5 New Tax Developments for PartnershipsMay 27, 2016
Are you involved in a partnership? Find out how your taxes may change for 2016.
There have been significant tax developments in the past few months that have affected the way partnerships and limited liability companies (LLCs) conduct their businesses. As covered in our recent blog, “Budget Act Provision Could Put Your Partnership at Greater Risk of an IRS Audit,” the recent Bipartisan Budget Act of 2015 revised partnership audit rules. In addition to this, new due dates, family partnership provisions, and proposed regulations regarding the tax treatment of fee-waiver arrangements, will change the way partnerships operate.
What’s brewing on the partnership tax front?
Accelerated due dates- The Surface Transportation and Veterans Health Care Choice Improvement Act of 2015 has changed the due dates for filing partnership federal income tax returns, Form 1065. For partnership tax years beginning after December 31st 2015, the tax return (or extension) is due one month earlier. For calendar year taxpayers, this means March 15th as opposed to April 15th.
Changes to varying interest rules- The IRS’ “varying interest rules,” are used to determine partners’ percentage interests in partnership tax items (like income, deductions and credits, gains, losses) in instances where the partners’ interests change during the year (i.e. someone leaves or joins). The new regulations allow partnerships to use one of two methods to determine distributive shares of partnership tax items when partners’ interests vary during the year:
- Interim-closing-of-the-books method- This method takes the partnership’s income statement from the beginning of the tax year through the date of the ownership change and uses it to allocate tax items up to that point of the partnership’s tax year.
- Annual proration method- In this method, partnership tax items can be prorated, or allocated on a proportional basis, for the number of days that an entering or exiting partner is part of the partnership.
Partnership audits- As mentioned above, our recent blog covers in more detail how the Bipartisan Budget Act of 2015 affects partnership audits.
Family partnerships- In addition to audit issues, the Bipartisan Budget Act also addresses family partnerships, which are partnerships consisting of members of the same family. There are new provisions in the act that clarify something that has been the source of argument through the years—determining who is a partner in this specific type of partnership. The new law clarifies that individuals with interest in a family partnership are considered partners even if the interest is received by gift. The law takes effect for taxable years beginning after December 31st 2015, so 2016 federal tax returns could be affected for family partnerships.
Disguised partnership payments for services
Under partnership rules, a payment between a partnership and partner can be done in one of three ways:
- As a Section 704(b) distributive share (the taxable allocation of income, loss, deduction, or credit from a business to a partner- based on the net income of the business)
- As a Section 707(c) guaranteed payment (payments guaranteed to be made to the partner whether or not the partnership makes a profit); or
- As a transaction under Section 707(a) where a partner has performed services to the partnership in a capacity other than as a partner.
The IRS issued new proposed regulations in July 2015 that will treat certain arrangements that result in payments to partners as “disguised payments for services.” This means that, the distribution from a partnership to partner is treated as taxable compensation income to the recipient partner. The partnership gets an offsetting deduction, lessening the overall profit of the partnership to be distributed among the partners.
Previously, these arrangements were regarded as an allocation of partnership profits and a related distribution of cash. By enacting this change, the IRS hopes to change the tax treatment of “fee waiver arrangements” or arrangements in which partnership service providers relinquish their right to receive current fees in exchange for an interest in future partnership earnings. New proposed regulations use a facts-and-circumstances approach to decide whether the arrangement is a disguised payment for services or a distribution of partnership profits.
If you’re involved in a partnership, you will want to take some time to understand how these new developments will affect business in 2016 and beyond. Being that some of these changes are very complicated in nature, it is best to contact your tax advisor to make sure you are fully cognizant of your obligations.
Questions? Contact our Tax Services Team.