Mary McNulty Quoted on New Partnership Audit Rules

Posted by Mary McNulty   Mary A. McNulty was recently quoted in a Tax Notes Today article (subscription required) on some of the open issues and uncertainties under the new partnership audit rules enacted last November in the Bipartisan Budget Act of 2015 (the “BBA”).  Mary also recently spoke on a panel on the new rules at the ABA Tax Section Midyear meeting.  To view the presentation click here. The BBA repealed and replaced the 1982 Tax Equity and Fiscal Responsibility Act (“TEFRA”) and electing large partnership (“ELP”) rules with a new regime for partnership audits and adjustments focused on partnership-level assessments and collections. Audit Determinations and Litigation The new rules require partnership-level resolution of all items of partnership income, deduction, gain, loss or credit.  The statute of limitations for adjustments is determined exclusively at the partnership-level (i.e., the partner’s statute of limitations will not be taken into account). The “partnership representative” represents the partnership in the audit and has the sole authority to act on behalf of the partnership.  The partnership representative binds both the partnership and the partners, and the partners do not have the right to participate in the proceeding or receive notice of the proceedings from the IRS.  Unlike the “tax matters partner” under TEFRA, the partnership representative is not required to be a partner of the partnership, but only a “person” with a  substantial U.S. presence. Partnership-Level Assessment and CollectionUnder the new partnership audit rules, the default rule is that the tax deficiency arising from a partnership-level adjustment is assessed against and collected from the partnership in the year that the audit or judicial review is completed.  The tax is assessed at the highest rate applicable to individuals.  This default rule is subject to two exceptions:Reduction in Partnership Liability.  The partnership tax may be reduced if the partnership can demonstrate the rate should be lower (e.g., the partnership items are allocable to a tax-exempt partner).  The partnership tax may also be reduced to the extent partners for the year under audit file amended returns and pay the tax. Election to Issue Amended Statements.  If the partnership does not want to pay the entity-level tax, the partnership can elect to issue adjusted partner statements (the equivalent to amended K-1s) to the partners for the year under audit.  The partners take the tax into account on their individual returns in the year in which they receive the adjusted partner statements. Small Partnership Election Out Partnerships with 100 partners or less can elect out of the new partnership audit rules, in which case the adjustments to partnership items are made at the partner level.  This election is available to partnerships  with 100 or fewer partners, each of which is an individual, a C corporation (including any foreign entity that would be treated as a C corporation if domestic), an S Corporations or an estate of a deceased partner.  Therefore, a partnership with another partnership as a partner is not eligible for the election out. Effective DateThe new rules are effective for partnership tax years beginning after 2017, although partnerships may elect to have the entity-level assessment apply earlier (for tax years beginning after November 2, 2015). The new rules are expected to increase partnership audit rates and the related tax assessments but create many unanswered questions.  If you have any questions about the new partnership audit rules or their impact, please contact Mary McNulty or any of the other Tax lawyers at Thompson & Knight.