On November 2, 2015, President Obama signed into law the Bipartisan Budget Act of 2015 (hereafter, BBA) which included drastic changes in the IRS’ ability to collect tax on partnership-level income as a result of an audit and also made changes to the rules regarding who represents the partnership under the new rules.
The new rules apply to tax years beginning after December 31, 2017 (2018 partnership returns), but a partnership may elect to have the new rules apply to tax years beginning after November 2, 2015 and before January 1, 2018.
New Partnership Audit Rules
Under the new rules, the IRS can audit partnerships, make adjustments, and assess and collect tax at the partnership level. On the plus side, partners would not be required to amend returns as a result of partnership audit adjustments. However, the consequences of this could result in partnership-level taxation at the highest effective tax rate. Additionally, those who are partners at the time adjustments are made may effectively bear the tax costs of any adjustments even if they were not partners in the year being audited.
All partnerships are subject to the new partnership audit rules unless they specifically elect out.
How does a partnership make an early election to adopt the new audit rules?
A partnership can elect to have the audit rules apply for any taxable years beginning after November 2, 2015, and before January 1, 2018 by providing the IRS with a written statement within 30 days of being selected for examination.
Currently, the IRS hasn’t issued final regulations as of yet. Therefore, we recommend you proceed with caution when considering early adoption. Additionally, an early election cannot be revoked without IRS consent.
Which partnerships may elect out of the new rules?
The two main criteria are that the partnership has 100 or fewer partners and that all partners are eligible partners. An eligible partner includes an individual, C corporation, eligible foreign entity, S corporation, or an estate of a deceased partner.
How does a partnership elect out?
The election to opt out of the partnership audit rules is made annually with a timely filed return and must include the name and taxpayer identification number of each partner. The partnership is also required to notify each partner of the election.
Are there any disadvantages to electing out?
The new rules require the IRS to limit its examinations to only partnership items at the partnership level proceedings. Opting out may increase the risk of exposure to a full IRS examination on the individual partners’ returns.
The Partnership Representative
Partnerships subject to the BBA audit rules are now required to have a “partnership representative.” The partnership representative can be any person (including a non-partner) with a substantial presence in the United States or an entity. The partnership representative has the sole authority to act on behalf of the partnership and all partners, the decisions of whom are binding with regards to all BBA audit rules including settlement agreements and elections. So, what happens if you don’t designate a partnership representative? The IRS will select one for you.
Unlike the prior TEFRA rules establishing the requirement that a Tax Matters Partner be designated, under the new rules, partners do not have any notification rights with regard to key stages of the audit, or rights to participate in the audit, appeal or later judicial review.
It is critical that you review and update your partnership agreements as necessary. At a minimum, consider the following:
- Who should be appointed the partnership representative?
- How will the partnership evaluate elections available under the new rules?
- What are the obligations of the partners and the partnership representative to seek or provide information to minimize the overall tax resulting from an audit?
- How will partnership-level tax liabilities be funded and allocated?
- What indemnification clauses should be required for former partners?
As always, ATKG is here to help. Please call us if you have questions or concerns.