New IRS Partnership Audit Rules

In June 2017, the IRS reissued regulations that will change how it conducts audits of partnerships. Under the new rules, the IRS has the authority to collect tax as a result of an audit directly from the partnership.

Currently, the assessment and collection of income taxes occurs at the partner level. This shift in administering the audit assessments is primarily aimed at streamlining partnership audits and raising revenue for incorrect tax positions taken by partnerships. The new regulations take effect for tax years beginning on or after January 1, 2018.

WHAT SHOULD I KNOW?
The new rules replace the current Tax Matters Partners with a Partnership Representative. Partnership Representatives have a wide range of powers and authority, generally including, meeting with IRS representatives, settling audits with the IRS as well as binding all partners to such agreements, extending statutes of limitations, and making certain elections on behalf of the partnership.

The IRS does allow partnerships to elect to opt-out of the new audit rules. In order to do so, the partnership must have 100 or fewer partners. Generally, partners must be individuals, C corporations, S corporations with certain types of shareholders, or estates of deceased partners. If any of the partners are other partnerships, trusts, or single member LLCs, the partnership cannot elect to opt-out of the new rules. The Partnership Representative must make the election to opt-out on a timely filed return.

HOW TO PLAN FOR THE NEW AUDIT RULES
Consult with your attorney and perform a thorough review of the partnership or operating agreement to ensure the agreement is updated to address the changes of the new audit rules. Some items to consider during the review include:

  • Elections - How will the entity make decisions regarding whether certain elections will be made, as they pertain to the new audit rules? If no decision framework is in place prior to an audit, the partners' interests could cause disagreement in how to proceed. 
  • Partnership Representative - How will the partnership representative be elected, changed, or identified? Given the vast authority the IRS has granted to the Partnership Representative, consider including how the Partnership Representative will be held accountable or whether certain powers should be restricted.
  • Purchases and Sales of Partnership Interests - If ownership changes occur between the tax year that is being audited and a subsequent year, the existing partners could be responsible for the former partners' share of the audit assessments. How will the agreement address any changes in partnership ownership to give the partnership recourse against partners that have different or no longer have ownership interest in the entity for their share of any potential audit assessments?

If your entity is taxed as a partnership, consult with your attorney and tax professional to review these new regulations and address any impact within your operating or partnership agreements, as appropriate.

To learn more, contact your Beene Garter professional at 616.235.5200.