Big changes coming to partnership audit rules

In 2015 new tax legislation was enacted and one of the aspects of the legislation overhauls the procedures for the IRS to conduct audits of partnerships, which includes Limited Liability Companies (LLCs) taxed as partnerships. The IRS has since released extensive proposed regulations on the new law, and the procedures will apply to all audits that occur after Dec. 31, 2017.

The changes are significant enough that most partnership agreements and LLC operating agreements for LLCs taxed as partnerships should be amended to address the changes or, at least, amendments should be considered.

Under current law partnership audits are conducted through a process known as the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA). Under TEFRA, if the entity is audited by the IRS any adjustments from the audit are made at the partnership level in one audit proceeding. Thereafter, the IRS makes changes to each partners’ separate individual return and any additional taxes, penalties, etc., are collected at the individual partner level.

The new law repeals TEFRA. Going forward, all partnerships (even small ones previously exempt from TEFRA) are subject to the centralized audit process although there is an ability to elect out if completed in a timely manner.

The biggest development is that any changes, taxes, penalties, etc. in an audit will be assessed at the partnership level and the partnership will be responsible for payment. This could be very important, particularly if ownership of the partnership or LLC has changed since the tax year being audited.

Other changes in the law include replacing the concept of a “tax matters partner” with a so-called “partnership representative,” and the partnership representative has broader authority than the tax matters partner did under TEFRA.

There is no cookie-cutter amendment that is going to work for both partnership and operating agreements. The amendments should address, at a minimum, the role of the new partnership representative (its authority and liability) and the liability of current and former partners or members if ownership changes occurred from the audited tax year to the time the audit actually occurs.

Partners in partnerships and members in LLCs taxed as partnerships are encouraged to contact their attorney to discuss amending their existing agreements. 

This Chuhak & Tecson, P.C. communication is intended only to provide information regarding developments in the law and information of general interest. It is not intended to constitute advice regarding legal problems and should not be relied upon as such.

Client Alert authored by: Mitchell D. Weinstein, Principal

This alert originally appeared in the Fall 2017 Corporate Focus newsletter.