We wrote in late November 2015 about the new partnership audit rules enacted as part of The Bipartisan Budget Act of 2015. At the time we told you that we were anticipating technical corrections to this law to correct inconsistencies and clarify certain areas. It now appears that there will likely not be a technical corrections bill so it will be left to the IRS to clear up the confusion. Fortunately, Congress gave the IRS broad latitude to issue regulations implementing these procedures.
To recap the new rules:
- They provide a streamlined single set of rules for auditing partnerships and their partners — and assessing and collecting any tax attributable to adjustments made in an audit at the partnership level.
- The rules generally apply to partnership tax years that begin after December 31, 2017.
- Partnerships may elect to have the new rules apply to any partnership return filed for partnership tax years beginning after November 2, 2015, and before January 1, 2018.
- Any adjustment to items of income, gain, loss, deduction or credit of a partnership for a partnership tax year (and any partner’s distributive share of such adjustment) is determined at the partnership level. Similarly, any tax attributable to such adjustment is assessed and collected — and the applicability of any penalty, addition to tax or additional amount that relates to an adjustment to any such item or share is determined — at the partnership level.
- Partnerships must pay tax equal to the “imputed underpayment,” which generally is the net of all adjustments for any reviewed year multiplied by the highest individual or corporate tax rate. However, the imputed underpayment may be modified if a partnership shows that a lower amount is appropriate based on certain partner-level information.
- As an alternative to taking the adjustment into account at the partnership level, a partnership can make an election to issue adjusted information returns to the reviewed-year partners. If this election is made, the partners take the adjustment into account on their individual returns in the adjustment year through a simplified amended-return process.
- Additionally, the new rules permit some (or all) of the partners, instead of the partnership, to pay their share of the tax on the partnership adjustment by filing an amended return
- Small partnership election out of new rules. Partnerships with 100 or fewer qualifying partners can elect out of the new rules for any tax year. As of right now, partnerships with other partnerships (or LLCs) or trusts as partners are not eligible to elect out.
- Who can participate in the audit? Unlike current law where any partner generally has the right to participate in a partnership audit, under the new rules, only the partnership and a single, designated partnership representative will be permitted to participate. Interestingly, the designated partnership representative need not be a partner. However, the partnership and all of the partners will be bound by actions taken by the partnership (or the partnership representative) in the audit and by the final decision in the proceeding. The statute does not provide for a method to remove a partnership representative.
As far as we know, the IRS has not yet begun drafting the implementing regulations. On Friday, March 4th, they released a notice requesting comments on twelve specific issues where they need assistance in issuing guidance. Comments are due back April 15th. We will be participating in the comment process and will be meeting with representatives from Treasury in mid-June when we hope to gain some additional insight. In the Notice, the IRS specifically said that they expect to issue guidance on early application of the new regime available in the near future and that Partnerships wishing to make that election should hold off until such guidance is issued to be sure of making a valid election.
In the meantime, what steps should you be taking? A number of accounting and law firms have been publishing articles encouraging partners and partnerships to take action NOW. We think they are being a bit premature. Nevertheless, we do recommend – as we said back in November – that you:
- Take the time to familiarize yourself with the revised partnership audit rules;
- Start to look over your current partnership or operating agreement particularly the provisions that deal with IRS audits under the existing rules; and,
- Begin discussions with your attorneys and your Friedman LLP tax professional on when and how to modify these provisions before 2018 to take into account the new rules.
There is no rush and we still lack complete information with respect to how the IRS intends to implement its new authority. As soon as that information becomes available, we will share it with you.