New Partnership Audit Rules, Time to Get Ready by Matt Campbell
December 7, 2017
Significant changes to IRS audit procedures are soon to come into effect for partnerships (and limited liability companies taxed as partnerships) applying to partnership tax years beginning in 2018. Under current law, IRS audits performed at the partnership level do not result in assessments at the partnership level. Instead, any audit adjustments (including any required cash tax payments) from an audit adjustment are assessed to the partners for the tax year under examination. Further, current law allows all partners to participate in the examination and appellate conferences, and requires the IRS to compute both the audit adjustment and any related cash obligation for each partner.
Beginning in 2018, except with respect to partnerships electing earlier application, the current U.S. federal partnership audit rules are repealed by new rules whereby if a partnership audit results in an underpayment of tax (an "imputed underpayment"), the IRS will assess and collect the imputed underpayment - including penalty and interest - from the partnership itself and not the individual partners. Since the collection of tax is being shifted to the partnership in the year an examination is concluded, this default rule can result in a shift in the economic burden of the tax to different partners if there are changes in a partner’s interest between the tax year examined and the adjustment year in which the audit of that tax year is concluded.
There are several elections under the new rules that a partnership can make to mitigate the impact of the new rules. One election is known as the “push-out” election and allows the partnership to pass the adjusted partnership items through to the partners of the partnership for the tax year under examination. In addition, the new rules require every partnership to designate a “partnership representative.” In contrast to prior law, the partnership representative will have the sole authority to act on behalf of the partnership and its partners. Accordingly, any desired restrictions or required consents on the authority of the partnership representative should be addressed in the partnership or LLC agreement.
The new partnership rules are expected to increase the audit rates for partnerships and action is encouraged now for partners to carefully review and revise their partnership’s operating agreements so that necessary provisions and considerations can be added.