Effective for tax years beginning after December 31, 2017, the IRS will begin enforcing new audit rules for all entities filing IRS Form 1065 (typically partnerships and multi-member LLCs filing as partnerships). These changes will impact how the partnership and its partners are audited, who is responsible for audit adjustments, and who makes important audit decisions for the partnership. In addition, the new rules provide new elections and opt outs that qualifying partnerships may make. Based on these significant changes, most partnership agreements and LLC operating agreements should be reviewed and important changes may need to be made.
Partnership Level Adjustments:
In most circumstances, the new audit rules require that any adjustments to items of partnership income, gain, loss, deduction or credit, and any partner’s share of such items, are determined at the partnership level. If the IRS determines a deficiency for the year under review, the IRS will assess and collect the tax deficiency directly from the partnership in the year the audit is concluded. This means that in cases where the partnership has changed some or all of its owners, the current partners could bear the burden of unfavorable adjustments and decisions made by past partners. Given this risk, the new rules provides certain elections qualifying partnerships may make.
Opt Outs and Push Outs:
While the new audit rules technically apply to all partnerships, the provisions provide an “Opt Out” election for certain qualifying partnerships. If an “Opt Out” election is made the partnership and its partners are audited separately. The Opt Out is available for partnerships with less than 100 partners who are individuals, Corporations, S Corporations and estates of deceased partners. In other circumstances, many partnerships may qualify for a “Push-Out” election. If a Push-Out election is made the burden for an underpayment is pushed out to those who were partners for the year under review. The Push-Out election may prevent new current year partners from bearing the burden for partners in a prior review year.
With the advent of the new rules, the concept of a “tax matters partner” is replaced by a “partnership representative”. The partnership representative is the sole point of contact between the partnership and the IRS. Under the new law, only the partnership representative has the statutory right to participate in a partnership level audit. Based on the broad level of authority that a partnership representative has, partnership agreements and operating agreements may need to be revised to state how a partnership representative is appointed and in what respect the partnership representative’s authority may be limited.
With the advent of the new partnership audit rules, IRS audits will likely increase. Partners and partnerships (and multi-member LLC’s filing as partnerships) need to understand how the new rules will impact their partnerships, what elections are available, whether elections like Opt Out and Push Outs should be made, who can make the available elections and how they are made. Our attorneys are available to help you with these and many other issues resulting from these new rules. Call us at your earliest convenience for a review of your existing agreement.