On June 13, 2017, the Treasury Department republished Proposed Treasury Regulations regarding the new partnership audit regime enacted as part of the Bipartisan Budget Act of 2015. Generally, the new partnership audit rules will be effective January 1, 2018.
As a result of the new partnership audit regime: (1) individuals and/or entities that were formerly owners of General Partnerships, Limited Partnerships and multi-member Limited Liability Companies (together “Partnerships”) during prior, audited tax years may escape liability for unpaid tax, and correspondingly (2) the existing owners of such Partnership (i.e., the owners of the Partnership at the time of the IRS collection process) will bear the economic burden entirely. Thus, in the absence of properly drafted Partnership and Operating Agreements, any existing owner of a Partnership may be economically liable for the unpaid tax of former partners/members of the Partnership. It is therefore critical that Partnerships and their owners review and modify their existing partnership and operating agreements immediately.
More specifically, under existing law, the IRS must generally audit a Partnership for a particular tax year, and to the extent of any tax deficiency, seek to collect the payments from those individuals and/or entities that were owners of the Partnership during the audited tax year. In contrast, under the new audit regime, the IRS may collect such unpaid tax from the Partnership itself at the highest tax rate in effect for the year under examination.
Under certain circumstances, however, Partnerships composed of 100 or fewer owners (and whose owners do not include any Partnerships or certain Trusts) may elect-out of the new audit regime, which election must be filed annually with the IRS. In addition, if certain strict requirements are met, many Partnerships can essentially revert back to the collection process under existing law by imposing liability on those individuals and/or entities that were owners of the Partnership during the audited tax year. Under the new regime, these critical elections are made by the “Partnership Representative” (in lieu of the “Tax Matters Partner”), which if not designated properly by the Partnership (and subject to the new rules on which individuals/entities can serve in that capacity), can be selected unilaterally by the IRS itself.
Accordingly, Partnerships that desire to comply with, or alternatively, elect-out of the economic uncertainties caused by the new audit regime should modify immediately their existing partnership and operating agreements, so that these documents are consistent with the new law.