By Michael D. Koppel, CPA, PFS, CITP, MBA
Retired Partner at Gray, Gray & Gray, LLP
While attention is focused on the major new tax law that has recently emerged from Congress, the Internal Revenue Service (IRS) is ready to implement changes in the way partnerships are audited. The “Centralized Partnership Audit” program was authorized by Congress in 2015, and will go into effect just a few weeks from now, on January 1, 2018. If you think the Centralized Partnership Audit won’t affect you because you don’t own a business, or because your business is not a partnership, think again.
The proposed regulation issued last summer indicates that if a partnership interest (including LLCs taxed as a partnership) is held by any type of trust the partnership will not be able to “opt-out” of the new rules. As a result, if you have assets in revocable trust that holds an interest in a partnership, you may be subject to the consequences of an audit.
In simple terms, the new audit rules mean that the IRS will not be sending out bills to the partners from the year under audit. Instead, the results of an audit by the IRS would be applied against the current assets of the partnership. Further, the amount charged to the partnership will be at the highest individual or corporate rate. The partnership can mitigate some of these effects, but the onus will be on the current members of the partnership and the “partnership representative” who will have wide ranging authority to make decisions on behalf of the partnership.
There are actions that most partnerships should consider making before year end. Certain partnerships can choose to “opt out” of the Centralized Partnership Audit program if they meet specific requirements before January 1, 2018. This election should be stated in the partnership agreement. 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 may include individuals, C Corporations, S Corporations, and the estates of deceased partners
However, a partnership cannot opt out if any partner is a:
- Another partnership
- 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. 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.
Former Gray, Gray & Gray tax partner Mike Koppel will lead a webinar at 4:00 pm on December 20, to clear everything up and provide you with all the information you need to make decisions. You can register for the webinar here.
In addition, 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 potential exposure, please contact Gray, Gray & Gray’s Tax Department at (781) 407-0300.