With news about the sweeping tax reform known as the Tax Cuts and Jobs Act grabbing most of the tax-related media attention, it’s easy to forget that big changes to the partnership audit process have also gone into effect for 2018. These changes have major implications for partnerships at both the entity level and partner level, and taxpayers involved in a partnership should make sure they are aware of the rules before an audit happens, not after.
Old rules v new rules
Under the old audit rules, a partnership that underwent the audit process would push out any audit adjustments to their respective partners. Any additional tax due was paid by the partners, at each partner’s marginal income tax bracket. Under the new rules, changes as a result of an audit are no longer passed along to the partners, but rather are paid directly by the partnership itself. The tax rate is no longer based on the circumstance of individual partners either; the net audit adjustment is assessed at the highest current Federal income tax rate for individuals or corporations. So, under current law, partnership adjustments would be taxed at 37%.
For certain partnerships, it is possible to elect out of the new treatment and instead pass out any audit adjustments as they would have been under the old rules. There are several requirements that must be met in order to opt-out, however:
- The partnership must have fewer than 100 partners
- Partners must be individuals, C Corporations, S Corporations or an estate of a deceased partner
- Partners can NOT be other partnerships, trusts, single-member LLCs or any estate other than that of a deceased partner
For partnerships that meet these requirements and wish to opt-out, there is an annual election that must be made each year on the timely-filed partnership tax return.
There are many other considerations for partnerships as a result of these changes to the audit process. Partners should review their operating agreements to determine if any amendments need to be made; consider re-structuring their partnership if they wish to opt out of the new rules but are currently not eligible; also, be sure to designate an appropriate “Partnership Representative” for audit purposes. Under the new rules, there is no longer a “Tax Matters Partner.” having been replaced by the Partnership Representative. Partnerships should take significant care in selecting this representative. Unlike the Tax Matters Partner of old, the Partnership Representative does not have to be a partner, but does have full authority to act on behalf of the partnership and its partners.
As always, be sure to contact your Henry+Horne professional advisor if you believe these issues might apply to you. Planning ahead for these changes and getting in front of any potential snags is a far better option than trying to figure it all out in the midst of an audit.
Austin M. Bradley, CPA