New Partnership Audit Rules – Changes are Coming
One of the provisions in the Bipartisan Budget Act of 2015 relates to new partnership audit rules which are set to be effective on January 1, 2018. Even though these new rules may be almost a year away, it’s not too early for partnerships to consider the upcoming changes.
For the last 30 years, partnerships and LLC’s have been governed by rules that permit the IRS to exam the tax returns and make adjustments at the entity level that affect all the partnership’s partners and LLC’s members. Accordingly, partnership and LLC agreements generally provide for the selection of a tax matters partner who has the right to interface with the IRS and the responsibility to notify the partners/members of the start of an IRS audit and terms of a settlement.
Currently, there are three different sets of rules for partnership audits:
*Partnerships with more than 10 partners are audited under the TEFRA rules which are binding on the partners.
*Partnerships with 100 or more partners that elect to be treated as ELP’s (Electing Large Partnership) are subject to audit procedures under which adjustments are reflected on the partners’ current year return rather than the affected tax year.
*Partnerships with 10 or fewer partners are audited as part of each partner’s individual audit.
For tax years beginning after 2017, new and existing partnerships will be subject to new partnership audit rules which are intended to streamline partnership audits into a single set of rules. Partnerships with 100 or fewer partners will be permitted to opt out of the new rules, and instead be subject to audits on the level of each partner.
The Bipartisan Budget Act repeals the TEFRA and ELP rules and creates an updated structure for auditing partnerships and their partners. Any adjustments that the IRS determines is taken into account by the partnership in the year that the audit is completed and tax is collected from the partnership, not the partners. In lieu of a tax matters partner, there will be a partner representative, who is not required to be a partners or member in the partnership or LLC. This person or entity will have the sole authority to act on behalf of the partnership in agreeing to settlements and final partnership adjustments.
All of the partners will be bound by the terms of the settlement or final audit report and the income tax deficiency will be computed at the partnership level and assessed to the partnership using the highest individual and corporate tax rate for each partner.
As an example, under the current rules, if an audit of a 2014 tax return is completed in 2018, the adjustment would be assessed at the individual partner level for the 2014 tax year. However, under the new rules, the adjustment would be assessed and deficiency collected at the partnership level in 2018. Clearly, this may cause an issue for partnerships if the partner composition changes from the year under audit to the assessed tax year.
Professionals drafting partnership and LLC agreements should address these new rules including the appointment of a partnership representative, decision to elect out of the unified audit rules, and further describe the representative’s authority to interact with the IRS.
If you would like to discuss the Bipartisan Budget Act new rules in more detail to see how it may affect your partnership(s), please do not hesitate to contact our office at (949) 260-1430.
Written by Jeff Olson, Partner
SKINNER FOUCH & OLSON LLP