Your partnership or LLC might be out of date thanks to the Bipartisan Budget Act of 2015 (“BBA”), which became law on November 2, 2015. The BBA creates a centralized audit system that applies to all partnerships, except those that elect out of it. An audit is initiated by the IRS mailing notice of the audit to the partnership and its partnership representative (discussed below).
If the IRS determines that tax is owed, it issues a Notice of Proposed Partnership Adjustment showing the imputed underpayment. The partnership has 270 days to respond by showing the imputed underpayment is too great. The IRS will issue notice of the final partnership adjustment following the end of the 270-day period. The partnership may then elect to pay the tax or to push the adjustments out to the partners.
Among other things, the BBA repealed TEFRA and the electing large partnership rules regarding audits. Under TEFRA, partnerships (including LLCs taxed as partnerships) with more than ten partners, and no partners that were pass-through entities, were subject to special audit procedures, and smaller partnerships could opt-in.
Among these procedures was the use of a tax matters partner and the ability of individual partners to participate in the audit. Partnership items were determined at the partnership level, and deficiencies were collected at the partner level. Most small partnerships were not audited or adjusted independently of their partners, but instead adjustments were made in individual proceedings.
The BBA did away with all of the above rules. Instead, all partnerships and LLCs taxed as partnerships are subject to a new set of rules. These rules could have important implications for all partnerships, but especially for partnerships that have used a tax matters partner in the past. These rules do not become fully applicable until 2018, but partnerships may opt-in to the rules early. You may schedule a meeting with Michael Kuzminski to discuss your options.
Here is a summary of some of the BBA provisions in more detail:
One major change in the partnership audit rules under the BBA is the creation of the “partnership representative.” Under the BBA, each partnership is required to designate a partner or other person with a substantial presence in the United States who has the sole authority to act on behalf of the partnership in audit proceedings. If the partnership does not designate a partnership representative, the IRS can select one for the partnership. It is important that all partnership agreements and operating agreements be updated to designate a partnership representative.
The partnership representative has substantially more power to bind the partnership than a tax matters partner under the old rules. In fact, the partnership representative is the only person with authority to act on behalf of the partnership in an audit under the BBA rules. The partners and the partnership are bound by actions taken by the partnership (acting through the partnership representative) and by any final decision in a BBA proceeding relating to the partnership.
The major benefit of the partnership representative over the tax matters partner is that the partnership representative can be any person with a substantial presence in the United States. A tax matters partner could only be a general partner, or, for an LLC taxed as a partnership, a member. Under TEFRA, an LLC managed by a manager was required to designate a member as tax matters partner, despite the delegation of authority to the manager. Under the BBA, the partnership or LLC can designate anyone as partnership representative, including a manager, accountant, or other tax expert.
Under the BBA, the partnership or LLC has a decision to make: will the entity pay the imputed underpayment of tax identified in an audit, or will it push the underpayment out to the partners? The default is that the partnership must pay any imputed underpayment, or, if the adjustment is not an imputed underpayment, reflect the adjustment in non-separately stated income or loss. The partners may adjust the amount of imputed underpayment owed by the partnership by filing amended returns for the adjustment year that take account of the adjustment. If all partners file amended returns, then the partnership will not owe anything.
The partnership may elect to have the partners, rather than the partnership, pay the imputed underpayment. This is done by the partnership making the election within 45 days following the notice of the final partnership adjustment and furnishing to each partner and to the IRS a statement of the adjustments. The partners then take the adjustments on their returns for the year in which they receive the statement, not the review year.
The IRS still needs to issue regulations implementing a number of these rules, so many of the details of these rules are unclear. Partners and members can, however, have some degree of certainty through a well drafted partnership agreement or operating agreement.
Eligible partnerships may opt-out of the new procedures. A partnership is eligible to opt-out if it issues 100 or fewer Schedule K-1s (including all shareholders of any S corporation partners) and each partner is an individual, C corporation, foreign entity that would be a C corporation if it were domestic, S corporation, or estate of a deceased partner. Call DWMK to discuss whether your company qualifies to opt out and how to make the required annual election with the company’s tax return. Because TEFRA and the electing large partnership rules are being repealed, an election to opt-out will mean that a review of partnership matters will be done at the partner level, not the partnership level.
The new BBA rules could have significant consequences for partnerships in the years to come, especially as the IRS continues to focus on partnerships as audit targets. For many partnerships, especially manager-managed LLCs taxed as partnerships, the flexibility of naming a non-partner partnership representative is a benefit. The partners should carefully consider whether opting in to the new rules early, or opting out of them entirely when the time comes, will be more beneficial to the partnership. Michael Kuzminski is prepared to assist in amending your partnership agreement or operating agreement, and Bill Frey and I are prepared to assist in considering the applicable tax consequences of either course of action. Schedule an appointment today.