February 25, 2019

New IRS Partnership Audit Rules Now Effective—Action Required for 2018 Partnership Tax Returns

Effective with the filing of most 2018 partnership tax returns, new Internal Revenue Service (IRS) partnership audit rules will now automatically apply to all entities taxed as partnerships, unless the entities’ owners elect otherwise.  The election to “opt out” of the new rules overall must be made every year on your timely filed partnership tax return.  So, as circumstances change from year to year, so too can your decision to opt out.

The new rules require that a partnership representative be designated [1] on its respective IRS Form 1065 for the 2018 taxable year (and all later taxable years), whether the partnership opts out or not.  Additionally, should a partnership desire to make the overall (or any other) opt-out election, only the designated partnership representative can make the election.  And, should a partnership fail to timely designate a representative, the Secretary of the Treasury will do so.

Designating a partnership representative is an important decision because he or she will have final power to bind the partnership concerning any audit adjustments and other things.  In light of such authority, the designation should be made carefully and deliberately, after a vote made in accordance with the requirements of the entity’s governing documents, which may need to be amended to include pertinent protective and other provisions.

What follows are the basics of the overall opt-out election choices:

  • Opt out on an overall basis, in which case the new partnership audit rules will not apply.  Only partnerships with 100 or fewer qualifying partners (as defined under special rules) can opt out of the new rules.  However, additional special rules exist related to tiered partnerships and complex ownership structures, such as trusts and other partnerships as owners.  If this election is made, each partner will be responsible for his or her share of an additional assessment of tax, penalties, or interest resulting from an audit, on a pro-rata basis, in the same manner as they have been historically.  We recommend that, in most cases, partnerships strongly consider making this election to opt out of the new audit rules on an overall basis.
  • Do not opt out, in which case the new partnership audit rules will apply.  In this case, any additional assessment of tax, penalties, or interest as a result of an audit will be the responsibility of the partnership, not the individual owners.  Any tax resulting from an audit will be imposed at the highest federal income tax rates at the time of the assessment.  Furthermore, any such assessment will be applied to the year the audit is completed, without regard to any ownership changes that might have occurred since the year under audit.  This means that the current owners at the time the audit occurs, whether partnership owners for the audited year or not, will pay tax at the highest marginal rate if deficiencies are identified.

In addition to the above options concerning opting out overall, there are other possible, but highly technical, elections which could prevent certain adverse consequences that might occur under the new partnership audit rules.  If you would like more information about any elections available under the new partnership tax audit rules or tax planning for partnerships, contact one of our PYA tax executives below at (800) 270-9629.

[1] See Internal Revenue Code § 6223(a); Treas. Reg. § 301.6223-1(a).

 

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