There are New Rules for Partnership Audits
The Bipartisan Budget Act of 2015, signed into law in November 2015, substantially changes the way the IRS can audit partnerships (unless they’re not treated as partnerships for tax purposes) and multimember limited liability companies (“LLCs”). The goal of these changes is to streamline the current partnership audit process.
The IRS acknowledges that partnership audits can be difficult because the process can require that auditors calculate each partner’s share of any adjustments found. The new rules generally go into effect for tax years beginning after December 31, 2017. However, partnerships may generally be able to elect to apply the rules for tax periods starting after November 2, 2015, and before January 1, 2018.
Audits at the Partnership Level
The most important change allows tax audits to be performed and any resulting adjustments may be determined and collected at the partnership — rather than the partner level. However, the law does provide some ways in which some partnerships can opt out of this treatment. This is in contrast with most auditing procedures which were in place prior to the laws passing. Under the old rules, for partnerships of up to 10 partners, the IRS would generally audit the individual partners.
For most partnerships of more than 10 partners, the IRS typically performs what’s often referred to as a TEFRA (named after the Tax Equity and Fiscal Responsibility Act of 1982) proceeding to conclude those issues which are best determined at the partnership level. Adjustments from these audits would flow for the year of the audit down to the partners, who then may have to file amended returns for the year under audit.
For audits of Electing Large Partnerships (“ELPs”), which are partnerships that have at least 100 partners, the adjustments generally flow through to the partners for the year in which the adjustment takes place, rather than the actual year under audit.
The new rules provide a single set of procedures for most partnerships. In addition, many adjustments will now be assessed in the year which the audit is completed, and not for the year under audit.
Despite this, partners typically will not be subject to joint and several liability for partnership adjustments. (Under joint and several liability, each party is independently liable for the entire amount of a relevant claim.)
Furthermore, the law also provides some exceptions. Rather than having all adjustments assessed at the partnership level, a partnership can choose to issue adjusted Schedules K-1 for the audited year to its partners who were members of the partnership during the year under audit. This could also include partners who are no longer with the partnership. The partnership must elect to do this no later than 45 days after the adjustment has been made. The partners for the year under audit would need to pay any additional tax owed as a result and amend their own personal returns for that year.
In addition, partnerships of 100 or fewer partners typically can choose to opt out of partnership-level audits, so long as all of its partners are either individuals, S corporations, estates, C corporations, or foreign entities that would be treated as C corporations. The partnership would need to continue to make this election each year.
Partnership members should certainly review their current operating agreements in order to determine what revisions, if any, that they should consider due to these changes. For instance, since the new rules can hold partners to a decision made by one representative who has sole authority to act on behalf of the partnership, the other partnership members may choose to define or alter the limits of this person’s role and authority. The agreements will also need to account for the fact that, under the new rules, partners could be liable for adjustments stemming from years in which they weren’t members of the partnership.
What it Means
These revised partnership audit rules are complex. They are expected to make it easier for the IRS to perform audits, so it follows that both large partnerships and multimember LLCs may be at a greater risk of being audited. Additional guidance is expected to be issued on the new rules this summer. Your accounting professional can also provide additional information, as well as advice on the impact of these changes.
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