Posted by Tim Thompson CPA PLLC

The New Partnership Audit Rules: How it affects You

The New Partnership Audit Rules: How it affects You

Partners need to examine and review their operating agreement for them to effect the new audit rules. 

As of the 2017 tax year, the IRS examined tax returns from a partnership based on each partner's share of the income, credits, and deductions. As of the 2018 tax year, the partnership level will determine the partnership examination. This will happen via a major "partnership representative." While the partnership representative does not have to be a partner, they must have the power to bind the partners before the IRS.

With these rules, however, the partnership might have to pay a tax deficiency. There are, however, two potential elections with the New Audit Rules. Applicable to small partnership, one election gives the grace to opt-out of the New Audit Rules. The other election involves re-allocating some or part of the obligation to the individual partners in the system when the tax year was under investigation. This applies to all partnerships.

To be classified as a small partnership, the partnership needs to have a hundred partners and below. Besides, the partners should be "eligible." In other words, they need to be an individual, a corporation, an S corporation, etc. should any of the partners be a trust or a partnership, and it does not qualify as a small partnership.

You should file your tax return early for you to have your opt-out election, which happens yearly. On making the opt-out election, it is essential to notify partners within 30 days. All deficiency obligations will be collected from the partners of a partnership after the opt-out election has been made based on the tax year.

Addressing This on Your Partnership Agreement 

The partnership agreement should reflect if the partnership representative is required and allowed to have a timely opt-out election. It could also forbid the transfer of partnership interest to third parties who are not an eligible partner. This is to ensure that the partnership is not disqualified from being a small partnership. 

Partnership Representative:

According to the New Audit Rule, the requirement for partners on tax matters also changed. The tax matter partner is a partner chosen to be the link with the IRS on all tax issues with the "partnership representative."

According to the New Audit Rule as well, a partnership representative is a person with the full authority to decide for the partnership with the IRS. Such a person may be a partner or not and have a substantial presence in the United States.

Addressing this on Your Partnership Agreement 

It is essential to amend tax agreements to substitute former requirements that have to do with a "tax matters partner." The substitution should be made with the fresh rules from the New Audit Rules that have to do with "partnership representative."

Since the partnership representative is the primary link between the partnership and the IRS, the partnership needs to include a provision in their agreement, which mandates the partnership representative to inform other partners and other individuals that were once partners before they make any decision related to the IRS. This is important as the partnership representative is authorized to bind the partners and partnership during an audit. 

Also, since the partnership level and individuals that were partners in the adjustment year bears the responsibility of the underpayment, there should be a provision in the partnership agreement. The aim of this provision is that partners in the examination year will be able to protect partners in the year the exam ends. In addition, they can adjust their tax return once the partnership representative mandates them to. 

Also, there could be an election from the partnership to push-out underpayments to the individual partners in the partnership during the examination year. Within 45 days from the day the final notice of partnership was adjusted, there should be an election. The aim of the election is to transfer all tax liabilities from the partnership itself to the partners. It also gives the partnership the right to question all changes. 

Tim Thompson CPA PLLC
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