New Rules Governing Audits of Partnerships Now in Effect

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In 2015, a new law put in place a new method for the IRS to audit partnerships and other entities, such as limited liability companies, that elect to be taxed liked partnerships. These new partnership audit rules went into effect for all tax years starting on or after January 1, 2018.
These new rules are a dramatic change in a variety of ways. Some – but not all – of these changes include:
Taxation at the partnership level. Partnerships, long considered ‘pass-through entities’ taxed at the partner level, are suddenly, under these new audit rules, paying tax at the partnership level.
The new rules apply to all partnerships…unless they don’t. Some partnerships may be able to opt out of the new rules if they do not have too many partners. Other partnerships may not be able to opt out of the new rules due to the way the IRS counts the number of partners or because the type of partners in the partnership prevents the partnership from having the ability to elect out of the new rules.
One partner rules them all. Partnerships must have a ‘Partnership Representative’ and if they don’t, then the IRS can appoint one. This Partnership Representative has the exclusive authority to make decisions for the partnership concerning all aspects of the audit – and the IRS will not look to state law or the partnership agreement for limits on this authority – and even keeps that authority for a time after the resignation and/or replacement.
Changes in partners of the partnership. As a general rule, the partnership pays the tax in the year the IRS makes the adjustment, meaning that the current partners, who are not necessarily the same partners as the partners in the year under audit, bear the consequences of the audit. The partnership, however, can elect to opt out of this rule, pushing the consequences of the audit back onto the partners who were partners in the year under audit. Both options, however, will have tax implications, albeit for different sets of partners.
Since the first partnership audits under the new rules are unlikely to begin until late 2019 or into 2010, partnerships still have time to amend their partnership agreements to ensure they are best positioned to handle an audit under the new rules. Some considerations might include:
Partnership Representative. Partnerships will need to decide who will be the Partnership Representative, what obligations the Partnership Representative will have, and what obligations partners will have to the Partnership Representative.
Opting Out. Partnerships will need to determine if they are able to opt out of the new rules and, if so, whether they should do so.
Different Partners. Partnerships will have to determine how to address the consequences of an audit taking place in a year when the partnership includes different partners than in the year under audit.
The new partnership audit rules are a complete change, both in form and substance, to the rules in place for tax years starting on December 31, 2017, and earlier. The new rules are complex, require new types of decision-making, and impact both former and current partners. Every partnership and every member of a partnership should pull their partnership agreement out of the desk drawer or off the bookshelf, review it, and determine what types of changes the partnership needs to make to the agreement. Fortunately, there is plenty of time for partnerships to think through their options clearly, make necessary and appropriate changes to their partnership agreements, and prepare themselves for the forthcoming new audit regime. Done properly, partnerships and their partners will put themselves in a position of strength, and give themselves a better opportunity for success, if and when the IRS comes knocking. At Milazzo Webb Law, our corporate and tax lawyers work together to ensure that our clients are not only prepared for today’s business and legal needs, but they are ready to face the challenges that will appear tomorrow. If you are a partnership, partner in a partnership, or are considering joining a partnership, make sure that you are ready if and when the IRS decides to take a look under your tax return.

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