New Partnership Tax Audit Rules: Ready or Not, Here They Come!
On November 2, 2015, the Bipartisan Budget Act of 2015, (the Act), H.R. 1314, 114 Congress/Public Law No. 114-74, made significant changes to the rules governing US federal income tax audits of partnerships (New Audit Rules). The New Audit Rules are codified at Internal Revenue Code Sections 6221 through 6241. On August 4, 2016, the IRS released temporary and proposed regulations relating to certain aspects of the New Audit Rules. And, on December 6, 2016, technical corrections to the New Audit Rules (Technical Corrections) were introduced in both the House of Representatives, H.R. 6439, and in the Senate, S. 3506.
The New Audit Rules take effect for taxable years beginning on or after January 1, 2018, and are intended to facilitate Internal Revenue Service (IRS) audits and adjustments with respect to certain types of partnerships. In the wake of the New Audit Rules, all partnerships should evaluate whether their agreements (existing as well as those in the negotiation stages) address the new rules.
The New Audit Rules apply broadly to partnerships with 11 or more partners at any one time during the tax year. A partnership is also subject to the rules if any of its partners is a partnership, a limited liability company which is treated as a partnership or as a disregarded entity (it is expected that additional guidance will be released in the future to allow a “look through” to the regarded member of a disregarded entity, but that guidance has not yet been issued), a trust, a nominee, a nonresident alien or an S corporation. Partnerships with 100 or fewer partners, however, may be eligible to elect out of the New Audit Rules. Recommended Action: The partnership agreement should address the election out and if the election out is intended to be perpetual, the agreement might include a covenant to remain under 100 partners.
The New Audit Rules provide for tax adjustments at the partnership rather than the partner level. Technical Corrections would focus the adjustments to amounts or items relevant in determining the income tax liability of any person (e.g., partnership items, affected items, and computational items). Mechanically, the partnership may cause its current partners to bear the tax liability or may “push out” the tax liability to the persons who were partners during the reviewed year. The election must be made no later than 45 days after receipt of a notice of final partnership adjustment. If the push out election is made, the interest rate on imputed underpayments is determined at the partner level and is 2 percent higher than the rate for imputed underpayments which are not pushed out. Technical Corrections would provide guidance with respect to the push out election for tiered partnerships. Recommended Action: Consider whether the push out election should be mandatory, and if so, amend the partnership agreement accordingly.
The TMP is no more! Under the New Audit Rules, the partnership designates a “partnership representative.” The partnership representative has the sole authority to act on behalf of the partnership in an audit. The partnership and the partners are bound by the actions taken by the partnership representative on behalf of the partnership. The partnership representative does not need to be a partner in the partnership. Recommended Action: Consider amending the partnership agreement to define the standards for selecting, terminating and replacing the partnership representative. Consider amending the partnership agreement to require the partnership representative to consult with the partners with respect to key issues, such as extending the statute of limitations, settling an audit, filing a petition for readjustment and making the push out election.
A partnership may elect to apply the New Audit Rules to any of its partnership returns filed for a partnership taxable year beginning after November 2, 2015, and before January 1, 2018. Temporary Regulations § 301.9901-22T provide time, form and manner for a partnership to elect into the New Audit Rules. Recommended Action: Consider whether there is any benefit to electing to apply the New Audit Rules before the mandatory application date. The benefits of electing early application of the New Audit Rules may include a more efficient audit process and the ability to cause current year partners to bear the tax liability following an adjustment. If your partnership is tiered with partnerships as partners, electing into an entity level tax may obviate the need to issue amended Forms K-1 and having to amend multiple federal and state returns due to an IRS adjustment.