Partnership Audit Changes January 1, 2018

Partnership audit procedures have been radically shaken up after 34 years of little to no change. For tax years beginning after January 1, 2018, generally audit adjustments will be made at the partnership level and the tax, penalties and interest as a result of the adjustments will be collected directly from the partnership[1].  All new and existing partnerships should consider revising and/or  including language in the operating agreement to provide a road map for navigating through these rules in the event an audit.  

The new rules could potentially be troublesome for a few reasons.  New partners could be affected detrimentally by an audit adjustment that occurred before they became a partner.  Partners who left the partnership before an exam was finalized could avoid paying their fair share of the tax liability.  The tax accessed on the underpayment as a result of an IRS exam and payable by the partnership will at least initially be higher than under the old rules.

A partnership is eligible to elect out of the new audit rules on an annual basis, if it issues fewer than 100 Schedule K1's and each partner is either an individual, estate, C Corporation, S corporation, or a foreign entity that would be a C corporation if it were domestic[2].  Partners who are also partnerships, tax exempt entities, trusts (including grantor trusts), would cause the partnership to be ineligible to elect out of the new rules.  The partnership must make this election on an annual basis on a timely filed return and notify each partner of the election.

 

Possible considerations to include in an operating agreement for this issue would be:

  1. Designation, resignation and removal of the partnership representative
  2. The authority, restrictions, responsibilities and standard of care owed by the partnership representative to the partnership and partners
  3. Should the partnership agreement indemnify new partners admitted to the partnership who did not own a partnership interest for the year under audit?
  4. If the partnership is eligible should the partnership be required to elect out of the new rules? If so, then should there be restrictions on what type of entities ownership can be sold or transferred to
  5. Should the partnership agreement require partners of the tax year under audit year be responsible to reimburse the partnership for the underpayment of tax liability as a result of an audit?

 

The issue of changes in the partnership audit procedures is larger than the issues we discussed here and we would recommend that you discuss these changes with our firm so that we can create a strategy to minimize the impact of these new procedures.  WE are available to talk with you about this issue at your convenience.

 

[1] IRC §6221(a)
[2] IRC §6221(b)