Five Things You Need To Know Now About the New Partnership Audit Rules
March 1, 2016
By: Amanda Wilson and Joseph Zitzka
Currently, most federal income tax audits of partnerships are governed by TEFRA, the Tax Equity and Fiscal Responsibility Act of 1982. In the simplest terms, TEFRA provides for a partnership audit to be conducted at the partnership level. Once concluded, any partnership adjustments are made at the partner level. Accordingly, adjustments only impact those partners who were partners in the year under audit.
The Bipartisan Budget Act of 2015 drastically changes this audit regime by repealing TEFRA. Once in effect, these new partnership audit rules will provide a default rule that the partnership, not the partners, pays the tax liability resulting from a partnership audit. A more detailed discussion of the new rules can be found here.
These new rules will go into effect for tax years beginning after December 31, 2017. This means that we will generally only start to see the rules implemented on tax returns filed in 2019. More simply, the change is coming, but it is still several years away.
So what are the five things you need to know now about these new rules?
- The new partnership audit rules will apply to all entities taxed as a partnership for federal income tax purposes (including multi-member limited liability companies that have not made a special election to be taxed as corporations). There is no grandfather rule.
- A partnership can elect out of the new audit regime if it has 100 or fewer partners. However, a partnership cannot make this election if any of its partners is a partnership. If your partnership includes other partnerships (including limited liability companies taxed as partnerships) as partners, you will be subject to these new rules when they go into effect.
- If you are currently negotiating a partnership agreement or revising an existing partnership agreement, you should consider adding provisions now to deal with the new partnership audit rules. This is because many of the tax provisions currently in your partnership agreement will no longer apply. For example, the TEFRA concept of a “tax matters partner” will be replaced under the new rules with a “partnership representative”.
- However, if you have an existing partnership agreement that you do not otherwise need to change, we do not recommend amending your partnership agreement now solely to address these new rules. As of today, we have no guidance from the Internal Revenue Service as to how to implement these new partnership audit rules, and significant guidance will be needed. We expect this guidance to be forthcoming over the next year. Therefore, unless you otherwise have a need to amend your partnership agreement, we would recommend waiting until we have such guidance.
- These new audit rules will have significant tax implications in the future if you are buying or selling an interest in a partnership (including an interest in a limited liability company taxed as a partnership). While not relevant for sales of partnership interests prior to 2018, you will need to watch out for this in the future.