The new partnership audit rules.

• Author: Keneally, Kathryn
• Position: ASK THE EXPERTS

The Expert: Kathryn Keneally

The Bipartisan Budget Act of 2015, signed into law November 2, 2015, repealed the long-standing audit and litigation procedures for partnerships that had been enacted in the Tax Equity and Fiscal Responsibility Act of 1982 and created a statutory framework for new partnership audit rules. The new partnership audit rules make fundamental changes to how the IRS will examine and make adjustments to returns for partnerships and all similar flow-through or disregarded entities that are currently treated in the same manner as partnerships for tax purposes, such as limited liability companies.

Question: What issues should partnerships and partners consider in response to the new partnership audit rules?

Answer: While the new rules take effect under the statute for tax years beginning on or after January 1, 2018, partnerships may elect to apply the new rules for the 2016 and 2017 tax years. More significantly, the impending changes to partnership audits require careful consideration of the provisions in partnership agreements now--well in advance of the effective date.

BARRING ELECTION, IMPUTED LIABILITY WILL SHIFT TO THE PARTNERSHIP

Most basically, Section 6221 (a) of the new partnership audit rules require that any adjustments be made at the partnership level and, barring an election by the partnership, that additions to tax, interest, and penalties be imposed and collected on the partnership level. Prior to the enactment of the new partnership audit rules, it was a fundamental principal that partnerships did not pay income tax. Adjustments to partnership income flowed through to the partners as adjustments for the taxable year under review.

Section 6225 of the new partnership audit rules provides that any tax adjustment will be taken into account by the partnership in the year that the adjustment is made. In other words, barring an election, an IRS examination of a partnership for the tax year 2018 that is concluded in 2022 will result in a liability against the partnership in 2022. In contrast, under TEFRA, an IRS examination of a partnership for the tax year 2012 that is concluded in 2016 will result in computational or affected item adjustments to the returns of the partners for the tax year 2012.

OPTIONS TO ELECT OUT MUST BE CONSIDERED

The statute contains two provisions for electing out of the new regime. The first, more limited option is provided in section 6221(b) for certain partnerships with 100 or fewer...