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Partnership audit rules in 2018: Four key changes

As of January 1, 2018, the rules that govern audits of partnerships have changed. In the past, the Tax Equity and Fiscal Responsibility Act (TEFRA) applied to these audits. The law required the Internal Revenue Service (IRS) to allocate the audit adjustments within partnerships amongst the partners.

This was not financially efficient for the IRS. To reduce this burden, President Barack Obama signed the Bipartisan Budget Act of 2015 into law.

There are many changes that come with this law. This first post on the Bipartisan Budget Act of 2015 will address a few of these changes. Four examples for partnerships to note include:

  • Law applies to all partnerships. In 2018 partnerships of all sizes are covered under the new regime. The "small partnership" exemption under prior law has been removed. Now a partnership needs to make an annual election on its return, the so-called "opt out election," to allocate partnership audit adjustments to its partners, rather than the partnership.
  • A shift in the burden. As noted above, the burden of the allocation of tax liability shifts from the IRS to the partnership itself.
  • A required designated representative. The new law requires partnerships to designate a representative. This individual receives notices from the IRS on behalf of the partnership and has the power to bind the partnership and the partners in an audit.
  • The option to push-out the tax burden. The IRS notes that the change could result in an unfair burden on one or more partners. If, for example, the IRS finds the partnership owes taxes from 2017, the 2018 partners receive the tax bill. The share of ownership interests in 2018 may differ from those of 2017. As a result, an inequitable allocation of the tax bill may result. The partners can elect to adjust the tax obligation. This is referred to as the "Push-out Election." This election is designed to result in a tax obligation that more accurately reflects the obligations present in the tax year under review.

Due to these changes, it is wise to update partnership agreements. A review could serve as a catalyst for this discussion. Our next post will provide more detail on this option.

Impact of audit rules: Increased audits of larger partnerships likely

As noted in a recent piece in The National Law Review, these changes will likely translate to an increased focus on audits of large partnerships. Partnerships can take steps to help reduce the risk of a negative outcome during an audit. An attorney experienced in challenging proposed tax assessments can work to preserve your business interests.

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