All partnerships should amend their partnership agreement for new IRS audit rules

On June 13, 2017, the IRS re-issued controversial regulations that implement a new centralized audit regime for partnerships. The new audit regime, which takes effect January 1, 2018, is designed to raise tax revenue and make it easier for the IRS to audit large partnerships. To that end, the new regulations allow the IRS to collect tax directly at the entity level from the partnership. Our alert, “How to plan for new partnership audit rules” explains why every partnership agreement must be reviewed and revised to account for the law changes.

Earlier in the year, the Trump administration issued a regulatory “freeze” on all federal rulemaking that resulted in the withdrawal of the partnership audit regulations. But as we reported at the time, the freeze on these regulations was expected to be short-lived due to federal legislation requiring the new audit regime to take effect Jan. 1, 2018.

The re-issued regulations are nearly identical to the regulations as they were first issued. But the fast-tracked notice and comment process may explore some issues and potentially result in changes through the final regulations. All comments to the IRS are due on Aug. 14, 2017 and a hearing is scheduled for Sept. 18, 2017.

Partnership audit hot topics

Among the hot topics raised in the rulemaking process are whether tiered partnerships may elect to have their partners – rather than the entity – pay any unpaid tax discovered upon audit. Partnerships may opt-out of the new audit regime only if they meet eligibility requirements, which exclude tiered partnerships and partnerships with more than 100 partners from opting out. Those partnerships that may not or choose not to opt-out nonetheless may make a “push-out” election. The “push-out” election allows the partners in the tax year under review to pay tax rather than the entity itself. Currently, the IRS is seeking comments on whether tiered partnerships may make this push-out election and push-out the tax payment obligation to partners beyond the first tier.

Regardless of how the rulemaking plays out, partnerships must plan for the new partnership representative that will replace the familiar tax matters partner concept. Because audits are now centralized at the entity level, the partnership representative has the power to bind the partnership and the partners in audits and other proceedings.

The partnership representative is thus charged with making important decisions such as whether to extend the statute of limitations, whether to enter into settlement agreements, whether and how to contest IRS determinations, and whether to make elections including the “push-out” election discussed above. And if the partnership does not designate a partnership, the IRS will do it for them.

Why to amend your partnership agreement

To keep pace with these changes and maintain control over decisions made during the audit process, all partnership agreements should be amended. Through the partnership agreement, the partnership may designate the partnership representative, place limits on the partnership representative’s authority, and plan for important taxpayer elections, among other things. Partnerships should also consider fiduciary responsibility for the powerful partnership representative. Keep in mind that conflicts of interest among partners and the partnership representative could lead to litigation.

As the Jan. 1, 2018 effective date approaches, McDonald Hopkins has prepared a specialized process for reviewing and revising partnership and operating agreements. Please contact a member of our tax team with any questions that you may have about the new audit rules.