Academic journal article Southern Law Journal

Statutory Changes in Partnership Tax Audits and the Resulting Need for Changes in Partnership Agreements

Academic journal article Southern Law Journal

Statutory Changes in Partnership Tax Audits and the Resulting Need for Changes in Partnership Agreements

Article excerpt

I. INTRODUCTION

In November, 2015, Congress repealed the Tax Equity and Fiscal Responsibility Act of 19821 (TEFRA) partnership audit rules and provided new partnership audit rules (also applicable to Limited Liability Companies (LLC) electing to be taxed as partnerships) effective for tax years beginning after December 31, 2017.2 The Bipartisan Budget Act of 20153 and technical amendments included in the 2016 Consolidated Appropriations Act4 (collectively BBA) rewrote the Internal Revenue Code (I.R.C.) partnership audit provisions and inserted conforming amendments elsewhere in the code.5 In May, 2017, the Internal Revenue Service (IRS) issued proposed regulations, to be used until final regulations are issued and sought comments due in August 14 of the same year.6 The BBA imposes an audit regime that is fundamentally different from the partnership audit regimes that preceded it. Implementation of the BBA depends on the extensive structure of rules that the Internal Revenue Service (IRS) has presented for comment and implementation.

The BBA statutory provisions and IRS regulations impose on partnerships (as opposed to individual partners) the obligation to identify and pay any deficiency7 unless the partnership meets the conditions required to elect out of the BBA audit rules8 or chooses to shift payment to partners.9 Individual partners are bound by the partnership level rulings on tax liability.10 Each partnership must elect a single partnership representative (PR) who is the sole point of contact with the IRS during the audit and whose actions bind both the partnership and its individual partners.11 Any deficiency is paid by the partnership in the year the adjustment becomes final, rather than by the individual partners, unless the partnership elects to push out payment of deficiencies found when the partnership is audited to those who were partners in the reviewed year.12 Both the BBA and implementing regulations substantially upend the prior system of auditing individual partners, changing both procedures and each individual partner's substantive rights.

The new BBA tax audit structure makes it desirable to include in partnership and LLC agreements provisions that address how the partnership will handle the elections inter-partner obligations, and relations between the partnership, its partners, and the IRS under the new audit and assessment procedures. Partnership and LLC agreements should address who will be the PR and his or her obligations to the partnership and partners. The agreements should consider the obligation of reviewed year partners to audit year partners and to each other. Finally, agreements should address who will be responsible for payment of deficiencies, interest, and penalties.

The provisions of the BBA and its implementing regulations are described in the next section. The following section suggests partnership agreement provisions that address issues raised by the new tax audit rules and resulting changes in relations among partners or LLC members and their entities.

II. SUMMARY OF BBA CHANGES TO PARTNERSHIP AUDIT RULES

A. The IRS Determines Partnership Tax Adjustments at the Partnership Level Unless the Partnership Elects Out of the Regulations: I.R.C. 6221

Adjustments to items of partnership income, gain, loss, deduction, or credit for the partnership taxable year and all partner distributive shares are assessed, adjusted, and collected at the partnership level instead of from individual partners.13 However, a partnership required to furnish 100 or fewer partner statements in a tax year to qualified partners may elect on its return to be excluded from the BBA rules (elect out) by notifying the IRS and each partner of the election.14 To elect out all partners be qualified partners. Qualified partners include individuals, C corporations, foreign entities that would be treated as a C corporation if they were domestic entities, domestic partnerships and LLCs, S corporations, and the estate of a deceased partner. …

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