New rules for income tax audits will go into effect for partnership tax returns filed for years ending after December 31, 2017. Proposed regulations that provide guidance were released on June 13, 2017. These regulations had previously been released in January 2017 but were later withdrawn as part of the new administration’s attempt to ease the regulatory burden. The new audit rules were enacted by the Bipartisan Budget Act of 2015 (BBA), which replaced the existing TEFRA rules.
Partnerships were either TEFRA or Non-TEFRA partnerships, based upon the number and types of entities that were partners in the partnership. The tax matters partner (TMP) was responsible for handling the TEFRA examination. After the partnership examination was completed, changes were made to all partner’s tax returns under an automatic administrative adjustment and that partner was responsible for paying the tax. Under TEFRA, Non-TEFRA partnerships were subject to the pre-TEFRA audit procedures, under which IRS must separately assess tax to each partner.
New Partnership Audit Rules
The new rules includes two sets of rules; one for small partnerships (Non-BBA) and the BBA rules.
Small Partnership Rules
Allows partnerships to opt out of the BBA regime if the partnership has 100 partners or fewer. S-corporations and their shareholders count as separate partners in determining the 100 partners. Under these rules the partnership is subject to the pre –TEFRA audit procedures under which IRS must assesses tax separately and directly to the partners.
The BBA Rules:
A partnership representative (PR) position is created. This position replaces the TMP in each partnership. The PR controls the examination with the IRS. It is not necessary for the PR to be a partner of the entity, but the PR must have a substantial presence in the US. This creates much greater centralization.
Partnership and partners are bound by audit decisions made by the partnership representative.
There are various collection regimes under the BBA, including having the partnership pay the imputed underpayment (default rule). The underpayment is based on the net positive adjustments which are then multiplied by the highest applicable rate. Another collection method allows the partnership to push out the tax liability directly to each partner so that each individual partner will pay their underpayments (including penalty and interest) personally.
Partnerships can only elect out of the BBA if they have eligible partners, and those partners are individuals, C Corporations, S Corporations, estates of deceased partners and foreign entities only if they are treated as C Corporations.
Partnerships will need to review their current agreements to determine if they are in compliance with the new BBA regime. Amendments to each partnership agreement are likely to be required.
Contact your partnership expert at Citrin Cooperman for the latest updates and advice.