Effective January 1, 2018, new rules apply for partnerships that modify the way the IRS conducts partnership examinations.
The change in law may require amendments to provisions in current partnership agreements to address the new tax procedures and preferences of the partners. Practitioners should review existing partnership agreements in light of these changes.
There are a number of decision points partners and practitioners should consider. For instance, the “Tax Matters Partner” under TEFRA has been eliminated and replaced by a new “Partnership Representative” whose rights and responsibilities differ significantly. The Partnership Representative does not have to be a partner and will bind the partnership, and its partners, in all dealings with the IRS. Additionally, the concept of “notice partner” has been eliminated, and a partner may no longer bring individual disputes or claims for partnership items. New and revised partnership agreements should be drafted carefully to provide the rights and responsibilities of the new Partnership Representatives (and should consider certain protections).
Substantively, the Bipartisan Budget Act of 2015 repeals existing TEFRA and Electing Large Partnership (ELP) rules, where now, any adjustments made to a partnership during audit will now have taxes paid at the partnership level. This is a dramatic change from the former method of looking to each partner to pay the additional tax. Importantly, the additional tax will be paid at the highest individual tax rate in the year of the examination (adjustment year) and not for the tax year in controversy (reviewed year).
This may have a significant impact if partnership interests are transferred. Partnerships will now have a stronger interest in maintaining the ability to communicate with former partners. The rule changes could also have an impact on the timeframe in which the IRS can audit the partnership. In the past, the Statute of Limitations for examination of a return was determined on a partnership or partner-by-partner basis. The new rules look solely to the filing of the tax return of the partnership to determine whether the examination period remains open.
Within the new statute there are a number of elections that the partnership will need to consider. For example, smaller partnerships (such as those with 100 or fewer partners) may be able to elect out of the new regime all together. This election must be made each year on a timely filed return. The partnership may also elect after examination to have the underpayment made at the partner level and take into account partner marginal rates. These new laws pose multiple decision points for partnerships including certain elections and handling tiered structures that are significant changes to tax procedure. Historically, and during my time at the Agency, the IRS encountered challenges in their efforts to audit partnership tax returns by having to administratively address each individual partner’s return at the end of an audit. TEFRA was enacted before the rise of the huge partnerships of today with tens of thousands of partners. The new regime is intended to make it easier for the IRS to perform their audits. As a result, the burden of working and adjusting each partner’s return will ostensibly shift to the partnership, partners, and perhaps most importantly, the partnership representative. All new partnership agreements should include provisions for the new statute, but strong consideration should be given to amending existing agreements. Now is the time for partnerships and their advisors to be discussing the new provisions and to make necessary modifications to existing partnership agreements and partnership transactions.
Please contact Steven Miller, alliantgroup’s National Director of Tax, at 202.808.7023 for more information