The Bipartisan Budget Act of 2015 created some new rules around Partnership Audits—rules that went into effect for tax years after January 1, 2018, with elections that may need to be made on this year's tax return.
Below are the top 3 changes you should know about if your business is a partnership (including LLCs that are taxed as partnerships):
- Partnership representative.
Under the new rules, each partnership will need to name a "partnership representative" (replacing the "tax matters partner" of the past), who will have the authority to act on behalf of the partnership and communicate with the IRS in regards to an audit or other proceeding. The partnership representative does not have to be partner, and if the partnership fails to select a representative, the IRS may appoint any person as the partnership representative.
The partnership representative will have the sole right to participate in a partnership audit or judicial proceeding, and will be the one required to inform the IRS if any elections will be made in regards to an audit. Partners will no longer have the right to participate in these matters, will not be notified by the IRS if the partnership is being audited, and will not be able to assist in the partnership's defense. Partners who want a voice in these matters will need to have their rights contractually included in their partnership agreement.
Additionally, partnerships may want to amend their partnership agreements to include key details around the partnership representative, such as who will serve as the partnership representative, how they will be appointed, how they will be removed, and how important decisions will be made.
- Tax will be calculated at the highest rate.
Under the new rules, any changes made by the IRS during an audit will be made at the partnership level, assessed in the year the audit is completed, and any additional tax assessed will be calculated at the highest applicable rate for individuals or corporations. This may result in current partners being held responsible for adjustments caused by actions taken by partners in previous years.
There are a few exceptions to these new rules—to be unaffected, the partnership must qualify for one of the following exceptions.
- Elect-out for small partnerships: A partnership can elect out of the new rules if they have less than 100 partners, and if those partners consist only of individuals, estates, C corporations, S corporations, and foreign entities that would be C corporations if they were a domestic entity. The partnership is ineligible to elect out if any of the partners are a partnership, a trust, a non-eligible foreign entity, an entity with a single owner that is not a corporation, the estate of an individual other than a deceased partner, or any person that holds an interest in the partnership on behalf of another person. This election must be made annually, on a timely filed return.
- Push-out election: A partnership can choose to elect out of the new rules by sending amended K-1's to those who were partners during the reviewed year, effectively "pushing out" any audit adjustments and collection of tax to the applicable partners. This election must be made within 45 days of receipt of the notice of a partnership adjustment.
- Rate adjustment: The taxpayer representative can choose to argue that some or all of any additional taxes that have been assessed should be at a lower rate.
This is just a high-level overview of the changes to partnership audit rules. If you have any questions about the new rules or how your partnership may be impacted, leave a comment down below or feel free to contact me directly, I'm happy to help!