The “Bipartisan Budget Act of 2015” contained an overhaul of the partnership audit rules. Under the new legislation, the IRS can collect taxes associated with audit adjustments at the partnership level, rather than solely passing them through to the individual partners.
The Act repeals the current TEFRA uniform partnership rules and similarly repeals the electing large partnership rules. The new rules generally apply to partnership tax years that begin after Dec. 31, 2017. However, except for the election-out rules for small partnerships, covered below, partnerships may elect (as directed by IRS) for the changes to apply to any return of the partnership filed for partnership tax years beginning after Nov. 2, 2015, and before Jan. 1, 2018.
Under the new streamlined audit approach, any adjustment to items of income, gain, loss, deduction, or credit of a partnership for a partnership tax year (and any partner’s distributive share of such adjustment) is determined at the partnership level. Similarly, any tax attributable to such adjustment is assessed and collected, and the applicability of any penalty, addition to tax, or additional amount which relates to an adjustment to any such item or share is determined, at the partnership level.
Partnerships must pay tax equal to the “imputed underpayment,” which generally is the net of all adjustments for any reviewed year multiplied by the highest individual or corporate tax rate. However, the imputed underpayment may be modified if a partnership shows that a lower amount is appropriate based on certain partner-level information. IRS will establish procedures to make such modifications where:
- One or more partner files an amended return
- The partnership shows that a part of the imputed underpayment is allocable to a partner that wouldn’t owe tax because it’s a tax-exempt
- The partnership shows that a part of the imputed underpayment is allocable to a partner which, in the case of ordinary income, is a C corporation, or in the case of a capital gain or qualified dividend, is an individual.
As an alternative to taking the adjustment into account at the partnership level, a partnership can make an election, not later than 45 days after a notice of final partnership adjustment, to issue adjusted information returns to the reviewed year partners. If this election is made, the partners take the adjustment into account on their individual returns in the adjustment year through a simplified amended-return process.
Under the Act, each partnership will designate a partner or other person as the partnership representative. This representative will have the sole authority to act on behalf of the partnership under new Subchapter C (Treatment of Partnerships) of the Code. Where a designation isn’t made, IRS may select the partnership representative. A partnership and all of its partners will be bound by the actions taken under new Subchapter C by the partnership, and by any final decision in a Subchapter C proceeding with respect to the partnership.
Partnerships with 100 or fewer qualifying partners can elect out of the new rules for any tax year. According to the House’s section-by-section summary of the Act, if the election is made, the partnership and partners would be audited under the general rules applicable to individual taxpayers.
More specifically, the new rules will not apply if:
- The partnership elects out for the tax year
- For that tax year, the partnership provides 100 or fewer K-1’s (this includes K-1’s sent out by any S corporation that is a partner)
- Each of the partners of the partnership is an individual, a C corporation, a foreign entity that would be treated as a C corporation were it domestic, an S corporation, or an estate of a deceased partner, and
- The election is made with the partnership’s timely filed return for the tax year and discloses the name and taxpayer identification number (TIN) of each partner of the partnership.
There are numerous unanswered questions that will hopefully get resolved through regulations, technical corrections, or other guidance in the future. Contact your MarksNelson professional with any questions.