New Partnership Audit Regime: Opt-Out, Push-Out, or Pay-Up?

In 2015, Congress passed a new law that changes how partnerships are audited by the IRS. It makes the partnership responsible for any extra taxes owed after an audit, instead of the individual partners. The Treasury and IRS had to create regulations for this new law, but there were a lot of problems with the rules. Even though there was a proposed fix in 2016, it didn’t pass. Finally, in 2017, the new rules were released, but there were only a few changes. This article only discusses the “opt-out” and “push-out” elections available under new partnership tax regulations. If a partnership chooses to opt-out, individual partners would be responsible for tax deficiencies instead of the partnership as a whole. This could be a good or bad thing depending on each partner’s share of the profits and losses. If a partnership can opt-out, audits and assessments would be done at the partner level rather than the partnership level. Choosing to opt-out of the partnership audit regime may seem fair and make sense because of its complexity. However, there are many factors to consider. Some partners may not want the IRS to review their personal tax matters, and some situations may be handled better under the regime. If the partnership opts out, the IRS can still audit them, but each partner would have to deal with their own tax matters separately. This could lead to multiple cases on the same issue and possibly inconsistent treatment. If a partnership decides to opt-out of certain tax rules, it can affect the tax and penalty responsibilities of the partners. This can also affect creditors and others who have a stake in the partnership. For example, if someone wants to buy a partnership interest, they may want to make sure the person selling will still be responsible for any taxes from previous years. The partnership can also choose to opt-out on a year-by-year basis, which gives them flexibility to make the best choice for their situation. The IRS is making it harder for partnerships to opt out of increased audits. To be eligible to opt out, a partnership can’t have more than 100 partners and each partner must fit specific criteria. The IRS is wary of partnerships trying to avoid audits by restructuring or using other entities to meet the opt-out conditions. They are also allowing some S corporations to be used to get around the eligibility rules. If a partnership wants to avoid paying taxes for audit assessments, it can make a “push out election” (POE) by shifting the responsibility to pay the taxes to the partners from the year of the audit. The partners then have to include their share of the taxes in their tax returns for the year of the adjustment. The partnership is no longer responsible for the taxes, unless the POE is found to be invalid. This option is useful for partnerships that can’t opt out of the default rule or want to reduce the risk of current partners being responsible for taxes that should have been paid by previous partners. Basically, when a partnership gets audited by the IRS and owes more taxes, the partners from that year have to pay the extra amount. The partnership has to let the partners know about the adjustments they made, and the partners have to pay interest on the extra tax until it’s paid off. The partnership can also choose to make specific partners pay part of the extra tax. But figuring out how this affects everyone’s financial accounts can be complicated, and the government is asking for input on how to handle it. If the partnership doesn’t opt-out of paying imputed underpayment, current partners will have to pay the taxes, penalties, and interest that should have been paid by partners during the reviewed year. The partnership agreement should address this, and partners should consider setting aside money to cover these costs. The partnership is liable for the underpayment, and it’s calculated at the highest federal tax rate in the reviewed year. This payment is not deductible and will reduce the basis of partnership interests. It’s important for partners to carefully plan and negotiate these rules in the partnership agreement. If a partnership owes too little in taxes, they can ask their partners from previous years to file amended tax returns that will increase their share of the tax burden. This lets the partners pay a lower tax rate based on their individual tax situations. There are specific conditions that need to be met for this to work, such as filing the amended returns on time and paying any additional taxes owed. The partnership also needs to provide proof to the IRS that these conditions have been met. If the time to file an amended return has passed, the partners can also try to make a deal with the IRS called a closing agreement. When drafting partnership and multi-member operating agreements, it’s important to address changes in the tax regime. Consider whether to mandate specific tax elections or leave it up to management or the partnership representative. Partners’ individual tax liability may be different from the entity’s, so it’s best to be flexible. If the decision is deferred, owner approval should be required. If the agreement mandates annual opt-out elections, it should also include restrictions on permitted transferees for estate planning purposes. In a partnership agreement, the owners need to consider how they can make sure the manager or partnership representative follows the rules for tax elections and approaches. They may need to have a way to remove the representative and appoint someone else if they don’t follow the rules. The agreement should also say what happens if the owners don’t follow the representative’s decisions. It should also require all owners to do what they agreed to for taxes and other things. The agreement should also cover things like getting updates on IRS audits and being able to have a say in hiring tax professionals. There are lots of things to think about when making a partnership agreement, but there are lots of resources available to help. The partnership audit rules are changing and there may be a new law coming. There are lots of articles and publications about the new rules. When a partnership gets audited, the IRS will deal with the partnership’s representative instead of individual partners. This could affect how partnerships are managed. This column is written by the Tax Law Section of The Florida Bar. It is about the principles of duty and service to the public and improving the administration of justice. It is written by various editors and the chair of the section.

Source: https://www.floridabar.org/the-florida-bar-journal/new-partnership-audit-regime-opt-out-push-out-or-pay-up/