Are You Taxed As a Partnership? Matters for You to Consider
For our clients and friends operating as business entities taxed as partnerships, we want to bring a few matters for your attention, including:
- IRS launches large partnership audits,
- Periodic reviews of partnership or operating agreements, and
- Recent congressional proposals regarding partnership taxation.
IRS Partnership Audit Program
In a previous Beyond the Bottom Line, we mentioned the IRS’ program to increase the number of partnership returns which are subjected to compliance audits. The number of new business entities filing partnership returns, including limited liability companies taxed as partnerships, has increased significantly over the last decade when compared to other business entities. The complexity of partnership tax law makes these returns a potentially rewarding audit target from the perspective of the IRS.
IRS Centralized Partnership Audit Regime and Operating Agreement Updates
We mention the partnership audit program, not to rehash what we may have discussed in previous comments, but to bring your focus to the importance of periodically reading over and updating your partnership operating agreements to reflect changes in tax law or to adapt the agreement to better address the operating rules for the entity as it and its owners evolve.
As you perform this maintenance of your operating agreements, one key factor to consider in light of increasing IRS audit exposure is the provisions addressing the centralized partnership audit regime or rules effective for tax years beginning in 2018. We have previously communicated these rules to you, but we continue to see operating agreements that do not appear to be amended since the rules became effective.
The new rules eliminated the concept of a tax matters partner (“TMP”) and introduced the term, “partnership representative (“PR”).” If an operating agreement still contains the tax matters partner term but not the partnership representative term, this is one indication that the agreement has not been amended in quite some time. If so, amendments to or a restatement of the agreement to consider these new audit rules or other entity management issues should be considered.
While we focus above on TMP versus PR, the currently effective audit rules contain substantive changes that can have a significant impact on the liability of the partnership and its partners – past and present – in the case of IRS audit adjustments. We encourage you to read over your partnership agreements and contact us if you would like our assistance in exploring your options under the new partnership audit rules and designing amendments to your agreements to manage those options.
Partnership Taxation Proposals
In September of this year, Senate Finance Committee Chair Ron Wyden unveiled draft legislation that would significantly affect the taxation of partnerships. Along with the unveiling, Sen. Wyden released a one-page summary of the proposals and a section-by-section summary of the draft legislation. The prospects for this draft legislation being introduced as a bill and passed as a stand-alone bill are uncertain. It does not appear that it will be included in the budget reconciliation bill currently being negotiated.
While an exhaustive study of the proposals may be premature for some, we present this information for those of you who would like to stay ahead of potential changes in the taxation of partnerships. Some key provisions in the proposals would:
- Require that debt be allocated to partners in accordance with partnership profits,
- Provide for mandatory basis adjustments upon transfers of partnership interests or certain partnership to partner distributions. These basis adjustments are generally optional under current law.
- Remove the substantial economic effect test or safe harbor and require that all partnership allocations be made in accordance with the partner’s interest in the partnership – the goal being to remove the optionality of current law, better prevent the shifting of tax attributes between partners, simplify the rules governing partnership allocations, and allow the IRS to better focus audit and enforcement efforts.
Additional provisions are explained in the link provided above for the section-by-section summary. Please reach out to your BMSS professional for assistance regarding any of the partnership matters we have discussed by calling us at (833) CPA-BMSS.