The New Partnership Audit Rules: Are You and Your Clients Ready?, 1117 ALBJ, 78 The Alabama Lawyer 423 (2017)

AuthorBruce P. Ely and William T. Thistle, II
PositionVol. 78 6 Pg. 423

The New Partnership Audit Rules: Are You and Your Clients Ready?

Vol. 78 No. 6 Pg. 423

Alabama Bar Lawyer

November, 2017

Bruce P. Ely and William T. Thistle, II

In late 2015, Congress passed the Bipartisan Budget Act of 2015 (the "BBA")1 as amended by the PATH Act of 2015. The BBA established a new partnership audit and assessment regime and repealed prospectively the current TEFRA partnership audit rules.2 As discussed below, the BBA greatly enhanced the Internal Revenue Service's ability to audit partnerships (including multimember LLCs). As a result, the new federal partnership income tax audit rules, which are scheduled to take effect on January 1, 2018, will have significant implications for the taxation of partnerships and their partners.

Currently, very few partnerships are audited, generally because the IRS cannot directly assess partnerships, but instead must pursue each partner for its share of the assessment, often through multiple tiers. The BBA repealed the existing rules regarding partnership audits and replaced them with fairly radical new procedures, which are codified under Sections 6221 to 6231 of the Internal Revenue Code. The new regime is designed to alter the burden of sifting through myriad assortments of partnership structures, saving time and expense for IRS revenue agents who the GAO notes are often not conversant with the intricacies of Subchapter K.

Under the new rules, the IRS will audit a partnership's tax items and the partners' distributive shares for a particular year ( the " reviewed year"), and any audit adjustments will be made at the partnership level and taken into account by the partnership in the year the audit or judicial review is completed (the "adjustment year"). If an audit results in a tax deficiency, the "imputed underpayment" presumptively will be assessed against and collected from the partnership rather than the individual partners. Unless the partnership timely elects out of the new regime, or unless certain elections are made as described below, the adjustment year partners will therefore bear the audit assessment, including interest and possibly penalties, even if some or all are different than the partners in the reviewed year. Thus, under the new rules, partners can be on the hook for someone else's income tax liability.

The January 1,2018 effective date of the new federal partnership audit rules is fast approaching, and it is clear that most of our (and likely your) Subchapter K clients (i.e., partnerships of all stripes and multi-member LLCs) have taken a wait-and-see approach. That's either because (a) they are not convinced the new rules apply to them or (b) because they have heard that the rules might be delayed or, at the very least, altered by a technical corrections bill or by IRS "interpretation" principally through their 277 pages of proposed regulations. Tax practitioners are beginning to panic, as evidenced by the titles of several recent law firm newsletters, our favorite being "Holding the Bag: Update Your Operating Agreement or Face the (Tax) Consequences."

From our involvement in the ABA Tax Section's Task Force on the State Implications of the New Federal Partnership Audit Rules and from speaking to various CPA and attorney groups over the past year or so, we have developed some frequently-asked questions that we hope will be quick reading for non-tax lawyers. We will use the terms "partnership" and "partners" throughout, but that includes multi-member LLCs classified as partnerships and their members where appropriate.

Why should my partnership clients be concerned about the new rules?

You may have heard that the Bipartisan Budget Act of 2015 created a comprehensive and radically new partnership audit regime. This is what "repeal and...

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