Legislation enacted late in 2015 provides new rules for IRS partnership audits. The new rules are a drastic departure from current rules and the IRS is hopeful that the rules will simplify the audit process and thus allow more partnership audits.
The provisions do not take effect until partnership tax years beginning on or after January 1, 2018, but an existing partnership may elect to apply the new rules to tax years starting in 2016.
Background
Under current rules, as provided by the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), when the IRS audits a partnership with more than 10 partners, the IRS determines any changes to the partnership return in a single audit with the partnership. After determining the appropriate adjustments for the partnership as a whole, the IRS must recalculate the tax liability of each partner for the year under audit.
For partnerships with 10 or fewer partners, the IRS must audit the partner and the partnership separately. These small partnerships may elect to be audited under the TEFRA procedures. Further, large partnerships (100 or more partners) could elect the 'unified TEFRA' audit procedures whereby current year partners would report the audit adjustment on their current (instead of audit year) tax returns.
New regime
TEFRA is repealed, and the partnership itself is required to pay the tax (at the highest tax brackets) related to the audit adjustments. Thus, the current year partners bear the economic impact. Interest and penalties, if any, are also paid by the partnership. Alternatively, the partnership may choose to a)furnish each audit year partner with audit information so that each audit year partner files their own amended tax return, or b) send the audit year partners a statement of adjustment, and those partners would pay any increase in tax on their current year tax returns, with an additional 2% interest (above the prevailing rate) as a 'toll charge' for not amending their audit year return.
Electing out
A partnership with 100 or fewer partners may opt out of the new regime. Thus, the IRS conceivably would have to conduct up to 100 audits of individual taxpayers.
Partners must be individuals, C corporations, foreign entities that would be domestic C corporations, S corporations (special rules apply for counting owners as partners), and estates of deceased partners (partnerships with LLCs or trusts as partners are not eligible to elect out). The number of partners would be based on the number of Schedules K-1 issued by the partnership. The IRS may prescribe rules for treating other entities as eligible partners.
Partnership representative
Unlike the Tax Matters Partner procedures under TEFRA, the partnership will designate a partnership representative (PR) to deal with the IRS, who does not have to be a partner. The PR will have sole authority to act on behalf of the partnership. The partnership and all partners will be bound by the actions of the partnership. The new law does away with TEFRA rights for individual partners to receive notice of the audit and to participate in the audit. Partnerships could organize a group of partners to advise the PR.
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