New Partnership IRS Audit Rules–What You Need to Know

By Paul Staples, Tax Supervisor | Financial Services Team

New Partnership Audit Rules

Last November, Congress passed The Bipartisan Budget Act of 2015 and issued new partnership audit rules, superseding previous legislation enacted under the Tax Equity and Fiscal Responsibility Act of 1982 (“TEFRA”). According to the U.S. Government Accountability Office (GAO), the number of large partnerships (those with at least $100 million in assets and at least 100 partners) had more than tripled between 2002 and 2011.[1]  Because of this, Congress determined significant changes were needed in how the IRS examines and adjusts income from partnerships.

Tax Liabilities Under New Partnership Audit Regulations

Under the new partnership regulations, any adjustments to income, deductions, credits, gain, or loss due to an IRS audit will be done at the partnership level. Because of this, any additional tax liability will be the responsibility of the partnership.[2] Under current regulations, any IRS adjustment is passed down to the individual members and they are responsible for any additional tax liability.  Under the new rules, the additional tax liability is computed by netting all adjustments to income, deductions, gain, or loss. That amount is multiplied by the highest applicable tax rate, which is currently 37%.[3] Since a partnership is considered a flow-through entity where tax is assessed at the owner’s level, the corporate tax rate of 35% is not applicable under the new laws.

As a part of these changes, the IRS is also implementing a new partnership representative role. This individual, who does not need to be a shareholder of the partnership,[4] will have the power to act on behalf of both the partnership and its members during any IRS audits. The partnership representative will also have the   authority to bind the partnership to any IRS adjustments as well as any court proceedings.[5]

It is important to note that there are certain situations where a partnership may elect out of the new partnership rules. As a general rule, a partnership is able to elect out of the new audit regulations if all of the following conditions apply:

1. The partnership has 100 or fewer Schedule K-1s.
2. Each partner is an individual, corporation (including S corporations and certain types of foreign corporations), or estate; if one of the partners is a partnership, you may not elect out.
3. The election is made with a timely filed return.

It should be noted that the election to opt out of the new partnership audit rules is required to be made on an annual basis and each partner must be notified each year that the partnership is making the election.[6]

Should an audit occur under the new regulations, there are some options available to the partnership related to any payment of additional tax liability. Prior to the official issuance of any IRS adjustment, the partnership may file for an “administrative adjustment request” (AAR), which allows the partnership to take the adjustment to income or deductions in the year the AAR is filed rather than the year under audit.[7] As well, a partnership has the option to elect within 45 days of receiving a final issuance of adjustment to issue revised K-1s to the partner and allow them to compute any additional tax due in the year the revised K-1 is received.[8]

The new proposed audit regulations will not go into effect until tax years beginning after December 31^st, 2017. However, it is important to start planning for the upcoming changes now. Among other things, operating agreements may need to be amended to reflect the new elections, structuring for new partnerships will need to be assessed, and each partnership will need to determine their partnership representative. If you have any questions, please reach out to your Keiter representative.

Questions on how the new partnership audit rules? Contact your Keiter representative or Email | 804.747.0000

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Additional Sources:

RIA Checkpoint, Complete Analysis of the Protecting Americans From Tax Hikes Act of 2015, Other Tax Provisions of the Consolidated Appropriations Act, 2016, and Earlier 2015 Tax and Pension Acts, Section 402

RIA Checkpoint, WG&L Federal Treatises, Partnership & Limited Liability Entity Taxation, Section 10.08

[1] U.S. Government Accountability Office, Large Partnerships: Growing Population and Complexity Hinder Effective IRS Audits (GAO-14-746T)

[2] IRS Notice 2016-23, Page 3 https://www.irs.gov/pub/irs-drop/n-16-23.pdf

[3] H.R. 1314 Bipartisan Budget Act of 2015, Section 6223 https://www.congress.gov/bill/114th-congress/house-bill/1314/text

[4] 2016-23, Page 4

[5] H.R. 1314, Sec. 6225(b)(1)

[6] IRS Notice 2016-23, Page 3

[7] HR 1314, Sec. 6227(b)

[8] HR 1314, Sec. 6226(a)