Time to Review your Partnership Agreement
Highlights of the New Partnership Audit Rules & Other IRS Actions
The Bipartisan Budget Act of 2015 (“the Act”) was signed into law on Nov. 2, 2015. The Act includes a complete overhaul of the procedures that apply to IRS audits of partnership returns of income, Form 1065. This applies to any entity required to file this form.
- The new rules are effective for tax returns filed for taxable years beginning on or after January 1, 2018. (Early election is available.)
- The new rules apply to all partnership returns. However, certain partnerships with 100 or fewer partners will be able to annually elect out of the application of the new rules for a tax year on a timely filed return. The opt-out is not available to a partnership that has a trust or another partnership as a partner.
- The Tax Matters Partner has been eliminated and replaced with the “partnership representative.” The representative does not need to be a partner and will have sole authority to act on behalf of the partnership in matters with the IRS. Based upon regulations, the representative is not required to notify the partners of an audit or request permission before agreeing to an audit adjustment. The partnership agreement should provide guidance on notification by and limitations on the representative.
- The tax year that is under audit is referred to as the “reviewed year.” The year in which the audit or judicial review is completed is referred to as the “adjustment year.”
- Any imputed underpayment is assessed and collected at the partnership level in the adjustment year. The adjustment generally is calculated using the highest rate of tax in effect for the reviewed year. The capital balances of the partners during the adjustment year will be affected by the change-not the partners during the reviewed year.
- Assessed taxes and interest will not be deductible.
- Based upon the representative’s decision, the partnership may elect to send adjusted information returns to all reviewed-year partners. This election must be made no later than 45 days after the date of the notice of final partnership adjustment. If the partnership makes this election, the imputed underpayment is paid by the reviewed-year partners.
In a regulation released in July, 2016, the IRS reinforced its position on partners as employees of the partnership.
- Unless the ownership is less than 2%, a partner cannot be an employee.
- Any payments received are guaranteed payments.
- The payments will be subject to self-employment tax.
- Fringe benefits are limited.
- Partner medical insurance premiums are treated as a draw-not a partnership expense.
- Partners cannot participate in benefit plans as an employee.
During 2017, partnership agreements should be reviewed and appropriate revisions made. Revisions to consider are:
- Replacing the Tax Matters Partner with a “partnership representative.”
- Restrictions and required actions in dealing with the IRS
- Reviewing the Opt-out option for the partnership
- Will the annual election be made, if available
- Review of current partners to determine eligibility for the opt out option
- Consideration of preventative measures regarding assignments of partner interests to persons that would preclude the inability to opt-out.
- Addressing payment of entity-level tax and allocation of the payment to past or current partners.
- Payment by the current partners,
- Generation of adjusted information returns for partners of the “reviewed” year,
- Collection of tax payments from prior partners,
- Consideration of change in ownership percentages,
- Indemnification of admitted partners, and or
- Bonding by former and/or retired partners.
- Confirming partners are not treated as employees.
- Review of payroll
- Review fringe benefits
- Classification of payments to partners as draws or guaranteed payments
The year 2017 is the year of review to consider, clarify and correct agreements and practices.