New Partnership Audit Rules May Require Action Soon by Partnerships and Partners

Absent an election by a partnership to apply earlier, for years beginning after December 31, 2017, new rules will govern IRS audits of partnerships.  Among other changes, the new law allows the Internal Revenue Service (“IRS”) to assess and collect taxes at the partnership level.  The governing and operating documents of any entity taxed as a partnership in the U.S. should be reviewed to be sure that the entity is in compliance with the new law and that any elections and directions that might reflect the will of the partners are timely instituted.  It is likely that most partnerships will need to make changes to comply with the new rules.
For ease of reference, all entities that are treated as partnerships for U.S. Federal income tax purposes (including multi-member limited liability companies, for example) are referred to herein as partnerships.
The new partnership audit rules were enacted as part of the Bipartisan Budget Act of 2015 (“BBA”).  The BBA rules replace the previous rules governing partnership audits enacted as part of the Tax Equity and Fiscal Responsibility Act of 1982 (“TEFRA”).  The IRS posted proposed regulations in January of 2017.  These proposed regulations were never officially published because of the regulatory freeze announced by the Trump administration on January 20.  The proposed regulations were reissued in June 2017.  They are essentially the same as the January proposed regulations.  Public comments about the proposed regulations are due by August 14.  A public hearing on the proposed regulations is set for September 18, 2017.
Some of the key provisions of the BBA rules, as currently interpreted by the proposed regulations, include the following:

1.  Each partnership must designate one “partnership representative” to serve as the sole contact between the partnership and the IRS.  The partnership representative replaces the TEFRA “tax matters partner.”  The partnership must designate the partnership representative for each tax year and must make the designation on the partnership’s return each year.  The partnership representative does not necessarily need to be a partner.  The partnership representative has broad powers to negotiate and reach agreements with the IRS.  Unlike the TEFRA rules, the BBA rules provide that partners will have no statutory right to participate in tax audits or litigation, no right to opt out, and no partner-level defenses.  There may exist partner-level modifications to a tax assessment, based on partner-level tax characteristics.

 

2.  There is provided an election out of the BBA rules for certain partnerships that issue 100 or fewer K-1s, provided that each partner of the partnership is an individual, a C corporation, a foreign entity treated as a C corporation, an S corporation or the estate of a deceased partner.  The owners of the S corporation are considered in the determination of whether the 100-or-fewer threshold is met.  The election out must be made annually on a partnership’s timely filed return, including extensions.  As a result of the election, the audit of partnership items is made at the partner level.

 

3.  Generally, the partnership must pay any increase in tax, also called the imputed underpayment, resulting from an audit.  The partners in the “reviewed year” could be different from the partners in the “adjustment year,” which is the year the partnership would be required to pay the nondeductible tax.  As an alternative to the partnership paying the imputed underpayment, the BBA rules allow a partnership to elect, not later than 45 days after the date of the notice of the final partnership adjustment (“FPA”), to pass the adjustment through to the reviewed year partners (“the push-out election”).  The proposed regulations provide very specific requirements for push-out statements to partners.

These provisions are just some of the changes provided by the BBA and the proposed regulations.  Partnerships and partners should study the proposed regulations and the final regulations that may be issued before yearend. Partnerships should consider adopting changes to governing documents and operating procedures to assure the proper handling of partnership audits and any tax adjustments resulting therefrom.  If you have questions about these new rules, please contact your HM&M tax advisor.

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