The Bipartisan Budget Act of 2015 created a radically new partnership audit regime. The current landscape—the TEFRA audit rules, the electing large partnership procedures and the default rules—has been repealed, effective for tax years beginning after December 31, 2017. Gone is the tax matters partner and the fundamental principle that partnerships are not taxpayers for income tax purposes. The partnership audit will now be performed by the IRS (and perhaps by the states) at the partnership level.
As a general rule, the partnership will be liable for any income tax deficiency, interest and penalties. By default, these underpayments of tax will be attributed to the partnership’s current partners, not those who owned the entity during the year under examination. You’re kidding, right? Absent an election to push-out these examination changes to the partners to which they rightfully belong, the partnership—and current ownership group—will be left holding the bill.
Worse yet, partners will have no statutory right to participate in the audit or any resulting appeal. A new designee, called the partnership representative, will have sole authority to act for the partnership and its partners. Why is this significant? Only the PR can make the previously mentioned push-out election. If missed, no one else can remedy the situation.
We expect many clients will be surprised their partnership is covered by these new rules. Being subject to the new rules can result from either having an ineligible partner or failing to timely make the annual opt-out election (included within the annual tax return) by filing Form 1065 even one day late. Relief from the entity-level tax regime can be had by partnerships that (a) issue 100 or fewer Schedules K-1 annually; (b) are owned by some combination of individuals, estates of deceased partners, C corporations and S corporations; and (c) as previously mentioned, timely file their Form 1065 and properly elect to opt out. In the case of S corporation partners, each shareholder is considered a partner for purposes of the 100 K-1 limit.
It will be important to examine ownership structures for potential ineligible members, to protect the ability to opt out of the new rules. Considerations about the appointment of a partnership representative will be most significant, as this designee controls the audit process with the IRS. It is likely the new rules will require amendments to your partnership/operating agreements. Please contact your CSH advisor if you have any questions.