The partnership audit rules went through a radical transformation with the passage of the Bipartisan Budget Act of 2015 (the BBA). The BBA ushered in a set of “new rules” that create a centralized partnership audit regime effective for audits of partnership tax years beginning on or after January 1, 2018. Okay, but why should I care about the new rules?
1. First, because the new rules require the vast majority of LLCs, LPs, and GPs to amend their operating or partnership agreements and the new rules add to and change the legal and tax considerations relating to how membership and partnership interests in LLCs, LPs, and GPs are purchased, sold, gifted, and otherwise assigned.
2. Additionally, although the “new” rules don’t sound very new, they are. They are new because even though the BBA was enacted in 2015 the new rules are effective for audits of partnership tax years beginning January 1, 2018. So, in a real sense, the new rules are “new.” They are also new for the reason that the new rules represent a complete departure from the prior rules – sometimes referred to as the TEFRA rules (another time). Perhaps most importantly, they are new because despite the broad impact these new rules represent – not just for partners and members in these entities but also for lenders, insurers, and other third parties – most people still are not aware of these new rules.
3. Further, you may not think of your limited liability company (LLC) as a “partnership” but if the LLC files its annual federal tax return using IRS Form 1065, then the LLC is a partnership. Through the lens of federal tax law, an LLC, limited partnership (LP), or general partnership (GP) that files IRS Form 1065 is a partnership and is subject to the new rules. Bear in mind, that LP and LLC includes “family” LPs and LLCs.
4. Finally, in case you are asking “why was this change made, everything seemed to be fine?”: Maybe fine for you, but not for the government. Under the old TEFRA rules, the IRS allocated partnership audit adjustments among the partners for the year subject to audit and then assess and collect underpayments at the partner level. But the TEFRA rules proved to be tiresome and resource consuming for the IRS. In contrast, under the new rules the IRS imposes any underpayment on the partnership itself, leaving the partners to duke it out amongst each other as to who is going to “chip in” how much. Although the foregoing explanation amounts to a gross simplification, you can see where this is headed. That’s right, it is widely anticipated that partnership audits under the new rules will dramatically increase.
Some changes in tax law receive a lot of attention and others don’t seem to get much attention outside of the small orbit of tax attorneys, CPAs, and financial planners. Unfortunately, this change just does not seem to have captured much interest outside of the tax geek universe. If it has been awhile since your operating or partnership agreement has been reviewed, then this is an ideal time to resurrect it from the bottom of your desk drawer and review it. If you are thinking about purchasing or selling your membership or partnership interest you may want to visit with your advisors before signing the documents. Ditto if you have a family LLC or LP and the current economic conditions have made you wonder if the time is right for making a gift of a membership or partnership interest.
Some partnerships will have a way to “opt out” of the new rules or otherwise respond to the new rules in a way that is more beneficial than to simply allow things to play out. Now is a good time to make your plan.