- Beginning in tax year 2018, IRS will audit, assess and collect taxes at the partnership level, instead of from individual partners
- Partnerships have some options to help reduce partnership-level taxes owed
- A new partnership representative will have authority to represent the partnership to the IRS
- Recommended actions for the coming months include consulting advisors and modifying partner agreements
"I've got some good news and some bad news for partners in business partnerships," said WBL tax partner Steve Horn.
"The bad news is partnerships can expect more IRS audits going forward now that new audit rules are in effect. The good news is there is still time for partners to do a little research and plan now to make the most of the new rules and be well prepared if they are audited."
For 2018, the Internal Revenue Service (IRS) is rolling out changes to its partnership audit rules that are designed to streamline the audit process by shifting the assessment and collection of taxes from partners to the partnership. The partnership can then pay the taxes directly at the highest tax rates then in effect—a new option—or amend all Schedule K-1s for the year under review.
Key to this change is the establishment of a new role within the partnerships. Partnerships will designate a point of contact for the IRS, a partnership representative, or the IRS will designate one. The new partnership representative can be partner or another person such as a trusted and experienced partnership tax accountant. Partnership representatives replace the "tax matters partner" and will have broad and binding authority to act on behalf of the partnership, making relevant elections, representing the partnership during an audit, negotiating settlements with the IRS, and seeking judicial review of an IRS adjustment. The IRS will save time because it passes the responsibility of matching and tracking partners to the partnership representative.
Certain partnerships may be able to elect out of the new rules:
- Partnerships with 100 or fewer partners may elect out of the new rules by making an annual election on a timely-filed Form 1065. This option is not available to partnerships that include partners that are also partnerships, including LLCs taxed as partnerships.
- Other partnerships may allocate the assessment to those who were partners during the audited tax year, if an election is made within 45 days of receiving a notice of final partnership adjustment. However, the IRS will increase the interest rate assessed on underpaid taxes two percentage points for the privilege of making this election.
"Partners should consult with their tax advisor and legal counsel as soon as possible to make sure their agreements cover the effects of the rule changes and the new role of the partnership representative," said Horn. He recommends partners consider the following during their review:
- Establishing qualifications for the partnership representative, determining the scope of their discretion, and defining the terms for removal or resignation.
- Specifying how the partnership will apply the new audit rules.
- Determining the type and timing of information to be shared between the partnership and its partners, including specific communications about this IRS rule change.
- Discussing restrictions related to transfers of partnership interests to ineligible partners.
If you have any questions about the changes to tax rules affecting partnerships, please contact Steven G. Horn, Tax Partner, at (770) 512-0500.