New IRS Partnership Audit Rules
The Bipartisan Budget Act of 2015 (BBA), results in a significant change to the way the IRS audits partnerships and limited liability companies that are treated as partnerships for tax purposes. The new rules will replace the current Tax Equity And Fiscal Responsibility Act of 1982 (TEFRA) unified partnership audit rules along with the electing large partnership (ELP) rules, in favor of a more streamlined audit regime, namely: allowing the IRS to audit partnerships and their partners (who, under the BBA, are not subject to joint and several liability for any liability determined at the partnership level) at the partnership level and assess and collect taxes against the partnership, unless the partnership elects out of the new regime. This legislation will impact the formation and operations of partnerships, as well as disposition of partnership interests and admission of new partners. The BBA is designed to facilitate IRS audits of partnerships, thus leading to more audit frequency, and completely overhauls the Service’s approach to partnership examinations. The new audit approach will have significant effects on the drafting of partnership agreements. Tax counsel will have to consider issues such as protection of minority partners and specifying which party will bear the cost of taxes imposed at the partnership level. The BBA clarifies that Congress did not intend for the family partnership rules to provide an alternative test for whether a person is a partner in a partnership. The determination of whether the owner of a capital interest is a partner would be made under the generally applicable rules defining a partnership and a partner. Further, the BBA clarifies that a person is treated as a partner in a partnership in which capital is a material income producing factor whether the interest was obtained by purchase or gift and regardless of whether the interest was acquired from a family member. The Joint Committee on Taxation estimates that this “clarification” will bring in $1.9 billion over the next 10 years. Partnerships have time to adjust with the new streamlined partnership rules applicable to returns filed for partnership tax years beginning after 2017. However, subject to certain exceptions, partnerships may choose to apply the new regime to any partnership tax year beginning after the date of enactment (November 2, 2015). The law applies to partnerships with over 100 partners, as well as partnerships which have another partnership as a partner. While the legislation does not go into effect until 2018, tax counsel should evaluate existing partnership agreements now to prepare clients for the commercial, operational and compliance impact of the new law, as well as incorporating the law’s provisions for all new partnership agreements.