New IRS Rules Regarding Partnership Audits (including LLCs), Part I
This blog will be part one of three regarding the new IRS BBA Rules regarding partnership audits that went into effect on January 1, 2018.
Background: For over 35 years the IRS has wrestled with effectively auditing partnerships and their partners (including LLCs and their members, once LLCs began being widely used in the 1990s). In 1982, Congress passed the Tax Equity and Fiscal Responsibility Act (“TEFRA”), from which the IRS created implementing regulations (the “TEFRA Rules”). The TEFRA Rules allow the IRS to perform a unified audit and adjust partnership items (income, gain, loss, deduction, or credit) at the partnership level. However, the TEFRA Rules permit individual partners to challenge IRS audit procedures at the partner level in separate proceedings, increasing the IRS’ burden.
After passage of the 2015 Bipartisan Budget Act (“BBA”), the IRS created implementing regulations (the “BBA Rules”) regarding partnership audits that went into effect January 1, 2018 and that now streamline the partnership audit process by allowing the IRS to make partnership level assessments and adjustments. The BBA Rules will potentially require a partnership’s current partners to be responsible for prior reviewed year partnership tax adjustments. In summary, the BBA Rules reduce the burden on the IRS by placing an increased burden on the current partners to both:
(1) satisfy tax deficiencies for prior tax years and then
(2) decide whether to
(a) take no action to recoup that expense from reviewed year partners for the audited year, or
(b) attempt to collect the deficiency from those reviewed year partners if the partnership has a mechanism in place to do so. Because LLCs are classified as partnerships by the IRS, I generally refer to partners and partnerships rather than members and LLCs.
What does this mean for partnerships/LLCs? They have several choices:
1. Opt-in early to BBA Rules (within 30 days after receiving an audit notice from the IRS) for taxable years beginning after 11/2/2015 and before 1/1/2018 and decide whether to push-out tax deficiency to reviewed year partners (can also make administrative adjustment request to IRS to opt-in after 1/1/2018); or
2. Do nothing, and the TEFRA Rules continue to apply for audited years beginning prior to 1/1/2018; then
3. Do nothing, and BBA Rules automatically apply for taxable years beginning 1/1/2018, and decide whether to push-out tax deficiency liability to reviewed year partners (within 45 days of IRS adjustment notice); or
4. Elect-out of the BBA Rules if the partnership is eligible to elect-out for tax years beginning 1/1/2018 (election will likely occur on Form 1065 starting in 2019 for tax years beginning 1/1/2018) (see attached flowchart for partnership eligibility criteria for election-out).
What types of partnerships/LLCs should be concerned with the effects of the BBA Rules?
1. Sole individual member – no
2. Sole entity member – maybe – depends on entity member type
3. Husband and wife/spouse partners – no
4. Multi-family individuals (including children/others) – no, if elect-out each year and has 100 or fewer eligible partners
5. Multi-non-family members (individuals) – no, if elect-out each year and has 100 or fewer eligible partners
6. Multi-non-family members (ineligible partner entities) – yes
7. Multi-non-family members (eligible partner entities) – no, unless has more than 100 members
The following blogs in this series will discuss changes that should be made at the partnership agreement (or LLC agreement) level so that each partnership/LLC has adequate provisions in place to address issues such as the partnership representative, indemnification, and keeping current and former partners informed of tax proceedings. For more information, see Proposed IRS Rules Published June 14, 2017, and Internal Revenue Bulletin 2017-28 (click here).
This information is provided for general educational purposes only. For more detailed analysis regarding specific partnership or LLC circumstances, contact one of our attorneys.