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PARTNERSHIP AUDIT RULES TAKE EFFECT JANUARY 1, 2018. IT’S TIME TO AMEND YOUR PARTNERSHIP AGREEMENT

The world of partnership audits will be changing on January 1, 2018. Congress passed the Bipartisan Budget Act of 2015 (the “BBA”) that made significant changes to the rules for auditing partnerships.  Included in these rule changes are several elections and other items which should be addressed in your partnership agreement.

  • Significant changes to who pays underpayments resulting from the audit.  Prior law resulted in partnership audit changes being made at the partnership level with the increased tax being paid at the partner level. The BBA changes that so adjustments resulting in underpayments are made at the partnership level and paid by the partnership in the year the audit is performed, rather than the partners in the year being audited.  The amount paid at the partnership level can be reduced if the partner files an amended return for the year under audit and pays the tax assessed or if the partnership can prove that a partner is a tax-exempt entity, a C corporation that has a lower tax rate or an individual where the underpayment relates to capital gains subject to a lower rate of tax.   
  • Opt-out election. A “small” partnership can elect annually to opt-out of the BBA rules entirely. A small partnership is a partnership with 100 or fewer partners and has only partners that are individuals, C corporations, S corporations, foreign entities treated as corporations, or estates or trusts of deceased partners.  This leaves out partnerships that have other partnerships as partners.
  • Push-out election.  A push out election allows a partnership who has not made the annual opt-out election for the year to elect to push-out (or transfer) the liability for underpayments to those who were partners in the year being audited. 
  • Significant changes to who manages the audit for the partnership and their authorized duties.  Under current law the partnership a “tax matters partner” must be chosen. The tax matters partner does not have full authority to act on behalf of the partnership so other partners still have the right to participate in the IRS audit process.  Under the BBA rules rather than a tax matters partner, a “partnership representative” must be appointed.  The representative full authority to act on behalf of the partnership including authority to make the push-out election, extend the statute of limitations and even take the audit to litigation while having no legal responsibility to notify the partners of the audit or its progress.  The partnership representative does not have to be a partner and if the partnership fails to identify a partnership representative the IRS may choose them.  
  • Election to apply BBA rules to earlier period. The new rules are effective January 1, 2018. However, a partnership may make an election to apply the rules to tax years beginning after November 2, 2015.  The election is made or Form 7036 or on a statement prepared by the partnership.  
  • Partnership or operating agreement amendments to consider. 
  • The conditions when the opt-out and push-out elections should be made, maintaining eligibility with restrictions on transfers, and the impact on former partners.
  • Maintaining eligibility for the opt-out election by restricting transfers of partnership interests to non-qualifying partners.
  • Redress current partners will have against former partners if the current partner pays tax, penalties and interest attributable to a year before they became a partner.
  • Manner of electing and removing the partnership representative, requiring notice of audits and assessments, limiting authorization to extend the statute of limitations or settle by requiring a certain share of partner agreement.

Please call the TKW tax team if you would like more information on this topic. 503.274.2849