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Prepare now for proposed partnership audit regime

Proposed rules issued by the IRS would implement the new centralized partnership audit regime enacted as part of the Bipartisan Budget Act of 2015. The new regime significantly changes the way partnerships would be audited by the IRS beginning in 2018, impacting every partnership and limited liability company (LLC) taxed as a partnership. The re-issued proposed regulations are substantially similar to the version first issued in January. (Read background.)

Centralized audit regime. Under the centralized audit regime, the IRS would audit the partnership’s items of income, gain, loss, deduction, credit and partners’ distributive shares for a particular year of the partnership. Any adjustments would be made at the partnership level and taken into account by the partnership in the year that the audit or any judicial review is completed.

Imputed underpayments. Imputed underpayments would be assessed and collected at the partnership level. Adjustments that don’t result in an imputed underpayment would generally be taken into account by the partnership in the adjustment year as a reduction in non-separately stated income or an increase in non-separately stated loss, or in the case of a credit, as a separately stated item.

Partnership adjustment. Following a notice of proposed partnership adjustment, a partnership generally would have 270 days to submit information to the IRS to modify the imputed underpayment amount to:

  • File amended returns by one or more reviewed year partners. Those amended returns would take into account the adjustments allotted to the partners, and include payment of any tax due with the amended return. The imputed underpayment at the partnership level would be determined without regard to the portion of adjustments taken into account by the partners’ amended returns. Tax-exempt partners, and the application of lower tax rates to certain partners, may be factored in to reduce the imputed underpayment.
  • Elect to “push out” adjustments to its reviewed year partners. The partnership must elect no later than 45 days after the date of the notice of final partnership adjustment. If elected, the imputed underpayment is paid by the reviewed year partners.

Partnership representative. A partnership representative must be designated under the centralized audit procedures. Actions taken by the partnership representative related to the centralized partnership audit would be valid and binding on the partnership and partners for tax purposes regardless of state law, the partnership agreement, or other document or agreement. The representative is designated for one year and generally may not be changed until the IRS issues a notice of administrative proceeding to the partnership. Only the representative would be permitted to defend against penalties, additions to tax, or additional amounts related to the partnership or any partner within the partnership. 

Electing out. Eligible partnerships with 100 or fewer “qualifying” partners would be able to elect out of the centralized audit regime. Additional rules apply to a partnership that is itself a partner. Call your TaxOps Advisor if this applies to you for more information.

If partnerships don’t opt-out, or don’t fit the opt-out requirements under these rules, they still have the opportunity to elect out of a partnership-level assessment. This election can be made at the time the partnership receives a notice of Final Partnership Administrative Adjustment from the IRS at the conclusion of the audit. If the partnership makes this election, then the partners in the partnership for the year under audit, and not the partners in the partnership for the year in which the audit is settled, would be responsible for paying any additional taxes, interest, and penalties. The underpayment of tax interest rate used is increased by 2% as a cost to this opportunity.

Push out election. A push out election, whereby a partnership elects to push out adjustments to its reviewed year partners, would required that any imputed underpayment is paid by the reviewed year partners. The proposed regulations do not address whether tiered partnership can push out adjustments beyond the first tier and instead invite comment on whether adjustments should flow through the tiers.

Takeaway

Businesses organized as partnerships and LLCs will want to take a closer look at their organization agreement to determine whether amendments might be necessary as a precaution to exposure. Reach out to your TaxOps Advisor to further discuss the tax impact of these new audit rules, particularly if you anticipate a change in partners after 2017.

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Alex Leugers can be reached at 720.227.0000 or aleugers@taxops.com.

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