Beginning in 2018, The Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) was repealed and replaced with a new partnership audit regime in which taxes and penalties due as a result of a partnership audit are assessed at the partnership level, rather than individually at the partner level. Some small partnerships (100 or fewer eligible partners) may have the option to elect out. The IRS has issued regulations to assist taxpayers in implementing these new rules.
- Many partnerships and limited liability companies will find it necessary or desirable to amend their partnership or operating agreement in response to the new rules. The familiar role of “tax matters partner” is replaced by a new, more comprehensive role of “partnership representative,” who is not required to be a partner. The partnership representative has sole authority to act on behalf of the partnership in regard to an IRS audit.
- The new rules provide that all partners are bound by the actions of the partnership representative and partners have no statutory right to receive notice of or to participate in the partnership-level proceedings. No contractual arrangement, including any partnership agreement or state law document, can limit or alter this authority. In addition, other than the partnership representative, no partner or other person may participate in any examination or other proceeding with the IRS. (A partnership may utilize a professional advisor, under normal “Power of Attorney” provisions.) Therefore, partnerships should carefully choose their “partnership representative” and assure that partnership agreements provide contractual protections for partners. Partnerships should also consider the ramifications of various partner actions and elections which affect both the partnership’s own financial condition and the tax attributes passed through to the partners.
Significant items included in the new audit rules:
- If your partnership is audited by the IRS, the IRS will audit the partnership’s income, gain, loss, deduction, credit, and partnership’s distribution of shares for a particular year of the partnership. Any adjustments that need to be made based on the results of the audit will be made at the partnership level and taken into account by the partnership in the year that the audit/judicial review is completed. In a significant departure from the current rules, any calculated underpayment of tax would be assessed and collected at the partnership level.
- Partnerships with 100 or fewer eligible partners may elect to opt out of the application of the new rules for a particular year on a timely filed return. Traditional audit, assessment, and collection statutes of limitations would then apply to the partners and the tax treatment of an adjustment to a partnership’s income, gain, loss, deduction or credit would be determined for each partner separately.
- If an otherwise eligible partnership has partners that include other partnerships, trusts, estates (other than the estate of a deceased partner) or disregarded entities such as single-member LLCs, it will not be eligible to make the election to opt out of the new rules.
- If a partnership decides to elect out of this new audit rule, the partnership must notify each of its partners of this election within 30 days of making the election in the form and manner determined by the partnership.
In light of these changes, we encourage you to contact us and/or your business attorney to schedule a meeting to discuss the new rules, implementation options and necessary revisions to partnership agreements. While the new rules do not impact audits of tax returns prior to 2018, changes to partnership agreements need to be made retroactively for 2018. We look forward to assisting you at your earliest convenience.