With the recent Bipartisan Budget Act of 2015, the IRS changed the way it would audit and assess taxes of partnerships. Since the passage of the act, there have been numerous articles and blogs explaining the changes to the partnership audit procedures including: Forbes article and McDermott, Will & Emery’s blog
For an explanation of partnership audit rules under Tax Equity and Fiscal Responsibility Act (TEFRA) of 1982, see Auditing Large Partnerships and TEFRA; and Navigating TEFRA Partnership Audits in Multi-Tiered Entity Structures.
- All partnerships are subject to the new rules regardless of size.
- There is an exception to this rule, a partnership can elect out of the new audit rules, if the partnership has fewer than 100 partners and if the partnership only has: individuals, C corporations, foreign entities (treated as C corporations if domestic) S corporations or estates of deceased partners.
- To Elect Out the partnership must follow the following rules:
- The partnership must elect the opt-out on its partnership return each year.
- The partnership must inform each of its partners of the election.
- The partnership must submit the names and taxpayer identification numbers of each of its partners, including S corporation shareholders treated as partners for purposes of the 100-partner test.
- Entity Level Tax
- At the conclusion of the partnership audit, IRS will be assessing the partnership the imputed underpayment at the individual or corporate rates, instead of assessing individual partners.
- IRS assess the partnership in the year in which the audit is concluded [present year], instead of the tax year which is under audit [past year(s)].
- Exception 1: If a partner pays the partnership level adjustment, the partnership’s imputed underpayment is reduced. Partners must file amended returns reporting their share of partnership adjustment and pay all taxes within 270 days of receiving notice of the proposed adjustment.
- Exception 2: Within 45 days of the Final Notice of Partnership Adjustment, partnership can elect to issue statement to partners who were partners during the years to under audit [past year] to reflect their share of the partnership adjustments, but the partners pay the liability for their share of the partnership adjustments in the year in which the audit is concluded [present year] at an interest rate 2% higher than the current rate, instead of interest running since the year under audit [past year].
- Partnership Representative.
- a. Similar to a Tax Matters Partner in Tax Equity and Fiscal Responsibility Act (TEFRA) of 1982, the new law requires that a partnership designate a representative to act on behalf of the partnership. If one is not appointed, the IRS can appoint the partnership.
The IRS sought these changes because the prior system (TEFRA) often delayed the assessment of tax on partners for several years after the partnership adjustments were determined at the partnership level. This was especially true for large partnerships or multi-tiered partnerships. The new changes now permit the IRS to assess the tax at the partnership level and leave it up to the partnership and/or its partners to determine whether they want to pay the tax in the year the partnership audit has concluded [present year] or in the years under audit [past years].
While the new rules present additional issues for partners and partnerships to work through and amend their partnership agreements, the new assessment rules appear to streamline the collection of taxes from partnerships and/or their partners, especially in large/multi-tiered partnerships.
However, like TEFRA (the prior partnership audit rules regime), it will take time before IRS, partnerships and partners understand the effects of the new rules.
If you know of a partnership or multi-tiered partnership that has committed tax violations and you have specific and credible evidence of the alleged tax violations, you should consider filing a tax whistleblower claim to report the alleged violations. Contact us to assist you in preparing your tax whistleblower claim.