Partnership Tax Audit Alert! – Radical Changes Coming

Posted on October 31, 2017 by Jon Mills

Partnerships and LLCs taxed as partnerships (hereinafter referred to as “partnerships”) will soon be subject to new IRS audit rules. Under the new audit rules, partnership audits will follow a new centralized audit regime that assesses and collects tax at the partnership level. These new audit rules are effective for partnership tax years beginning after December 31, 2017.

Under the new audit rules, partnerships will be liable for any underpayment of tax, including penalties and interest, resulting from an audit of the partnership. The goal of this new centralized partnership audit regime is to make it easier for the IRS to collect underpaid taxes assessed as a result of a partnership audit. Fortunately, partnerships with 100 or fewer partners can generally elect out of the new audit rules. However, there are certain requirements that must be met to elect out, including that none of the partners can be partnerships or LLCs (this is a very common structure).

Another significant change made by the new rules is the introduction of the “partnership representative.” The partnership representative replaces the “tax matters partner” that everyone is accustomed to under the current rules. The partnership must make a separate designation of the partnership representative every year on its tax return. If a partnership representative is not selected, the IRS, subject to a 30-day notice period, may select any person to serve as the partnership representative. The partnership representative has expansive authority under the new rules, thus it is important for the partnership to make an affirmative decision by designating the partnership representative.

Maynard Cooper’s tax and business attorneys have analyzed the new partnership audit rules and continue to stay on top of the related guidance issued by the IRS. New operating agreements will need to incorporate specific language to comply with the new rules (and most existing operating agreements will need to be reviewed and amended in the near future). The new audit rules are currently scheduled to go into effect for partnership returns for the 2018 tax year. Thus, partnerships should make sure they have addressed the new audit rules by the time the IRS begins auditing 2018 tax years.