President Obama signed the Bipartisan Budget Act of 2015 (the "Act") this past November 2. The Act significantly alters the procedures for partnership tax audits by replacing the existing audit rules under the Tax Equity and Fiscal Responsibility Act of 1982 ("TERFA"). The Act will be effective beginning after December 31, 2017, and most existing partnership agreements will need revisions to ensure compliance from that date.
A few of the key features of the Act are:
- The IRS will assess tax adjustments from audits at the partnership--rather than at the partner--level.
- The Act replaces the "Tax Matters Partner" with a "partnership representative who has distinct rights and obligations.
- The Act provides for an alternative method under which the partnership can elect to impose liability for underpayment of taxes on the partners for the tax year for which an adjustment is made.
- There is an opt out provision for partnerships with 100 or fewer qualifying partners.
If you are a partnership--even a small partnership potentially eligible for opting out of the new regime--you need to meet with experienced counsel to ensure eligibility and compliance. Many analysts currently believe that the new audit rules are going to lead to an increase in the number of partnership audits. Do not be caught off guard. Among other compliance matters, you need to consider:
- Identifying and setting parameters for the powers and obligations of the partnership representative
- Whether you are eligible to opt out and, if so, to take the legally necessary steps to ensure recognition of the opt out by the IRS
- Amending the partnership agreement to prevent partners from assigning interests to any entity treated as a partnership for tax purposes (since this may significantly affect your ability to opt out or use the alternative method described in the Act)
- Including special allocation provisions for audit adjustments at the partnership level
Purchasers of existing partnership interests also need to consider:
- Reviewing carefully all of the partnership's prior tax returns to assess the risk of shifting liability to the current partners (in the event no opt out is available)
- Securing indemnifications from the seller as to tax liabilities for prior tax years
Remember: limited liability companies treated as partnerships for tax purposes are covered by this Act! Until Treasury issues further guidance on the Act (which I expect to begin happening fairly soon, if not by summer 2016), I will be encouraging my clients to pursue strategies to ensure "opting out," clearly delineating the powers of the partnership representative, ensuring that all partners assist and comply with the partnership representative's requests, and setting backup plans to use the alternative method in the event the opt out fails.