Scarinci Hollenbeck, LLC
The Firm
201-896-4100 info@sh-law.comFirm Insights
Author: Scarinci Hollenbeck, LLC
Date: October 19, 2016
The Firm
201-896-4100 info@sh-law.comThe Bipartisan Budget Act changed the procedures for auditing tax returns filed by partnerships. The TEFRA partnership audit procedures which were adopted in 1982 and the electing large partnership rules are repealed effective for returns filed for partnership tax years beginning after 2017.These rules will be replaced with a new set of rules for auditing partnerships and their partners at the partnership level.
Under the new approach, adjustments to a partnership’s items of income, gain, loss, deductions, and credits will be made at the partnership level. This means that the partnership for the first time in 75 years will be subject to a partnership level income tax. The tax rate will be the highest individual or corporate rate. Any additional tax, penalty, or additional amount related to the tax will also be determined at the partnership level [IRC Sec. 6221(a), effective after 2017]. If an adjustment to the partnership items is made, the partnership will be required to pay tax equal to the imputed underpayment, which is generally the net of all adjustments for the year under audit multiplied by the highest individual or corporate tax rate.
However, partnerships that can show that the underpayment would be lower if it were based on certain partner-level information can pay the lower amount. The information needed to show that a lower underpayment amount should apply could include amended returns of partners, the tax rates applicable to specific types of partners (e.g., individuals, corporations, or tax-exempt organizations), and the type of income subject to the adjustments ( IRC Sec. 6225, effective after 2017).
Instead of taking the adjustment into account at the partnership level, a partnership can elect, not later than 45 days after receiving a notice of final partnership adjustment, to issue adjusted Schedules K-1 to the partners who were in the partnership in the year under audit. Those partners would then take the adjustments into account in the adjustment year by filing amended returns through a simplified amended return process (IRC Sec. 6226 , effective after 2017). This is called a “push out elections” which countermand the default rule above and makes the partners individually subject to the tax liability. Under this rule the interest rate on any deficiency paid by a partner is 2% higher than it would otherwise be.
Under the revised audit rules, partners generally must treat each item of income, gain, loss deduction, or credit attributable to a partnership consistently with the partnership’s treatment of the item. Any underpayment of tax by a partner due to failure to comply with this consistency requirement will be treated as a mathematical or clerical error (subject to the summary assessment procedures of IRC Sec. 6213(b)(1), and that the abatement requirement under IRC Sec. 6213(b)(2) will not apply. The consistency rule will not apply if (a) the partnership has filed a return but the partner’s treatment of the item is (or may be) inconsistent with the treatment on the partnership’s return or (b) the partnership has not filed a return, provided the partner files a statement with the IRS identifying the inconsistency [IRC Sec. 6222, effective after 2017].
Partnerships with 100 or fewer partners can “opt out” of the new rules for any tax year, in which case the partnership and its partners will be audited under the general rules for individual taxpayers. Generally, to elect out, each of the partners has to be an individual, a C or S corporation, a foreign entity that would be treated as a C corporation were it domestic, the estate of a deceased member, or another person identified in future IRS guidance [IRC Sec. 6221(b), effective after 2017]. Notwithstanding if a partnership has a partnership or trust as a partner, they cannot elect out and they are subject to the new audit default rules.
Instead of waiting for the new rules to come into effect, partnerships generally can elect to apply them to returns filed after November 3, 2015.
The position of “Tax Matter Partner” has been replaced with “Partnership Representative. The “PR” need not be a partner. This person will have exclusive power to deal with the IRS. This means that the Partnership Representative will decide on resolving the tax issue and can allocate the additional tax in a manner that he, she or it deems reasonable.
Under the new rules, partners who are in the partnership in the year an adjustment is finalized bear the economic burden of any imputed underpayment paid at the partnership level, regardless of whether they were partners in the year the adjustment arose. This means that if a partnership’s tax year of 2018 is audited in 2020 and an adjustment is made in 2022, the partners who exist in 2022 will bear the economic burden of the adjustment for 2018 even though they might not have been partners in the audit year.
Adding an indemnification agreement to partnership agreements, under which partners who sell or liquidate their interest before an audit agree to be responsible for any adjustment attributable to years they were a partner, could address this problem.
The repeal of the TEFRA audit rules will have significant impact on every Partnership and LLC Operating Agreement and business deal.
Significant Impact on Preparation of Partnership Agreements
Significant Impact on Partnership Transactions
All existing and newly-formed partnerships should be considering provisions to be included in amended or new partnership agreements.
Because the audit rules have changed, the economic exposure of partners and members in LLCs have changed as well. Partners and LLC members will have to rethink their agreements, and come up with indemnifications, deal with indemnification by former partners, consider escrows in the event of purchase of partnership interests, and so on and so forth.
Do you have any questions? Would you like to discuss the matter further? If so, please contact me, Frank Brunetti, at 201-806-3364.
No Aspect of the advertisement has been approved by the Supreme Court. Results may vary depending on your particular facts and legal circumstances.
While filing annual reports may seem like a nuisance, failing to do so can have significant ramifications. These include fines, reputational harm, and interruption of your business operations. In basic terms, “admin dissolution for annual report” means that a company is dissolved by the government. This happens because it failed to submit its annual report […]
Author: Dan Brecher
Antitrust laws are designed to ensure that businesses compete fairly. There are three federal antitrust laws that businesses must navigate. These include the Sherman Act, the Federal Trade Commission Act, and the Clayton Act. States also have their own antitrust regimes. These may vary from federal regulations. Understanding antitrust litigation helps businesses navigate these complex […]
Author: Robert E. Levy
If you’re considering closing your business, it’s crucial to understand that simply shutting your doors does not end your legal obligations. Unless you formally dissolve your business, it continues to exist in the eyes of the law—leaving you exposed to ongoing liabilities such as taxes, compliance violations, and potential lawsuits. Dissolving a business can seem […]
Author: Christopher D. Warren
Contrary to what many people think, corporate restructuring isn’t all doom and gloom. Revamping a company’s organizational structure, corporate hierarchy, or operations procedures can help keep your business competitive. This is particularly true during challenging times. Corporate restructuring plays a critical role in modern business strategy. It helps companies adapt quickly to market changes. Following […]
Author: Dan Brecher
Cryptocurrency intimidates most people. The reason is straightforward. People fear what they do not understand. When confusion sets in, the common reaction is either to ignore the subject entirely or to mistrust it. For years, that is exactly how most of the public and even many in law enforcement treated cryptocurrency. However, such apprehension changed […]
Author: Bryce S. Robins
Using chattel paper to obtain a security interest in personal property is a powerful tool. It can ensure lenders have a legal claim on collateral ranging from inventory to intellectual property. To reduce risk and protect your legal rights, businesses and lenders should understand the legal framework. This framework governs the creation, sale, and enforcement […]
Author: Dan Brecher
No Aspect of the advertisement has been approved by the Supreme Court. Results may vary depending on your particular facts and legal circumstances.
Consider subscribing to our Firm Insights mailing list by clicking the button below so you can keep up to date with the firm`s latest articles covering various legal topics.
Stay informed and inspired with the latest updates, insights, and events from Scarinci Hollenbeck. Our resource library provides valuable content across a range of categories to keep you connected and ahead of the curve.
Let`s get in touch!
Sign up to get the latest from the Scarinci Hollenbeck, LLC attorneys!