Partnership Audit Rules
Overview of the New Audit Rules
Under the new streamlined audit approach, the IRS will audit the partnership’s items of income, gain, loss, deduction, credit and partners’ distributive shares for a particular year of the partnership (the “reviewed year”). Any adjustments will 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 (the “adjustment year”).
In a significant departure from previous rules, the general rule is that an “imputed underpayment” will be assessed and collected at the partnership level. An adjustment that does not result in an imputed underpayment generally will 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.
Partnerships will have the option of modifying the imputed underpayment by following rules published in the regulations. A partnership generally will have 270 days to submit information to the IRS to modify the imputed underpayment amount following receipt of a notice of proposed partnership adjustment. One method would be the filing of amended returns by one or more reviewed year partners. Those amended returns would take into account the adjustments allocable to the partners, and include payment of any tax due with the amended return. In that case, the imputed underpayment would be determined without regard to the portion of adjustments taken into account by the partners’ amended returns. In addition, the existence of tax-exempt partners, as well as the proper application of lower tax rates to certain partners, will be taken into account to reduce the imputed underpayment.
As an alternative to the general rule that an imputed underpayment is assessed and collected at the partnership level, a partnership may elect to “push out” adjustments to its reviewed year partners. The partnership must make this election no later than 45 days after the date of the notice of final partnership adjustment. If the partnership makes this election and sends the required adjustment statements to reviewed year partners and the IRS, the imputed underpayment is paid by the reviewed year partners.
Under the new rules, a partnership can initiate an administrative adjustment request, which it may want to do if it believes that an overpayment has been made. The adjustment would be taken into account in the adjustment year. Such a request would be in lieu of filing an amended partnership return.
Traditional Audit Rules for Partnerships that Elect Out
Partnerships with 100 or fewer eligible partners may elect out of the application of the new rules for a particular year on a timely filed return. Traditional audit, assessment and collection statutes of limitation will apply to the partners of electing partnerships; the tax treatment of an adjustment to a partnership’s items of income, gain, loss, deduction or credit will be determined for each partner in separate administrative and judicial proceedings. If an otherwise eligible partnership has partners that include other partnerships, trusts, or disregarded entities, it will not be eligible to make this election out.
Preparing for the New Rules
Many partnerships and limited liability companies will find it necessary or desirable to amend the partnership (or operating) agreement in response to the new audit rules. For example, the familiar tax matters partner is replaced in the new regime by a partnership representative who is not required to be a partner and who has broad powers to take binding actions affecting both the partnership and its partners. Partnerships should carefully choose their representative and ensure that their partnership agreements provide guidance for the exercise of the representative’s broad statutory authority. Partnerships also should consider the ramifications of various partnership actions and elections, including the push out election, that affect both the partnership’s own financial condition and the tax attributes passed through to the partners. The new rules also provide that partners generally may not participate in or contest the results of an examination or other partnership proceeding without permission of the IRS. Therefore, the partnership should consider what safeguards might be appropriate to protect its own and its partners’ interests in the event of an audit.
Please contact your Gettry Marcus professional if you have any questions regarding this information.