For decades, IRS audits for partnerships and LLCs treated as partnerships were mired in inefficiency and inconsistency, eventually rendering them unmanageable under an increasingly complex, multi-tiered process. In response, Congress passed the Bipartisan Budget Act of 2015, which included provisions to help simplify the partnership audit process. These provisions apply to tax years beginning after December 31, 2017.
Though these new rules do streamline the process significantly, they also create new potential pitfalls for the unwary. Here are some of the most salient changes for business owners:
- All examinations regarding partnership items of income, gain, loss, deduction, or credit will now be conducted on the partnership level and the determinations will be binding on all individual partners. Further, there are no longer any audit development notification requirements.
- There is no longer a “tax matters” partner. Instead, a “partnership representative” must be designated and will have the authority to act on behalf of the partners.
- IRS audit adjustments will generally result in liability at the entity level and also apply when partnership returns are amended. However, your business lawyer can help mitigate the entity-level risk by shifting responsibility to the appropriate partner(s).
- Partnership level tax liability is assessed in the year that the audit or ultimate judicial review is completed, meaning that the tax assessment does not relate back to the year the item was reported on the tax return. This can burden new partners with tax liability predating their admission to the partnership. Luckily, this is another area where a competent business lawyer can greatly reduce risk by apportioning liability to the partners that owned their interest in the year at issue.
- All partnership level adjustments will be taxed at the highest Federal income tax rate, currently 37%.
- A partnership can elect to avoid partnership level taxation and shift tax liability on audit adjustments by “pushing out’ the adjustments to the reviewed-year partners, who would be required to take adjustments into account in the adjustment year through a simplified amended return process.
- A partnership with 100 or less partners may opt out of the new partnership audit rules if each of the partners is an individual, a C corporation, a foreign entity that would be treated as a C corporation if it were domestic, an S corporation, or an estate of a deceased partner. This election can be incorporated into your company agreement by your lawyer.
Considering the serious implications of these new rules, we strongly encourage all business owners to review the agreements governing their limited liability companies or partnerships to ensure their agreements conform to these new rules and include the appropriate opt-out provisions if applicable and advisable. Our team of experienced business lawyers is ready to ensure that these agreements are updated to reflect the new tax rules that are in effect for 2018.
This article is legal information and should not be seen as legal advice. You should consult with an attorney before you rely on this information.