What if you bought into a partnership today and discovered you would be responsible for a portion of an IRS tax adjustment attributable to a year prior to your investment? Seems a bit unfair? New partners need to be aware of how this new tax law change will affect their investment and what sort of liability exposure may be brought upon them.
In a nut shell, and in very general terms, starting for tax years ending after 2017, absent exceptions or a partnership actively opting out, the IRS will be assessing tax adjustments at the partnership level. As often happens in times of change, some will benefit whilst others will bear a disproportional burden.
For those partnerships which do not utilize the option to elect out or are not eligible to opt out, the tax adjustment will be taxed at the highest applicable individual or corporate tax rate; big departure from the prior system in which the tax adjustment was passed through to the ultimate partner’s return and tax assessed at that partner’s applicable graduated rate of tax.
The tax, interest and penalties will be paid by the partnership, unless the partnership elected to pass through the adjustment (see conditions below), with the result that the partners who previously benefited from that income allocation, and who are no longer partners in the partnership, will have the benefit of escaping the assessment.
If certain requirements are met, the partnership may either opt out of the new rules altogether or allocate the income attributable to a partnership adjustment to persons who were partners for the year to which the adjustment relates. A partnership may elect, within 45 days after receiving the IRS’ final partnership tax adjustment, to furnish each partner a K-1 containing the partner’s share of the adjustment. The partner will then compute any added tax for the year of the change, but the assessment is reported and paid on the return for the year in which the event occurred.
Topics for consideration
Add a partner indemnification clause that would require the individuals who were partners for the year in which the audit adjustment applies, to reimburse the partnership for imputed underpayments.
Consider amending the operating agreement to require an election out of the new rules if the partnership qualifies for such option. Secondarily, the partnership may consider the option to prohibit the sale of a partnership interest to a partner whose interest is titled in a manner that would prohibit an election out.
The information above on partnerships is general in nature and should not be relied upon. Now is a good time to reach out to your professional tax advisors as decisions should be addressed now, not at the final hour.
Debra Callicutt, CPA, MBA