The partnership audit rules are in for a major overhaul. The recently-enacted Bipartisan Budget Act of 2015 (BBA) is replacing the existing partnership audit framework with a new regime. The new rules, however, are not immediately mandatory—they will generally apply “to returns filed for partnership taxable years beginning after Dec. 31, 2017.” So, for many partnerships, now is the time to review their current agreements and to plan for (or around) the new rules.
While the new legislation affects partnerships generally, it is particularly aimed at addressing the IRS’ struggles to audit large partnerships. Large partnerships (that is, partnerships with 100 or more partners and $100 million or more in assets) have proliferated in recent years, and they have become an increasingly important structure in our economy. However, perhaps surprisingly, they are rarely audited. There are a number of reasons for this, but not least among those reasons is the difficulty presented by the current partnership audit rules.
The current partnership audit framework was largely enacted as part of the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA). Under TEFRA, the IRS generally audits a partnership at the entity level, and then (if the audit results in adjustments) the IRS makes “flow through” assessments to each partner. This procedure, however, has proven extremely difficult and resource-intensive—particularly when it comes to large partnerships with many partners.
The BBA, in an effort to address this challenge, takes a different approach. It generally allows the IRS to directly assess the partnership itself, rather than requiring “flow through” assessments to its partners. That is, the BBA generally allows the IRS to impose entity-level liability where an audit results in adjustments. This entity-level liability is imposed in the year of the adjustment. This represents a major change, and in some cases, this procedure could prove quite inequitable. For instance, if the partnership’s partners have changed (as will often be the case), the new partners may ultimately bear the economic burden of the assessment, even though the old partners may have enjoyed the economic benefit of the partnership’s prior tax treatment.
As this demonstrates, the BBA will dramatically change the nature of many partnership audits in the future. There will be many other changes too, including changes to the “tax matters partner” concept, the ability to “opt-out” of the partnership procedures, and the governing statute of limitations. While the act’s overall impact remains to be seen, practitioners can certainly expect to see an uptick in the audit rate for large partnerships, along with a host of procedural changes.
To read the BBA language, please click here.
To read my recent article, The Evolution of Partnerships and Partnership Audits, click here.