By Michael D. Koppel, CPA, PFS, CITP, MBA
Retired Partner at Gray, Gray & Gray, LLP
For many years, a partnership or a Limited Liability Company (LLC) that filed as a partnership had limited the consequences of an IRS audit. However, because of the growing number of LLCs, the IRS is becoming more aggressive in targeting partnership returns, and significant changes are scheduled to come about in just a few weeks.
As part of the 2015 Bipartisan Budget Agreement (BBA), Congress has created a “Centralized Partnership Audit” program that paves the way for simpler collection of taxes from certain partnerships for tax years beginning after 2017.
The good news is that many partnerships have the choice to elect out of this new program, thus, in practical terms, continuing their limited protection from an audit. But to have the option to elect out, your partnership must meet certain requirements by January 1, 2018, and you will subsequently need to make an annual election on your tax return.
Two conditions must be met for a partnership to be eligible to opt out:
- The partnership can issue no more than 100 Schedule K-1s for the year
- Every K-1 is issued to an “eligible partner,” which includes individuals, C Corporations, S Corporations, and the estates of deceased partners
A partnership cannot elect out if any partner is a:
- Trust (including grantor trusts)
- IRA or nominee
- Limited Liability Company (including disregarded single member LLCs)
- Bankruptcy estate
Partnerships that fall outside guidelines must participate in the Centralized Partner Audit program. It is imperative that you review your partner list and determine whether or not any of your partners fall outside these guidelines, as a single ineligible partner in place on January 1, 2018 will disqualify the partnership from opting out. In some cases, the partnership or LLC partnership agreement may need to be amended to comply with the new rules.
What if your partnership is audited?
If your partnership elects out, any audit that you may be subject to will follow the old rules. This includes each partner having responsibility for the audit, and each will be assessed separately for any tax on income adjustments.
For those partnerships that participate in the Centralized Partner Audit program, an audit will be potentially more costly. Important elements include:
- Any tax, interest or penalties will be collected from the partnership, not individual partners
- As a result, current partners – not partners from the audit year – will bear the cost for payment of additional taxes
- The tax will generally be assessed at the highest tax rate
- A Partnership Representative, designated on the partnership’s tax return, will have sole authority to act on behalf of the partnership and all partners, with more authority to act than those with the previous TMP (Tax Matters Partner) designation
It would appear that electing out of participation in the new program is the safest route for most partnerships. However, the eligibility requirements and conditions for electing out are complex and include deadlines that are coming up quickly.
Things may still change, and Gray, Gray & Gray will continue to keep track of any potential changes as well as their possible impact on our clients. For more information on the new partnership audit rules, or for assistance in determining your entity’s eligibility, please contact Gray, Gray & Gray’s Tax Department at (781) 407-0300.