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Budget Act Provision Could Put Your Partnership at Greater Risk of an IRS Audit

February 12, 2016

New partnership rules could put you at greater risk of being audited by the IRS.

If you’re a partner in a partnership, a tax law provision that was recently signed into law merits your attention. The provision is part of the Bipartisan Budget Act of 2015, and it revises the partnership audit rules that had previously been established by the Tax Equity and Fiscal Responsibility Act (TEFRA). The new rules are significant because they could put your partnership at greater risk of being audited by the IRS.

The TEFRA Rules

Under the TEFRA unified partnership audit rules, generally, if a partnership has more than 10 partners, the IRS completes an audit at the partnership level and determines the appropriate adjustments. But then it must recalculate each partner’s tax liability for the year.

Partnerships with 100 or more partners can elect to have adjustments made at the partnership level and then have those adjustments simply flow through to the partners (rather than the IRS calculating each partner’s liability). Not surprisingly, few large partnerships make this election.

Without the election, if a partnership has, say, hundreds of partners, that means the IRS has to calculate hundreds of partnership adjustments, which is time-consuming and costly for the IRS. Therefore, the TEFRA rules have limited the number of large partnership audits the IRS has been able to conduct.

The New Rules

The 2015 budget act replaces the TEFRA partnership audit rules with rules that generally require large partnerships to be audited at the partnership level — and for tax adjustments to be made and collected from the partnership. What does this mean?

When auditing a large partnership, the IRS will not only determine adjustments to income, deductions, gains, losses and credits at the partnership level, but also assess any additional tax liability resulting from these adjustments at the partnership level. In addition, it will apply any penalty or other additional amount related to the adjustments to the partnership itself. This greatly simplifies the audit process for the IRS.

The new rules do, however, provide large partnerships with an election to issue adjustment information to the exam-year partners rather than applying the adjustment at the partnership level. The partners would then account for the adjustment on their individual returns for the year in question. The election must be made no later than 45 days after a notice of final partnership adjustment, and it can be revoked only with IRS consent.

Certain partnerships with 100 or fewer partners will be able to elect out of the new rules altogether, but it must be done on a timely filed return.

Respite for 2016

These are only some of the highlights of the new partnership audit rules. The rules are complex, and additional IRS guidance is expected.

The good news for large partnerships is that the new rules generally apply to tax years beginning after December 31, 2017. So you have some time to assess your situation and evaluate your partnership’s audit risk. We can help. You’ll also want to review your partnership agreements, noting that, under these new rules, current year partners may be paying for changes to a year prior to their joining the partnership. This can raise a number of legal questions involving distributions, redemptions, valuations, and others.

So please contact us if you have questions about the new rules, how they might affect your partnership and whether there are steps you can take to help reduce your audit risk. Questions? Contact Us.

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