Howdy Partners! IRS Partnership Audit Rules Have Changed

9/13/2018 - By John Mascaro, CPA & Eric Linder, CPA

REMINDER: As of January 1, 2018, the landscape for how the IRS audits (or “examines”) a partnership tax return has changed. A new “centralized partnership audit regime” is now in place for tax years beginning in 2018.

The New Audit Regime

In a nutshell, the new examination procedures will allow IRS to assess tax liability resulting from audit adjustments at the partnership level only, with any additional tax, penalty and interest to be treated as an assessment at the partnership level itself, rather than a liability of each partner. IRS collection efforts for such liability will also be directed to the partnership itself, rather than to individual partners.

Are All Partnerships Impacted?

Not all partnerships are affected. Partnerships with 100 or less eligible partners may opt-out of the new audit procedures. That said, even those partnerships not affected will still need to take action and include an election out of the new audit regime when filing 2018 partnership tax returns in 2019.

Partnership Representative

The Proposed Regulations require that a partnership affected by the new audit regime designate a partnership representative. They also describe the eligibility requirements for this representative, the extent of the representative’s authority, and whether a designation is or is not in effect. The Regulations also allow IRS to designate a partnership representative where the partnership has not done so.

Election Out of Centralized Partnership Audit Regime

As mentioned above, “eligible partnerships” may elect out of the new audit regime and continue to have IRS essentially follow prior procedures. An “eligible partnership” may elect out of the centralized partnership audit regime only on a timely filed tax return (including extensions). A partnership is an eligible partnership if it has 100 or fewer partners during the year and, if at all times during the tax year, all partners are “eligible partners”, as defined in the proposed regulations.

A partnership has 100 or fewer partners during the year if it is required to furnish 100 or fewer Schedule K-1 statements during the tax year for which the partnership makes the election. Special rules apply to partnerships that have S corporation partners. Also, a husband and wife are not treated as a single partner for these purposes.
An “eligible partner” is any person who is an individual, C corporation, eligible foreign entity, S corporation, or the estate of a deceased partner.
An “ineligible partner” is any person who is another partnership (or LLC taxed as a partnership), a Disregarded entity (e.g., Single-member LLCs), an Estate of an individual other than a deceased partner, a Nominee Partner, or a Trust.

The partnership must disclose the names, correct TINs, and federal tax classifications of all partners and, if there is an S corporation partner, additional information is required for disclosure. An election out is not valid unless all of these requirements are satisfied.

In addition, the electing partnership must notify each partner within 30 days of making the election. For partnerships that elect out, the IRS will open deficiency proceedings at the partner level to adjust items associated with the partnership, resolve issues, and assess and collect any tax that may result from the adjustments. The IRS intends to carefully review a partnership’s decision to elect out of the centralized partnership audit regime.

The aforementioned rules are just some the most important aspects of the new IRS audit regime for partnerships. We recommend that partnerships review their existing operating agreements with their legal counsel to include appropriate modifications as necessary for the above new rules. If you have any questions about this article, feel free to email John Mascaro or Eric Linder.

About the Authors

John Mascaro, CPA
John is adept in helping companies develop and execute complex domestic and international tax strategies. He has served some of the world’s largest companies in varied industries, including IBM, Schlumberger, Siemens; and later specialized in the entertainment and media industry. View Full Bio

Eric Linder, CPA
Eric is a manager in the Tax & Accounting Services Department of Saltmarsh, Cleaveland & Gund. Prior to joining Saltmarsh in August 2015, Eric worked with a global accounting and advisory firm performing business tax services for clients spanning a variety of industries including retail, healthcare, professional service firms, and manufacturing. View Full Bio