In November 2015 Congress enacted significant changes to partnership tax audit and adjustment rules. In June 2017 the IRS re-released proposed regulations to implement these new rules. This legislation and the proposed regulations may have significant impact on the federal income tax treatment of partners and partnerships, especially in these key areas:
- The requirement to elect a partnership representative
- The Internal Revenue Service (IRS) may now assess additional tax, interest and penalty on a partnership
- The possibility of significant changes related to reporting income taxes on partnership financial statements
What is a Personal Representative?
The new rules removed the designation of tax matters partner (TMP). Instead, a partnership will need to make an annual election on their U.S. partnership tax return to select a partnership representative (PR). A partnership will want to make sure to properly complete this PR section of the tax return or otherwise be subject to a PR appointment by the Internal Revenue Service. Once the IRS has selected the PR this election is irrevocable for the year.
The PR has the ability to contractually bind the partnership with regard to tax matters. The PR will be the individual or entity who is involved with the audit process, the person(s) who have the ability to extend the statute of limitations, and also to decide whether or not to agree with the findings of an audit.
Who can the partnership elect as the PR? The PR does not have to be a partner of the partnership. However, the PR must meet the following requirements: 1) the individual must be able to meet with the Internal Revenue Service in the United States; 2) the PR must have a physical address within the United States and a phone number with a United States area code where the PR can be reached; and, 3) the PR must have a valid U.S. taxpayer identification number.
How will the IRS approach your partnership audit?
The new partnership audit rules change how IRS audit findings will be administered and enforced. The new rules shift the responsibility for the collection and administering of the audit findings from the Internal Revenue Service to the partnership. In addition, the partnership, rather than the partner, may be responsible for the payment of additional taxes, interest and penalties related to the audit. Generally, under the new rules the IRS will assess the partnership for the tax due on proposed partnership audit adjustments using the highest individual tax rate of 39.6%. In addition, there will be provisions which will allow the partnership to reduce the tax burden for tax-exempt partners, individual partners with long-term capital gains or qualified dividends, and partners who file amended tax returns as a result of the assessment.
Push-Out Election available
One important provision that many partners should be aware of is the push-out election. If a partnership elects to amend the partner K-1’s within a 45-day time frame the tax will be assessed at the individual partner level and not the partnership.
How the new partnership audit rules may impact your Financial Reporting Requirements
These new partnership audit rules could have a significant impact on the financial statements of the partnership. In the past, financial statements of a partnership would generally include a standard disclosure indicating that the taxes are determined at the individual partner level. However, the new regulations will require partnerships to review their transactions and analyze their tax positions to see if they meet the more-likely-than-not standard and possibly record a deferred liability for possible partnership level tax in the event of an IRS audit. For example, how will the underpayment tax be treated – as a distribution to the partners or as an additional expense of the partnership? In addition, the financial statements may need to disclose in the footnotes whether the partnership has elected out of the new rules or if a 45-day election to push-out the income and deductions were the result of the audit.
Are these new rules necessary?
Some partners may be question whether these changes to partnership tax audits were really necessary. The IRS has been facing significant issues with regards to the assessment and collection of tax, interest and penalties discovered during its audit findings under the current system. This problem has continued to grow as more entities have elected to be taxed as a partnership in recent years. The Government Accountability Office (GAO) recently concluded that from 2002 to 2011 the number of large partnerships increased by over 250%, but the rate of large partnership audits did not. In 2012 the audit rate for large partnerships was only 0.8% compared to over 27% for corporations. The new partnership audit provisions are intended to change how the IRS will administer and assess audit findings in order perform audits in a more efficient and cost effective manner for the government.
The new partnership audit rules are scheduled to go into effect in 2018 and public hearings on the proposed regulations are set for September 18, 2017. Partners and partnerships have some important planning decisions to make prior to December 31, 2017. These questions should include whether to amend the partnership agreement as well as who to elect as the partnership representative along with several other important questions. These decisions could have a significant impact on the overall bottom line of the partnership. We at Herbein + Company, Inc. have a good understanding of the upcoming changes to the partnership audit rules and are prepared to assist our clients with the important questions that should be addressed prior to year-end.
For additional information, please contact Christopher F. Dingman, CPA at firstname.lastname@example.org.