New IRS Partnership/LLC Audit Rules

Beginning with the 2018 returns, there are major changes to the audit rules that impact partnerships and LLCs taxed as partnerships. The new rules make the partnership, not the partners/members, liable for any payments due as a result of an audit. In addition, audit adjustments will be reflected on the partnership return for the year that the adjustment is finalized, rather than the year under review. The tax will be calculated at the highest individual rate in effect for the audit year, unless you elect out.

Partnership Representative

In lieu of a Tax Matters Person, partnerships/LLCs must now select a Partnership Representative. This representative will possess the sole authority to act on behalf of the partnership in all matters related to the partnership audit, including protests to the Appeals office and litigation in court of disputed tax adjustments. The representative must be designated annually on the partnership return and is effective on the date that the return is filed.

The partnership agreement must establish procedures for selecting, removing, and replacing the partnership representative.

Small Partnership Exception

There is an opt-out election available to small partnerships, defined as those with 100 or fewer qualifying partners/members. If a small partnership opts out, the audit will be conducted at the partner/member individual level. The election must be made on a timely filed return (including extensions) for the tax year to which the election applies. The election must be made annually.

Qualifying partners/members include:

·     an individual;

·     a C corporation, or foreign entity that would be treated as a C corporation if it were a domestic entity;

·     an S corporation; or

·     the estate of a deceased partner.

A partnership that has other partnerships or trusts as partners will not be able to opt out of the new partnership-level audit rules.

Eligible partnerships must amend their partnership agreements to address the opt out election. It should include language to prohibit the transfer of partnership interests to ineligible partners or limit the number of partners to 100 or fewer to preserve the opt out election.