In 2015, Congress enacted a federal partnership tax audit regime, which repealed and replaced the old partnership audit regimes including Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) with a new centralized set of rules (the New Partnership Tax Audit Rules) that, notwithstanding the general flow-through nature of partnerships for federal income tax purposes, assesses and collects any federal taxes due as a result of a partnership audit at the partnership entity-level. As discussed in more detail below, we strongly recommend that every single entity treated as a partnership for US federal income tax purposes revise its operating document(s) to address the New Partnership Tax Audit Rules as soon as possible, and preferably before 31 December 2017.

The New Partnership Tax Audit Rules are fully effective for partnership taxable years beginning after 31 December 2017. Any change to that effective date would require an act of Congress, which we believe to be highly unlikely at this point in time. Thus, beginning 1 January 2018, the IRS is no longer required to individually assess each partner's share of any tax due as a result of a partnership audit subject to the New Partnership Audit Rules. Instead, under the default rules of the new audit regime, the partnership is liable for an imputed underpayment based on the adjustments made at the partnership level. As a result, if there has been any change in the partners' ownership percentages following the year under audit, including the removal or addition of partners, the partners of record on the date the audit is finalized, instead of the partners of record for the year under audit, could effectively bear the cost of the additional tax owed by the partnership absent a contractual agreement to the contrary. This could present a mismatch of the tax burden among the partners over that period. In addition, without taking advantage of certain modification procedures or push out elections, the imputed underpayment calculation may, for some partnerships, overstate the amount of tax due had the partnership and partners reported the partnership adjustments properly.

Also, the New Partnership Tax Audit Rules require each partnership to designate a partner or other person with a substantial presence in the United States as the "partnership representative," who will have the sole authority to act on behalf of the partnership in the event of an audit. The partnership may designate an entity as the partnership representative (including the partnership itself), as long as the partnership appoints a "designated individual" as the sole individual to act on behalf of the entity partnership representative. Unlike current rules, the partnership representative is not required to even notify partners of an audit and has sole discretion to settle IRS tax disputes without consent of the partners. If a partnership agreement does not appoint a partnership representative (or designated individual, as applicable), the IRS may select any person to serve in such role, and the partnership and all of its partners will be bound by the actions taken by that person.

Any partnership (domestic or foreign) required to file a partnership return in the United States is subject to the New Partnership Tax Audit Rules. There is a limited exception for certain eligible partnerships to elect out of the new audit regime, but such election must be made every year and requires certain disclosures of partner information to the IRS.

Based on the foregoing, it is imperative that every partnership agreement currently in effect be revised (or a side agreement is entered into) to address the New Partnership Tax Audit Rules. Ideally such amendments would be entered into by 31 December 2017, to address any changes of ownership during 2018. At a minimum, every partnership needs to designate a partnership representative. Given the unprecedented powers of this role and the complexity of the New Partnership Tax Audit Rules, agreements are needed to address partners' rights to audit notification, audit participation and input on IRS settlements and elections.

Clients should review their structures to confirm the existence of any partnerships, and to the extent they have current partnership agreements (that have not been amended), they should be aware of the New Partnership Tax Audit Rules.