During the past summer the IRS issued final regulations concerning partnerships audits. The new regulations are effective for partnership tax years beginning after December 31, 2017. The regulations significantly affect audit representation and audit adjustment tax assessment and are applicable to all partnerships. Partnership Agreements and LLC Operating Agreements typically address these concerns and these documents should be updated to reflect how your group plans to respond to the new regulations. We strongly urge you to contact your attorney to review your current agreement and adopt the appropriate changes.
Highlights of the new audit procedures:
- Audit adjustments will be taken into account and taxed in the year the audit is completed, not the reviewed year.
- Current partners, therefore may suffer the tax burden of adjustments to years when there was a different partnership group.
- The rate of tax assessed on adjustments may be higher than the partners’ tax rate.
- Eliminates the ability to offset gains and losses from other partnerships.
- All partnerships are subject to the new rules.
- Small partnerships (100 or fewer partners) with eligible partners may elect to opt out. Individual partners are then audited. The election must be made annually.
- Eligible partners include – individuals, C corporations, foreign entities taxed as C corporations, deceased partner estates.
- Ineligible partners include – disregarded entities, trusts (including revocable trusts), IRAs, nominees or retirement plans.
- All shareholders of S corporations that are partners are counted toward the 100-partner limit.
- The “Tax Matters Partner” is replaced with Partnership Representatives. The Partnership Representative has sole authority to bind the partnership and its partners.
- The representative does not need to be an individual, a firm or other entity may serve.
- IRS may appoint a representative where none is indicated.
- The partnership representative is obligated to raise penalty defenses on behalf of both the partnership and its partners.
- Notification provisions require IRS only need contact the Partnership Representative and is no longer required to contact each partner.
- If a partnership fails to opt out, partners may still file amended returns reporting their share of the adjustments in the appropriate years to shift the tax burden back to the partners. Partner Rep must file a statement with IRS within 270 days.
- Partnership may elect to Push Out adjustments to Reviewed Year Partners. Must issue amended k-1’s within 45 days of issuance of the Final Adjustments. Adjustments reported in adjustment year.
- Partnership / Operating Agreement drafting issues:
- Partnership Representative appointment
- Partnership Representative restrictions
- Opt Out language
- Recoupment of tax, penalty interest from former partners.
- Prohibition on partner types affecting the ability to opt out
- Payment of audit representation costs
- Adopt new terminology
- Partner notification requirements
Many small partnerships with eligible partners will likely find it advantageous to opt out of the new rules. Please contact us, however, on making the election specific to your situation.
Batley CPA, LLC