Life Happens: Advice for Those Entities Filing Forms 1065
Life happens: law changes and we get to meet with our advisors again.
In 2015, legislation was passed to change rules regarding audits of partnership returns. Proposed regulations providing guidance in implementation were issued in late 2016. The changes are effective for all entities filing Form 1065 for years beginning after December 2017.
The current administration has delayed the formal implementation of the regulations but the law change will occur in less than seven months. Every operating agreement and/or partnership documents have to be reviewed to implement the changes.
Out with the old
Tax matters partners are obsolete. The partnership agreement has to designate a partnership representative which will be reflected on the partnership return. The representative does not have to be a partner. This representative is the sole contact with the IRS in conducting the audit. They can extend the statute of limitations and agree to any audit changes. The law does not require the representative coordinate, notify, or poll the partners before reaching an agreement
Why is this important?
If the audit results in additional income or a reduction in credits, the partnership pays the tax on behalf of the partners at the highest ordinary tax rate. The tax, interest and penalties will be reported in the current year return as nondeductible expenses. If the partners in the year under review are different than the partners in the year of the audit, an inequity results. The capital of the current partners is impacted regardless of their ownership position in the audit year.
If the partnership qualifies, it can “elect out” of these new provisions. (The IRS would then have to assess each partner for their portion of the change.) The election has to be included in a timely filed return. To qualify, the partnership cannot have more than 100 partners. None of the partners can be another partnership or foreign entity. If one of the partners is an S corporation, the underlying shareholders will be included in the count.
If the partnership does not qualify for the election out, there is another option. Upon receipt of the assessment from the audit, the representative can “push out” the assessment to the partners of the year under review. The partners would report the additional tax on their next timely filed return. The partnership is still liable for any uncollected assessments.
Summary of items to address:
- Designation of partnership representative and removal or replacement process
- Limitations or additional responsibilities of the representative (for example, notification requirements, polling requirements and liability issues)
- Decisions regarding elections
- Allocation of taxes if partners are added or retire
- Actions if partners do not pay their portion of the assessments
- Partnership count including detail of underlying owners of S Corporations
Your accountant and attorney are available to assist you in this matter. Summer is a good time to change-why mess up the year-end holiday season.