname.lastname@example.org