Posted by UP YOUR ASSETS INC

A Breakdown Of The Centralized Audit System Regime

A Breakdown Of The Centralized Audit System Regime

What is the Centralized Audit System Regime (CPAR)?

Partnership returns, unless you are eligible to opt-out and do so, will automatically be subject to the "streamlined method" of the IRS for collecting and auditing taxes relating to partner firm.

According to the "centralized method," once verified, the IRS will correspond directly to a representative of the designated association (indicated on Form 1065 each year). This representative will have the exclusive power to represent and bind the entire company to any IRS administrative or judicial tax proceeding.

Also, according to the CPAR, if a tax increase is assessed as a result of the audit, the company must pay the tax at the highest individual tax rate, instead of determining tax for each partner separately.

An essential feature of the new regime is that the tax is levied on partnership and not on partners.

A significant number of associations previously exempted from the  Tax Equity and Fiscal Responsibility Act (TEFRA) of 1982 audit standards will now be subject to the new regime. The IRS published the final settlement in 2018, and its partners, companies, and consultants must be aware of the rules contained in the new regime concerning the method of controlling companies and the method of calculation, valuation and the resulting tax liability is computed.

The new plan generally imposes a commitment to the company concerning the amounts owing as a result of the IRS audit adjustments. The tax increase becomes an obligation of the company in the year in which the taxes are definitively determined (the "adjustment year"), rather than those which were partners for the year under review (" the revised year "). The TEFRA rules, now repealed, did not include a legal mechanism for the collection of income taxes and generally required the IRS to attempt to pay unpaid taxes directly to the partners.

The Benefits Of The Centralized Audit System

  • Simplify the audit process by allowing resolution as quickly as possible
  • The association will pay the additional tax in place of each partner

Disadvantages Of The Centralized Audit System

  • Taxes will be levied at the highest individual tax rate (currently 37%) instead of the lower individual tax rate of each partner (there is still a method of taxing individual partners, but the designated representative must do it.) 
  • The appointed association representative will have many decision-making powers related to the IRS that could conflict with other partners.
  • The representative of the designated association due to the extension of powers may be exposed to possible legal action by other partners.
  • Audits are usually only 2-3 years after the filing of the return. The partners at the time of the filing of the declaration cannot be partners at the time of the audit, which makes it difficult or impossible to obtain capital contributions from former partners to cover the taxes owed by the company.
  • It is recommended that a lawyer review and amend the affiliation agreement to define/limit the responsibilities of designated representatives.

Who Can Choose Not To Use The Centralized Audit System?

  • Generally, associations with fewer than 100 members and no inappropriate partners (listed below) may choose not to participate.
  • Ineligible partners
  • Associations, trusts, certain foreign entities, Single Member LLCs, and other "ignored entities."
  • The exclusion of the choices must be made on a form 1065 presented within the time that includes the extensions.

Note: If you choose to abandon the "regime," you must notify each partner within 30 days of filing Statement 1065.

Who Should Elect Out?

In general, if eligible "opting out" option may be the most preferred option. However, all the Pros and Cons listed above, which are not identified here, must be taken into account before making a decision.

If you do not elect out, who should be the designated representative? In general, we recommend the appointment of a partner in the association, but this is not required

For political reasons, neither PLC Rouse Norton nor any of its employees will accept to be designated representative.

The designated person may change each year. However, once selected and filed on Form 1065, this year's representative can only be changed if the IRS determines that an incorrect assignment has been made.

Conclusion

Replacing the TEFRA rules with the new regime presents many challenges and new reporting requirements for associations, and eligible partners and associations will have to decide whether or not to opt for the new regime. Special attention should be paid to those who are named PR. Before filing the 2018 tax returns, corporations and their partners should ask their professional tax advisers to consult with their consultants to understand and analyze the implications of these new auditing and election provisions.

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