by Dustin Cutlip, CPA
As we make our way through the 2018 tax year much attention is focused on the Tax Cuts & Jobs Act (TCJA) and the impact it will have on individuals and business entities. However, partnerships [including Limited Liability Companies taxed as partnerships] should also be aware of the newly enacted partnership audit rules and how the new rules may impact the language within partnership agreements.
For taxable years beginning after December 31, 2017 the old provisions of the Internal Revenue Code that governed partnership audits, known as the TEFRA procedures, were replaced by a new centralized partnership audit regime. This new regime was created as part of the Bipartisan Act of 2015 [later amended by the Consolidated Appropriations Act of 2018]. These new rules were created largely to help streamline the audit process for large partnerships, but small closely held partnerships are also governed by these new rules. As a result, all partnerships (big and small) should consider taking corrective action.
Entity Level Assessments
Under the new audit rules the assessment and collection of underpaid tax, including interest and penalties, resulting from partnership audits will now be assessed at the partnership level. This is a drastic change from the partner level assessment under the old procedures and will certainly complicate matters for partnerships as they try to match up the economic burden of audit assessments to the corresponding partner(s). This becomes an even bigger challenge when the ownership interest within a partnership changes and partner(s) who would bear economic burden for an audit assessment are no longer partners in the partnership. Given the natural time lag on audit assessments this will be a common issue that partnerships will be faced with in the future. Luckily there are some steps that can be taken to help mitigate the adverse impacts of these new rules.
Elect Out Entirely
Certain partnerships may be eligible to elect out of the entity level assessment entirely and default back to the old partner level assessment under the TEFRA provisions. In order to be eligible for this election a partnership must have 100 or fewer partners and all partners must be either individuals, C or S corporations, the estate of a deceased partner, or a foreign entity that would be treated as a C corporation if it were domestic. This election is not automatic and must be made on a partnerships timely filed federal income tax return. Partnerships should consider adjusting the language in the partnership agreements to address compliance in the area as applicable [e.g. limiting the eligibility of new partners to ones that meet this criteria].
“Push Out” Election
Partnerships may be able to make what is known as a “push out” election which would give the partnership the ability to push out audit adjustments to the partners who ultimately would have faced the economic burden under the old rules [this would include former partners]. Partnerships should consider including appropriate language in the partnership agreements to address the ability to make “push out” elections and obligate partners, both current and former, to indemnify the partnership for their allocable share of the economic burden of audit assessments.
Tax Matters Partner Eliminated
Under the new audit rules the “Tax Matters Partner” is no longer an applicable term and has since been replaced by a “Partnership Representative.” The representative can be any individual, or entity, with substantial presence in the United States and does not have to be a current partner in the partnership. The representative has complete authority to act on behalf of the partnership and the actions of the representative can legally bind all partners. Partners now have no right to receive notice or participate in any audit proceedings, as this is all handled by the partnership representative.
Partnerships should consider updating their partnership agreements to designate an appropriate partnership representative. Partnerships should also consider adding language to the partnership agreement to put restrictions on the powers the representative has (as allowable) in certain cases.
All partnerships should be aware of the new partnership audit rules and should analyze and modify partnership agreements accordingly. These new rules are particularly important to consider before a partnership makes any structural or ownership adjustments [transfers, new admissions, and retirements] amongst its current partners in the coming months/years.
If you have any questions on how the new partnership audit rules impact your partnership please contact a member of our team!