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The Bipartisan Budget Act of 2015 (“ACT”) made significant changes to the Internal Revenue Service’s (“IRS”) partnership audit rules effective for partnership or limited liability company (taxed as a partnership) tax years beginning in 2018. See below for information related to the new IRS audit rules.
If you have any questions with respect to the legal implications of these new rules, we strongly encourage you to seek guidance from legal counsel. If you have not already done so, it may be prudent to revisit and update as appropriate your partnership or limited liability company operating agreements to address areas of concern, and if available please forward a copy of the update (amendment) of the agreement to us.
To ensure that Hall, Kistler & Company LLP, has the required documentation in our files to support your decision as to how to apply the new partnership audit rules to your 2018 income tax return, we request that you complete and sign the form below.
Please complete this section before signing below
Name of Partnership or LLC (taxed as a partnership):
Name of Designated Partnership Representative1:
Are you a small partnership (with 100 or fewer eligible partners*)?
*Important: Each S-Corporation shareholder counts as a partner for purposes of the “100 or fewer eligible partners” rule. Eligible partners are individuals, C-Corporations, S-Corporations, and estates of deceased partners. If any partners are other partnerships, LLCs or trusts (regardless of whether they are disregarded), then please mark NO.
If you responded YES to the above question, this indicates that your partnership may elect to “opt out” of the new partnership audit rules by making an annual election on a timely filed Form 1065. Please indicate below if you would like our firm to make this “opt out” election on your behalf:
_____________YES: I/We do want to “opt out” of the new partnership audit rules.
_____________NO: I/We do not want to “opt out” of the new partnership audit rules.
By your signature below, you acknowledge and agree that Partnership Name has the ultimate responsibility for decisions related to the application of the new audit rules to your partnership.
|Partnership Name|| |
1 The Partnership Representative under the new rules has a much more expansive role; the Partnership Representative has
the sole and exclusive authority to act on behalf of the partnership and to bind all partners with respect to partnership matters subject to the partnership audit rules.
New IRS Tax Audit Rules for Partnerships (or LLC taxed as a Partnership)
The Bipartisan Budget Act of 2015 (“Act”) made significant changes to the Internal Revenue Service’s (“IRS”) partnership audit rules effective for partnership tax years beginning in 2018. How the new audit rules will affect a partnership and its partners will depend, in large part, on choices the partnership, the partnership representative, and/or the partners make or fail to make.
This article provides highlights of some of the key aspects of the new partnership audit rules and offers some risk management guidance and tools to help firms minimize potential liability issues.
The new rules, which assess and collect tax at the partnership level, replace the old Tax Equity and Fiscal Responsibility Act of 1982 (“TEFRA”) audit rules that allowed the IRS to audit the partnership but required any ultimate tax adjustments to be collected from individual partners.
However, while TEFRA generally applied to large partnerships, the new partnership audit rules apply to large as well as small partnerships. Under the new rules, the IRS will audit at the partnership level but will be relieved of the burden of having to collect tax from individual partners. If the IRS determines that additional tax is due at the conclusion of an audit, the Act allows the IRS to impose tax, interest, and penalties on the partnership at the entity level in the year of the adjustment, at the highest rate then in effect for individuals or corporations (the “default rule”). Consequently, the partnership would pay the tax directly, causing the then-current partners to indirectly pay their respective share of the tax.
However, two provisions under the “default rule” permit partnerships to reduce the tax owed at the time of the assessment. The first provision allows the partnership to provide the IRS with sufficient information regarding the individual tax attributes of the affected partners (e.g., tax-exempt status, etc.) to help reduce the tax. The second provision would permit one or more partners to amend their tax returns for the year under examination taking into account all adjustments properly allocable to such partners and pay tax due with their amended returns.
Alternatively, the Act does have provisions to allow certain partnerships the ability to elect out of the new rules. (Refer to section “Available Options for Partnerships” below for more details.)
The Act also eliminated the position of “tax matters partner” and replaced the position with a “partnership representative.” The partnership representative under the new rules has a much more expansive role. As explained in more detail below under the sections “New Partnership Representative Role” and “Risk Management Guidance,” the authority granted to this new role poses some significant concerns as to who should serve as partnership representative, as well as the scope and limits of the authority granted to this position under a partnership agreement.
Available Options for Partnerships to Elect Out of the New Audit Rules
The Act does allow for the following options to elect out of the new audit rules:
• Small partnerships (100 or fewer eligible partners*) may choose to “opt out” of the new partnership audit rules by making an annual election on a timely filed Form 1065 for the applicable tax year. This option will not be available to any partnership that itself has partners that are also partnerships (including LLC’s taxed as partnerships, LLC’s that are taxed as a disregarded entity, or trusts regardless if they are disregarded.)
*Note: Each S-Corporation shareholder counts as a partner for purposes of the “100 or fewer eligible partners” rule. Eligible partners are individuals, C-Corporations, S-Corporations, and estates of deceased partners.
• Another option, the “push out” election, is available to partnerships once a notice of final partnership adjustment is issued. The partnership would need to make a timely election within 45 days of receiving a notice of final partnership adjustment to “push out” the assessment to the individuals that were partners during the audited tax year. However, the election comes at a cost: The rate of interest assessed on underpaid taxes rises two percentage points (i.e., from 3% to 5%) if this election is utilized.
Under the above options, the partnership would pass through the tax adjustment to the persons who were partners during the audited tax year by issuing amended Schedules K-1. Each partner receiving an amended Schedule K-1 would be required to amend their returns for the audited tax year.
New Partnership Representative Role
Under the new rules, the partnership representative has the sole and exclusive authority to act on behalf of the partnership and to bind all partners with respect to partnership matters subject to the partnership audit rules. This authority includes, but is not limited to, making relevant elections, representing the partnership during an audit, negotiating and agreeing (or disagreeing) to settle with the IRS, and seeking judicial review of an IRS adjustment.
The Act allows the appointment of any person – partner or not – “with a substantial presence in the United States” as the partnership representative. The IRS has not yet provided guidance as to what “a substantial presence in the United States” means, but it is expected that the Act will allow for a broader array of potential people who will be eligible to represent the partnership. Partnership and LLC agreements should be revised to provide for who will act as the partnership representative because, in the absence of an appointed person, the IRS has the discretion to pick a partnership representative. The filing of the 2018 Form 1065, U.S. Return of Partnership Income, will be the first return requiring a person to be designated as the partnership representative.