New rules for partnership audits are effective January 1, 2018
October 26, 2017 - Posted by: admin - In category:
The way in which the IRS audits partnerships will change at the end of 2017. Per the Bipartisan Budget Act of 2015 (great name, right?), on January 1, 2018 the landscape relating to partnership audits by the Internal Revenue Service will have shifted dramatically. Why should you care? Great question. If you are directly or indirectly part of an entity that is taxed as a partnership, you will want to discuss with your accountant as part of year-end tax review and planning.
John M. Cunningham, a New Hampshire corporate attorney, has written a short article on these new rules. This article is a good primer for attorneys, accountants, and business owners. Click here to access a copy of the report.
In addition, Lexology.com has a similar article by Holland & Hart on the same subject. If you are affiliated with a business entity that is taxed as a partnership (partnership, limited partnership, multi-member LLC or otherwise), you should review these things, learn all that you can and then schedule a meeting with your business accountant. I am not an accountant (obviously), but I have worked with a great many accountants and other professional advisors over the years. In my experience, the rules relating to partnership tax accounting are among the most complex in the already-complex world of corporate tax and accounting. Therefore, these new tax audit rules are most definitely not within the realm of “do-it-yourself” either in the general comprehension or the planning and implementation. Further, as with so many other things relating to tax, accounting, and law, these are not going to be one-size-fits-all determinations. What makes sense for one partnership, both before and after the application of the new tax audit rules, is not necessarily going to be the correct approach for another partnership.
To illustrate the point about the case-by-case application of these new rules and recommended steps to take in advance to plan for the same, let’s focus on one particular recommendation made by Mr. Cunningham in his article. Item number four of his article suggests that in order to ensure classification as a “small partnership”, partnerships which now are owned by one or more revocable trusts should request the trustees to distribute the applicable partnership interests pro rata to the beneficiaries of such trusts. Is that the right thing to do? It depends.
For hypothetical partnership A–after review and careful discussion with the relevant individuals and the accountant, they may determine that such a course of action is wise and prudent. However, for hypothetical partnership B, an entity which holds many highly appreciated assets, making such a distribution to beneficiaries at this point would guarantee the loss of step-up in basis for such assets. That would not be wise. For that circumstance, the parties weigh the risk of a possible audit and the possibility of the IRS finding under-payment of taxes (both unlikely events) vs. the certainty of loss of step-up in tax basis if such pro rata distributions are made. In that scenario, it is logical to conclude that preserving step-up (a veritable certainty) is more important than protecting against a remote audit risk.
So again, please be aware of these new partnership audit rules taking effect January 1, 2018 and schedule a discussion with your tax advisor right away (prior to December 31) to review if and how they might be applicable to your partnership interests, as well as any recommended steps that should be taken before the end of the calendar year 2017.