New IRS audit procedures introduced in the Bipartisan Budget Act of 2015 will hold a partnership responsible for paying any tax and related interest and penalties resulting from an IRS audit, beginning with the 2018 tax year. Up until now there has been limited guidance on how to actually implement these rules, even after the IRS released proposed regulations in June 2017. However, after considering a plethora of written public comments and public hearing statements, the Treasury recently issued final regulations — effective January 2, 2018 — for opting out of the centralized partnership IRS audit regime. In addition, the Treasury has proposed new regulations related to international and push-out/tiered partnership concerns.
Opt Out Election
The previously proposed regulations stated that a partnership may opt out of the new IRS partnership audit rules altogether if it had 100 or fewer partners for the taxable year and all partners were eligible partners. The final regulations make the following clarifications about who, how and when.
Who is an eligible partner?
The final regulations state that eligible partners of the partnership DO NOT include:
- A trust, including grantor trusts/living trusts
- A foreign entity that would be not be classified as a corporation if it were organized under domestic law
- A disregarded entity, including single member LLC's owned by an individual or other type of eligible partner
- Estate of an individual other than of a deceased partner
- A nominee or similar person who holds an interest on behalf of another person
Note that even though the above entity types are ineligible partners, there is a provision in the regulations that allows for Treasury and the IRS to expand on the types of other eligible partners as they gain experience with these new audit rules.
It’s also important to note the Treasury clarified that an S corporation partner's shareholders do not need to be eligible partners for the S corporation itself to be eligible.
How do you tally the final partner count?
The count includes any person who was a partner of the partnership or shareholder of an S corporation partner during the tax year. Accordingly, each K-1 statement issued to a partner of the partnership is counted, including each K-1 issued to all S corporation partners, as well as each K-1 the S corporation partner issues to each of its shareholders (even though shareholders don’t have to be “eligible” partners, they do in fact still need to be included in the overall partner count).
Husband and wife will be counted as two separate and distinct partners if both are partners in the partnership. Any K-1s provided to beneficiaries by an estate of a deceased partner will not be included in the partnership count.
As a basic example, consider a partnership that has 51 partners, comprised of:
- 50 individual partners and
- One S corporation partner, which has 50 shareholders
This partnership is deemed to have 101 partners due to the 101 statements that are required to be issued. Thus, the opt-out election is not an option for this partnership.
When can you make the opt-out election?
The final regulations also clarify the mechanics of the election, including timing. The election must be made on an eligible partnership’s timely filed return, including extensions, for the taxable year to which the election applies.
New Proposed Regulations
The Treasury and the IRS have been busy issuing new proposed regulations regarding the IRS audits as well.
Issued November 30, 2017 - International Tax Rules. These proposed regulations address items such as tax withholding on foreign persons, withholding to enforce reporting on some foreign accounts and the treatment of creditable foreign tax expenditures of a partnership. The comment period will remain open until January 29, 2018.
Issued December 19, 2017 – Push-out Election and Tiered Partnerships. The push-out election requires “reviewed-year” partners, those who were actually partners during the years under IRS review, to pick up their share of the adjustment and bear the tax burden. However, the new proposed regulations provide guidance on the ability to push out those adjustments beyond the first tier of a tiered partnership so that each pass-through partner in an ownership chain may choose to either pay the tax, penalties and interest or push the adjustments to their partners. These regulations also provide a compliance mechanism for collecting tax from a non-compliant pass-through partner. The comment period remains open until March 19, 2018.
There are still outstanding items to address, such as how to apply adjustments to partners’ outside basis and capital accounts. However, despite the AICPA and American Bar Association’s continued requests that the Treasury delay the implementation of these rules due to their complexity, ongoing significant revisions to the temporary regulations seem likely — as do the undue burdens taxpayers and the IRS will likely face.
Read more on how to prepare for the new IRS partnership audit rules.
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.