Auditing partnerships with the new centralized audit regime
By: Dylan Metz, CPA
The 2018 tax year ushered in the centralized audit regime, which enacted new IRS protocol for auditing partnerships. The regime was created from the 2015 Bipartisan Budget Act (BBA), which repealed the Tax Equity and Fiscal Responsibility Act (TEFRA) partnership audit procedures that had existed for over three decades. The BBA’s new centralized partnership audit rules are effective for tax years beginning after December 31, 2017.
The new audit regime dictates that tax adjustments will now be determined, assessed, and collected at the partnership level. Therefore, if the IRS determines an underpayment has occurred in prior years, the imputed underpayment is assessed against the partnership itself rather than the partners holding interests in the entity. Generally, the calculated imputed underpayment is the total net adjustment assessed against the partnership multiplied by the highest federal individual or corporate income tax rate for the year under audit. For partnerships with frequent changes in partners, these new audit rules create the potential for current partners to effectively bear the responsibility for additional tax rather than the partners that existed at the time of the year under audit.
In this circumstance, an alternative option called the “push-out” election exists. If a partnership is assessed a tax adjustment, it has 45 days from the date the final adjustment is mailed by the IRS to make this election and “push out” the adjustment to the partners that held interest in the entity during the tax year under audit. This election provides the partnership some form of flexibility if a tax adjustment is imposed.
The centralized audit regime has created the new role of Partnership Representative, which replaces the previous Tax Matters Partner designation required under TEFRA. The Partnership Representative will receive all correspondence on audit proceedings from the IRS and will have sole authority to act on behalf of the partnership and its partners. Accordingly, the actions of the Partnership Representative are completely binding on the partnership. The Partnership Representative is to be identified on the partnership’s federal tax return. It is an annual designation and is only effective for the tax year for which it is made. Although the role can be performed by an individual who is not a partner in the partnership, the representative must at least have a substantial presence in the United States to allow for communication with the IRS.
Partnerships have the option to elect out of the new centralized regime if it meets specific criteria. To be eligible for the opt-out election, the partnership must have 100 or fewer partners, all of which must be either individuals, S corporations, C corporations, foreign entities that would be treated as C corporations if they were domestic entities, or estates of deceased partners. If the partnership qualifies to elect out of the centralized regime, then the IRS will be required to conduct the audit on a partner-by-partner basis, rather than at the partnership level.
Implemented for tax years beginning after December 31, 2017, effectively all partnerships are now regulated by the centralized audit regime. Partnerships must understand the changes in audit procedure and the importance of the new Partnership Representative role. It may be necessary to adopt new organizational policies or modify partnership agreements to explicitly outline the responsibilities of the Partnership Representative. Partnerships should also consider the specific criteria needed to elect out of the new regime, as it may impact decision-making when obtaining future investment. All partnerships should now prioritize developing a strategic plan for adapting to the new centralized audit regime. Questions about partnerships? Feel free to contact your Maloney + Novotny representative or use this online contact form.
Schreiber, Sally P. “IRS Finalizes Centralized Partnership Audit Rules.” The Tax Adviser, 1 May 2019, www.thetaxadviser.com/issues/2019/may/irs-finalizes-centralized-partnership-audit-rules.html.
Thomson Reuters. “Key Issue 6B: Centralized Partnership Audit Regime.” Thomson Reuters Checkpoint, 2018. Retrieved from Thomson Reuters Checkpoint database.
Trivedi, Shamik. “Issues and Considerations in Appointing a Partnership Representative.” The Tax Adviser, 1 Jan. 2019, www.thetaxadviser.com/issues/2019/jan/appointing-partnership-representative.html.