NEW PARTNERSHIP AUDIT RULES by Attorney Allen Ratcliffe


New partnership audit rules affecting general and limited partnerships and limited liability companies (the “Partnership”) went into effect in January of 2018.  The new rules provide that in the event of an audit in which the IRS makes net positive adjustments increasing the Partnership’s taxable income, the Partnership will be responsible to make the tax payment, including additions to tax in the form of penalties.   The IRS is no longer required to determine each partner’s share of the adjustments.

The new term “Partnership Representative” replaces the term “Tax Matters Partner” to represent the Partnership. The Partnership Representative does not have to be a partner or a member but must be a person having a “substantial presence” in the United States. Where a designation is not in effect, the IRS may select any person as the Partnership Representative. A Partnership and all partners or members are bound by any actions taken by the Partnership (through the partnership’s representative).

The new rules are meant to assist the IRS in auditing Partnerships, and are not designed to increase fairness. They will likely result in more partnership tax audits and more revenues collected from Partnerships and partners or members.

The Partnership level income tax liability resulting from an audit will be assessed and collected from the Partnership for the “adjustment year” in which the adjustments become final, not the “reviewed year” that was audited.  This can result in a huge economic distortion if the reviewed year partners or members are not the same as the adjustment year partners or members.

Eligible Partnerships may make the election out of the new audit rule. However, Partnerships with trusts, revocable trusts, or disregarded entities as partners or members, do not have that option available.  This means that very few Partnerships will have an option to elect out of these new rules.

You may want to revise your partnership agreement or operating agreement in order to:

1) Name a Partnership Representative;

2) Perhaps provide an indemnification for individuals who were not partners or members during the reviewed year, but are subject to a share of a partnership tax adjustment because they were a partner or a member during the adjustment year; and

3) Have current partners or members agree to pay their pro rata share of tax adjustment for a year in which they were a partner or a member, but were not a partner or a member during the adjustment year.

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