Rules governing partnerships have changed, and as a result, the number of IRS audits is expected to increase.
The rules changes, which went into effect Jan. 1, 2018, were implemented in large part to reduce administrative hurdles for the IRS. What they have done, however, is altered the rights of partners in partnerships, including LLCs taxed as partnerships, and created administrative hurdles for taxpayers.
Under the old rules, if a partnership was to be audited or had been found to have underpaid taxes one year, each partner was notified individually by the IRS of the assessment and collection actions.
Now, however, partnerships are required to name a partnership representative who will be the sole point of contact for the IRS. This representative, who must be identified on the partnership’s federal income tax return, can be a partner or a non-partner. The IRS recently issued final regulations, which indicate the partnership itself can be designated as its own representative. However, an individual will still need to be designated to act on behalf of the partnership.
It is imperative that the partnership representative be selected carefully because this individual is given broad authority to resolve any partnership audit with the IRS, whether or not it is a favorable outcome to the partnership. Again, the IRS is obligated only to provide notice of any audit to the partnership representative.
With this in mind, it would be wise for the partnership to draw up a contract that requires the partnership representative to give notice and obtain consent from the other partners before making any decisions. That stated, the IRS is not bound to communicate with anyone but the partnership representative.
The partnership rules also mandate that any underpayment of taxes must be paid and handled by the partnership as an entity rather than by any individual partner.
The partnership could elect to have the individuals who were partners during the tax year in question pay any taxes due as a result of the audit. Again, though, the responsibility of tracking down those partners – who may or may no longer be affiliated with the partnership – and securing revised Schedules K-1 will be with the current partnership members and not the IRS, as it had been in years past.
Smaller partnerships – those with 100 or fewer partners consisting of individuals, estates of deceased partners, C corporations or S corporations – can opt out of this new partnership regime by making an annual election with their partnership tax return. However, note that partnerships whose partners holding their interests in trusts, including grantor trusts, cannot opt out. Furthermore, the IRS has stated that it will increase audits of those partnerships that do opt out. Even so, we recommend that any of our clients who are eligible take advantage of this opt-out provision.
What does this mean for you? In short, if your partnership does not qualify to opt out of these rules (such as those who have a trust as a partner), we recommend you contact an attorney to update your partnership or LLC agreements to name a representative and outline that representative’s responsibilities. Additionally, you should be aware of the potential for increased IRS audits and be prepared for the administrative burden and cost involved with complying with audit requests.
Please do not hesitate to contact us if you need more information about these new partnership rules.
