The Bipartisan Budget Act of 2015 created new IRS audit procedures that are set to make big changes in how partnerships are audited for tax years beginning after December 31, 2017.
In general, the new rules will hold a partnership — as opposed to individual partners —responsible for paying any tax and related interest and penalties resulting from an IRS audit. This likely will make it easier for the IRS to audit more partnerships. (Read more about the significant changes in “End of an Era: What Revised Rules Could Mean for Future IRS Partnership Audits)
With many changes ahead, there are certain areas partnerships should be addressing now, before preparing their 2018 tax returns, to help ensure they are prepared and protected.
Make this election to opt out of the new partnership audit rules altogether. To opt out:
- Partners can only be individuals, corporations (including S Corporations and foreign entities that would be corporations if they were domestic) and estates of deceased individuals
- Partners in the partnership cannot be
- another partnership
- a foreign entity that would be not be classified as a corporation if it were organized under domestic law
- estate of an individual other than of a deceased partner
- nominee or similar person who holds an interest on behalf of another person
- a trust
- The partnership cannot issue more than 100 K-1s (including K-1s issued to any S Corporation partner and to each of the shareholders of all S Corporation partners)
- The election must be made annually on the partnership’s timely filed income tax return
UPDATE: Find out the latest on opt-out rules in "IRS Finalizes Opt-Out Rules for IRS Partnership Audits; Proposes Additional Regs"
Make this election to have the “reviewed-year” partners, those who were actually partners during the years under IRS review, pick up their share of the adjustment and bear the tax burden. The election must made after the IRS determines its final audit adjustment.
Partnership Agreement Amendments
Of course any decisions related to your partnership agreement should be discussed with your attorney, but a few areas of discussion include:
- Specify how the partnership representative will be determined, must they be a partner, etc.
- Note the duties and liabilities of the partnership representative
- Note who will directly or indirectly bear the tax and related costs of adjustments (including any imputed underpayment) — Will the partnership bear the costs (and thereby, have the current adjustment-year partners indirectly bear those charges), or will the reviewed-year partners bear those charges?
- Remove language regarding the role of tax matters partner, which will be replaced by the partnership representative
- Note if the opt-out election will be made, if the partnership is eligible; if eligible, note whether or not transfers of partnership interests to an entity that would make the opt-out election ineligible would be permitted
- State whether the partnership will make the push-out election, and, if so, if the partnership will require former partners to provide information so it can make the election
Timeline for Preparedness
- Even though the rules allow for amending partnership agreements up until the 2018 tax return deadline, we highly recommend reviewing existing partnership agreements for any potential amendments before the end of 2017
- Any new partnership agreement that arises in 2017 should also account for these new rules and their potential application
- Transactions involving the sale of partnership interests that close on or after January 1, 2018, should account for these new rules
Considerations for 2018 tax returns
- A partnership that is eligible and desires to elect out of these new partnership audit rules will need to make an election on their 2018 tax return
- All partnerships must designate a partnership representative on their 2018 income tax return
- If the partnership representative is an entity, appoint an individual through whom the partnership representative will act
- Confirm all partner information is accurate and current for existing and former partners
Keep an Eye Out: What We Don’t Know
The proposed regulations do NOT address:
- How the application of these rules will affect a partner’s basis in their partnership interest and their capital account balances
- How the push-out election will be applied to tiered partnerships
- How modifications and tax rates of partners that are foreign persons or entities will be determined
- How these rules will apply at the state level
So what’s the good news? First, each and every item may not apply to every type of partnership. However, partnerships must be diligent in exploring these areas to see which will have the greatest impact. Second, it is possible to protect your partnership, if done proactively. That’s why a collaborative discussion with your legal counsel and tax advisors now is imperative to help ensure your partnership is making the best decisions possible and is prepared for when the new rules take effect.
Cohen & Company is not rendering legal, accounting or other professional advice. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts and circumstances.