Did you know the new partnership rules may impact your share of partnership taxes and penalties upon an IRS audit? They may also impact you if you are no longer a partner in future years or have not been a partner in the year of the audit adjustment. The new rules are effective for 2018 (tax years that begin after December 31, 2017), although the AICPA requested the rules be delayed to 2019.
Whether delayed or not, there are at least two important items to consider:
- Do you qualify to elect out of the new rules?
- Have you reviewed your partnership agreement with your attorney to align with the new rules?
Do you qualify to elect out of the new rules?
To qualify for electing out of the rules, you must have 100 or less K-1 partners AND the partners can only be individuals, C corporations, S corporations, eligible foreign entities, or an estate of a deceased partner. Note the 100 limit includes S corporations and each one of its shareholders. In other words, all of the shareholders of the S corporation that are partners in a partnership will need to be included in the count of 100. You cannot elect out if any of the partners are ineligible tax entities, such as partnerships, trusts or disregarded entities. This means that even some partnerships with just a few partners will be subject to the new audit rules, because one or more of the partners is an ineligible entity.
Have you reviewed your partnership agreement with your attorney to align with the new rules?
We recommend you review the following with your attorney as you may need to amend your operating or partnership agreement. Areas to review include but are not limited to:
Who will be responsible to pay the tax and penalties?
The new default will be for the adjustments to be made at the partnership level:
- Current partners, even if not a partner in the year of examination, will share in the cost. The cost is calculated as the sum of the IRS adjustments multiplied by the highest individual or corporate tax rate, which may be higher than some partner’s rates. Current partners would also share in the benefit, if the adjustment is a decrease in income or increase in loss.
- A more time intense and costly option could be to evaluate all partners’ tax impacts, which may or may not result in a lower overall shared cost.
Election to push-out the adjustments to partners of the year examined:
- Consider adding language regarding the push-out election option, which allows for the IRS adjustment to be pushed instead to the partners who had ownership during the year the IRS is adjusting. This means each partner receives their share of the adjustment, similar to the typical K-1 pass-through treatment and taxation at the partner’s rate. It also means prior owners will have a liability based on their prior ownership even though they no longer receive K-1’s. The election must be filed within 45 days of the IRS final adjustment letter.
An alternative to the election is to add language that requires prior partners to make contributions to the partnership for their share of the adjustments. Either option is intended to relieve the impact on new partners.
Who will be the designated partnership representative and how will this position will be administered?
Have you replaced the ‘tax matters partner’ phrase with partnership representative?
- This individual replaces the tax matters partner and does not have to be a partner.
- The partnership representative has total authority with regards to the audit, so we recommend you add language requiring the representative to notify partners when an IRS notice is received, keep partners apprised of audit activities, and notify partners of the audit results prior to accepting any audit changes.
- They would also receive IRS notices, could consent to extend the statute of limitations, could settle with the IRS, and would need to be selected each year with the partnership tax return.
In summary, although the new rules impact audits that may occur after 2018, you should start planning now by reviewing and possibly amending your operating or partnership agreements. Please let us know if we can assist in any way. We continue to monitor if the IRS will postpone the effective date or change these new regulations.