On June 13, 2017, the IRS re-released proposed regulations interpreting provisions of the Bipartisan Budget Act of 2015 that repeal the current rules governing audits of partnerships (and any LLC taxed as a partnership for Federal tax purposes). The regulations were initially released in the last few days of the President Obama administration. Within a matter of days thereafter, President Trump issued an executive order withdrawing these regulations (among others), leaving taxpayers and advisors with unclear guidance on how this new partnership audit regime would be administered.
The new regime generally affects partnerships for tax years beginning after Dec. 31, 2017 and replaces the current audit rules with a controversial new centralized partnership audit regime that generally assesses and collects tax directly from the partnership (or LLC) itself, rather than its partners (or members). By assessing and collecting tax from the partnership, these new rules can have a material impact on the economics of a partnership if there is a change in ownership of the partnership from the year audited to the year of the assessment. The new regime can also have an impact when purchasing or selling a partnership, or interests therein, because a purchaser may inherit tax liabilities relating to prior year tax returns.
In the proposed regulations, the IRS has acknowledged that assessments against the partnership likely will impact the adjusted tax bases and capital accounts of the partnership’s partners, as well as the inside basis and book value of the partnership’s property. The proposed regulations reserve a place for, and request comments on, rules to address these potential adjustments to tax basis, capital accounts and book values.
Certain “eligible” partnerships may elect out of the new regime, but many partnerships will not be eligible to elect out. Two conditions must exist to be eligible to elect out. First, the partnership must have fewer than 100 partners. Second, all partners of the partnership must be eligible partners. Eligible partners are individuals, C corporations, foreign entities that would be treated as C corporations if domestic, S corporations and estates of deceased partners. Accordingly, any partnership having another partnership (or LLC) as one of its partners is not eligible.
The new regime replaces the concept of the “tax matters partner” with the “partnership representative.” The partnership representative has broader powers than the tax matters partner possesses under the current rules.
The new regime also contains an election under which the partnership representative may elect to “push out” adjustments to its reviewed year partners rather than pay the imputed underpayment.
In light of this new regime, any currently existing partnership (and LLC) should review its governing agreement, which will likely need to be amended to take into account these new rules. New partnership agreements will need to address the current audit rules for the rest of this year and the new audit regime beginning in 2018.
Gardere’s tax practice group has closely followed these rules since they were enacted in 2015, awaiting these proposed regulations to better advise our clients on this new audit regime. We look forward to consulting with you to address the impact of these important new rules.