At the beginning of 2018, new partnership audit rules went into effect that make substantial changes to the way partnerships will be audited by the Internal Revenue Service. Partnership tax years beginning on or after January 1, 2018 will be subject to these rules. These audit rules also include LLCs who file tax returns as partnerships. Under the old rules the partnership was audited but the ultimate tax adjustments were assessed and collected from the individual partners. Under the new rules, the IRS will continue to audit at the partnership level but will be relieved from the burden of having to collect the tax from the individual partners. Instead, the IRS now has the authority to impose tax, interest and penalties at the partnership level in the year of the adjustment at the highest individual income tax rate – meaning current partners may find themselves responsible for a tax liability on events prior to their admission into the partnership. If there were ownership changes between the year that the tax return was filed for and the year that the tax return was audited, current partners who were not partners in the year under audit may end up paying tax under the new default rules.
The Act does have provisions to allow certain partnerships the ability to elect out of the new rules:
Partnerships with fewer than 100 eligible partners may choose to make an annual, irrevocable election on their timely filed Form 1065 to “opt out” of the new audit regime. Eligible partners do NOT include other partnerships, LLCs, or trusts, so a number of small partnerships will not be able to elect out of these rules.
Partnerships may “push out” any final audit adjustment to the partners within 45 days of receiving a final audit partnership adjustment. This election comes at a cost – the rate of interest assessed on underpaid taxes raises 2% if this election is utilized. Under the ”push out” option, the partnership would pass through the tax adjustment to the persons who were partners during the audited tax year. Those partners would be responsible for all taxes, penalties and interest due as result of the audit adjustment.
Among other changes, the Act eliminated the role of the Tax Matters Partner and replaced it with the Partnership Representative – a far more expansive role. The partnership representative has the sole and exclusive authority to act on behalf of the partnership and to bind all partners. The authority includes, but is not limited to, making relevant elections, representing the partnership during audit, negotiating and agreeing/disagreeing to settle with the IRS, and seeking judicial review of an IRS adjustment. With such authority granted to this role, significant concern should be given as to who should serve as the partnership representative.
In the event of a partnership audit, Pugh CPAs will be available to assist with the audit process and work with the IRS auditors as we have always done. You will be able to designate us as having power of attorney with the IRS to assist in resolving questions and issues on the return(s) and providing you guidance and advice during the audit. However, the partnership representative will have the ultimate authority to make final decisions about the audit and is the person the IRS will look to for binding the partnership on audit decisions.
It’s important that your partnership take action in light of these new rules. Partnerships should contact their legal counsel to review and update partnership agreements to address items such as:
- Identifying a partnership representative, including authority and responsibility of the partnership representative;
- Establishing procedures for choosing whether to elect out of the new partnership rules; and
- Establishing extent to which the partnership representative may be indemnified by the partnership.
Please note, we will need your decision regarding this matter before we are able to file the partnership’s tax return. As stated above, we do suggest you contact your legal counsel before updating your partnership agreement. If you have not already communicated with us regarding your decision, please reach out to your Pugh CPAs Tax Advisor so we can discuss in greater detail.
*All of our partnership clients are receiving this information to ensure that everyone is aware of the changes. *