A major change to partnership audits was signed into place by President Barack Obama on November 2nd following the passage of the Bipartisan Budget Act of 2015 by Congress on October 30th. Previously, partnerships with more than 10 partners ("TEFRA" partnerships) and certain "Electing Large Partnerships" had different audit procedures. The new rules eliminate those approaches in favor of a streamlined process of audit rules; however, partnerships with 100 or fewer exclusively qualifying partners may opt out of the new rules and be audited under the general rules applicable to individual taxpayers. Qualifying partners are individuals, estates, S corporations and C corporations.
Under the new audit regime, the IRS examines the partnership items (income, gain, loss, deduction, credit and distributive shares) for a partnership taxable year (the "audited year"). Adjustments resulting from the audit are taken into account in the current year by the partnership, rather than the individual partners, and resulting liabilities are calculated using the maximum tax rates. However, the partnership can reduce the liability by providing amended returns of partners, information on lower tax rates applicable to specific partners, and information on the type of income at issue.
In the alternative, the partnership can opt to issue adjusted partner information returns (Form K-1s) to the audited year partners, rather than taking the adjustment into account at the partnership level. If the partner-level adjustment is used, however, the IRS will levy the interest at two percentage points higher than if the adjustment had been at the partnership level.
These rules will take effect for tax years beginning January 1, 2018 or later.
Partnership and LLC agreements should be evaluated to review how audit issues are currently addressed by the partnership in light of these substantial changes. Our corporate and tax lawyers can work with you on how to modify your agreements. Additionally, we have experienced tax controversy lawyers who can assist you with any audits, appeals and tax litigation.