On Nov. 2, 2015, the Bipartisan Budget Act of 2015 (BBA) became law. The BBA provides new rules that will replace the long-standing Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) and the Electing Large Partnership rules that previously governed partnership audits. Some minor changes were made by the PATH Act (Dec. 18).
These new rules drastically change established partnership tax law and, as a result, practitioners should review their clients' partnership agreements in light of the changes.
Under the BBA rules, if a partnership understates its income or overstates its deductions, it is subject to an income tax. The tax is imposed and payable in the year the audit is completed or, if the partnership seeks judicial review, the year the court decision is final.
Consequently, the economic burden of the tax could be borne by partners who had no interest in the partnership when the partnership generated the income or claimed the disallowed losses. Conversely, if a partnership overstated its income in a prior year, the benefit of correcting that overstatement will accrue to the current partners, not those who were partners in the earlier year.
In some instances, the BBA calculations will actually benefit taxpayers by letting partnerships deduct capital losses against ordinary income and converting a net capital loss into an ordinary loss! Where additional tax is owed, however, the BBA provides a rule that allows the partnership to elect to "push out" the adjustments to those who were partners in the years audited. In such case, those partners will be liable for the tax, but in the year in which the audit adjustments become final.
Some partnerships may even be eligible to elect out of the BBA rules entirely. In that event, the IRS will have to make adjustments individually to each partner's tax return.
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