Have You Updated Your Operating Agreement to Avoid the New Harsh Partnership Audit Rules?
Congress has enacted significant changes to the partnership audit and adjustment rules that will impact nearly all partnerships (and LLCs taxed as partnerships) when they go into effect starting in 2018. The Bipartisan Budget Act of 2015 (P.L. 114-74) was signed into law on November 2, 2015, which repealed the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) audit rules and replaced them with new rules designed to streamline partnership audits.
The changes are expected to dramatically increase the audit rates for partnerships and LLCs, and will require partners to carefully review and revise their entity’s operating agreement. The new rules generally apply to partnership returns filed after 2018, but careful planning today will help mitigate unfavorable consequences.
Both the AICPA and the ABA Section of Taxation have submitted comments requesting a delay in the effective date of the new partnership audit rules for one year until December 31, 2018, due to the expansive changes and substantial effort that will be required on the part of Treasury, the IRS, the tax practitioner community and taxpayers to develop and comply with new rules.
Important new provisions that may impact you
- The IRS may collect any additional tax, interest, and penalty directly from the partnership rather than from the partners, which could result in the imposition of tax at the highest individual tax rate, without taking into account any deductions or other tax attributes at the partner level.
- Current partners could be responsible for tax liabilities of prior partners.
- New elections and opt-outs are available, and your agreement may need revision to specify who makes these decisions.
- There are many new tax terms and concepts that will likely require you to adjust your partnership’s operating agreement.
Particularly, the new term “partnership representative” replaces the prior “tax matters partner.” Under the new rules, the partnership representative is critical, as they act at the single point of contact between the IRS and the partnership and have full authority to bind the partnership and the partners during an audit, absent contrary provisions in the operating agreement.
Potential opportunities and the need for planning today
New partnership and operating agreements should be drafted with these new rules in mind. Existing partnerships and LLCs should revise their operating agreement to reflect and draft around these changes.
Certain partnerships with 100 or fewer partners may elect out of the provisions, by making an annual “opt-out” election with their timely filed partnership tax return (Form 1065). Unfortunately, partnerships with trusts or other partnerships as partners cannot currently opt out of the new rules.
For a more detailed discussion on the new partnership audit rules and how to plan for and draft around them, click here. Please contact us if you would like to discuss these new partnership changes and review your planning opportunities. Don’t Worry, We’ve Got This!