1333 Columbia Park Trail, Suite 220    |    Richland, WA 99352    |   509.735.4444

Shea Meehan shaking hands with a client during a business meeting.

New Business Partnership Audit Rules, Coming in 2018

The Effects of the Bipartisan Budget Act of 2015 on IRS Examinations of Partnership Returns.

New partnership audit rules apply starting in the 2018 tax year.1

The new rules shift some of the burden of federal tax enforcement from the IRS to partnerships under examination. Under the current Tax Equity and Fiscal Responsibility Act (TEFRA) rules, partners are entitled to notice of the beginning and end of administrative proceedings in which they may participate.2 The IRS must also assert liability for partners’ shares of partnership tax adjustments against individual partners. TEFRA has been administratively burdensome for the IRS. That burden will be reduced and shifted to partnership taxpayers under the new rules.

The general audit rules under the Bipartisan Budget Act of 2015 (BBA) allocate to the partnership, in the year the audit occurs or whenever liability is ultimately determined after adjudication (adjustment year), the burden from adjustments made to returns from the tax year under review (review year).3 The liability is then allocated to those who are partners in the adjustment year on their K-1 statements for the adjustment year. Under TEFRA, once adjustments are determined at the partnership level, deficiencies are assessed against partners for their share of liability. The BBA general rules shift the previous year’s liability into adjustment year liability for the current partners. However, the partnership may elect, within 45 days of notice of a final partnership adjustment, to have the adjustments traced back to those who were partners in the review year.4 Even so, a partner’s share of the adjustment will be applied to the partner’s (or ex-partner’s) personal return for the adjustment year.5 Those acquiring partnership interests should be sure to negotiate the contingent liability created by the BBA rules.

Partners should also discuss whether they can or want to elect out of the BBA rules.

If the partnership opts out of the BBA rules, the partners will be subject to the existing deficiency procedures for individuals.6 The annual election is only available to partnerships meeting certain criteria. A partner must be (i) an individual, (ii) a deceased partner’s estate, (iii) a C corporation, (iv) an S corporation, or (v) a foreign entity which would be treated like a C corporation if it were domestic.7 The partnership cannot be required to file more than 100 K-1 statements to partners. Those issued by a partner that is an S corporation to its shareholders will also be included in the tally.8 The partnership must make the election on a timely filed return, disclose the name and identification number (i.e. an individual’s SSN or ITIN, or an entity’s EIN) for each partner, and each shareholder of a partner that is an S corporation, and notify each person or entity identified that the election has been made.9

The Tax Matters partner will now be called the “partnership representative.”10 Each partnership must elect a partnership representative, or the Treasury Secretary may select someone for the role.11 The partnership representative must be a person with a substantial presence in the United States, though not necessarily a partner.12 The partnership representative will have full (and sole) authority to represent the partnership under the BBA rules, and the partnership representative’s actions will be binding upon the partnership.13 (The partnership will also be bound by any final decisions rendered in a BBA proceeding with respect to the partnership.14) The BBA rules give the partnership representative significant authority and responsibility. The partnership representative does not have to be a partner, so you should consider whether a partner is qualified or if a tax professional might be a better fit. Keep in mind that the partnership representative will be the sole contact between the business and the IRS, so whomever you chose should be a trusted individual who is ready to handle the responsibility, keep partners informed, and fairly represent the partnership.

If you are a partner in a partnership, or a member in an LLC taxed as a partnership, you should consider how the new rules impact your business.

The election to opt out of the BBA rules is something that can be reconsidered each tax year. This allows for flexibility when dealing with an LLC or other disqualified partner. The potential liability for review year tax items is particularly important when any change in ownership occurs. The election to charge review year tax items back to those who were partners in the review year is permanent, so the consequences should be examined based on the long-term goals of your enterprise.

[1] Bipartisan Budget Act of 2015, Title XI, sec. 1101 § 6241(g)(1) (2015) (enacted)
[2] 26 USC 6223(a); 26 USC 6224(a).
[3] Bipartisan Budget Act of 2015, Title XI, sec. 1101 § 6225(a) (2015) (enacted)
[4] Bipartisan Budget Act of 2015, Title XI, sec. 1101 § 6226(a) (2015) (enacted)
[5] Bipartisan Budget Act of 2015, Title XI, sec. 1101 § 6226(b)(1) (2015) (enacted)
[6] Joint Committee on Taxation, General Explanation of Tax Legislation Enacted in 2015, p. 58, Election Out (March 2016).
[7] Bipartisan Budget Act of 2015, Title XI, sec. 1101 § 6221(b)(1)(C) (2015) (enacted)
[8] Bipartisan Budget Act of 2015, Title XI, sec. 1101 § 6221(b)(1)(B) (2015) (enacted); Bipartisan Budget Act of 2015, Title XI, sec. 1101 § 6221(b)(2)(A) & (B) (2015) (enacted)
[9] Bipartisan Budget Act of 2015, Title XI, sec. 1101 § 6221(b)(1)(D)&(E) (2015) (enacted); Bipartisan Budget Act of 2015, Title XI, sec. 1101 § 6221(b)(2)(A)&(B) (2015) (enacted)
[10] Bipartisan Budget Act of 2015, Title XI, sec. 1101 § 6223(a) (2015) (enacted)
[11] Bipartisan Budget Act of 2015, Title XI, sec. 1101 § 6223(a) (2015) (enacted)
[12] Bipartisan Budget Act of 2015, Title XI, sec. 1101 § 6223(a) (2015) (enacted)
[13] Bipartisan Budget Act of 2015, Title XI, sec. 1101 § 6223(a)&(b)(1) (2015) (enacted)
[14] Bipartisan Budget Act of 2015, Title XI, sec. 1101 § 6223(b)(2) (2015) (enacted)

Need help understanding how the new partnership audit rules will impact your business in 2018?

We can help.  Contact our office today.

DISCLAIMER: The information contained on this website is for informational purposes only and is not for the purpose of providing legal advice. Every case involves a unique set of circumstances. If you have a legal issue, you should contact an attorney to discuss the issues or problems that are specific to your case. The information contained on this website is not intended to promise any specific results and does not form any contractual obligation on behalf of Walker Heye Meehan & Eisinger, PLLC.