The impact of the Tax Cuts and Jobs Act continues to draw significant attention for the upcoming 2018 filing season. However, let’s not forget about another tax law change effective for the 2018 filing season: the partnership audit regime. With the new partnership rules, it is important that your partnership addresses the following questions:
- Is your partnership electing out of the new rules? or,
- Who are you designating as your partnership representative?
What has changed?
The Bipartisan Budget Act (BBA) of 2015 introduced a new audit regime as it relates to partnerships. Prior to the BBA, partnerships were audited using the provisions of the Tax Equity and Fiscal Responsibility Act (TEFRA) of 1982 that required individual partners be audited. Tracking the income between partnerships and all the various partners required a significant amount of resources to adequately determine an overall audit picture of the entity. The BBA changed the structure so the IRS would only be required to audit the partnership itself; assessing any penalties, interest, or adjustments to the partners within the partnership during the year the audit was conducted.
What information should be included in the 2018 partnership tax return?
With the changing environment, a mechanism was provided for qualifying partnerships to elect out of the new regime. In addition, the IRS and Treasury published final regulations (T.D. 9829) in January 2018 that added clarity to electing out as well as outlining the role of the partnership representative under the new audit regime.
To elect out of the audit regime, the partnership must:
- Have 100 or fewer partners during the year, and
- All of its partners must be “eligible partners” at all times during the tax year with “eligible partner” being defined as any person who is an:
- C Corporation,
- “Eligible foreign entity,”
- S Corporation, or
- An estate of a deceased partner
In addition, the election must be made on a timely filed partnership return (including extensions) for the tax year in which the election relates. The partnership must notify each of its partners within 30 days of making the election. The election must include the following:
- Correct U.S. taxpayer identification number (TIN), and
- Federal tax classification of each partner and each shareholder of a partner that is an S Corporation
A partnership will not be eligible to elect out of the new partnership regime if it has a partner that is itself a partnership or disregarded entity such as a disregarded single-member limited liability company (LLC) or a grantor trust. Also, all eligible foreign partners – even those with no U.S. filing requirements – must apply for and obtain a valid U.S. TIN for the partnership to file a valid election. If a partnership is interested in electing out, it may want to consider restricting the number, type of partners, and the ability of its partners to change tax status.
If a partnership either isn’t eligible or chooses not to make the election out of the new regime, partnership representatives must be designated to assist in the audit process.
Designating a partnership representative
Only one partnership representative is allowed for a partnership taxable year. The partnership representative will remain named as such until the date on which the representative is terminated by valid resignation, valid revocation, or determination by the IRS that the designation is not in effect.
To be a partnership representative, the following requirements must be met:
- Substantial presence in the United States
- Person makes themselves available to meet in person with the IRS in the United States at a reasonable time and place as determined by the IRS,
- The person has a United States taxpayer identification number, a street address that is in the United States and a telephone number with a United States area code.
- Capacity to act as the partnership representative
- The designation of a partnership representative must be made with the partnership return for the taxable year. The representative is effective on the date the return is filed. A partnership representative may resign by notifying the IRS.
- The partnership representative has the sole authority to act on behalf of the partnership for all purposes. Except for a partner that is the partnership representative or the designated individual, no partner, or any other person, may participate in an administrative proceeding without the permission of the IRS.
To make sure your partnership has complied with the new partnership audit regime rules, you will need to properly reflect your decision to either elect out of the new audit rules or identify a partnership representative in your timely filed tax return on or before March 15, 2019 (or September 15, 2019 if you extend your partnership tax filing).
If you have any questions or would like more information on this topic, please contact your Lurie advisor.