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Changes to Partnership Audit Procedure

December 17, 2015

On November 2nd of this year, the Bipartisan Budget Act was signed into law.  The new law replaces the current Internal Revenue Service partnership audit procedures. There will no longer be a mandatory pass through of the audit adjustments to the partners and the attendant tax liabilities imposed on him or her unless an eligible partnership (as  described below) makes an election out of the new rules on its timely filed tax return.  The tax, together with interest and penalties, will be calculated and collected at the partnership level, unless the partnership elects to have the partners bear the tax liability attributable to partnership- level audit adjustments. The tax will be assessed at the highest possible tax rate and it will be the partnership’s responsibility to demonstrate that the liability was lower because of a partner or partners’ specific tax circumstances.
A partnership may opt out of the new rules, but only if it has fewer than 100 eligible partners (eligible partners are individuals, C Corporations, S Corporations and estates of deceased partners). Trusts and partnerships are not eligible partners.
These rules raise many issues as to the language in Partnership Agreements including, but not limited to, the following questions:
  1. Who should have the authority to designate the audit representative?
  2. If eligible, who decides whether to opt out of the new rules?
  3. After the audit, who decides whether the tax shall be imposed at the partnership or partner level.
  4. Who pays for the audit and costs of proving a lower liability as a result of the partners' personal tax situation?
  5. Should the partnership prohibit partnerships and trusts as partners?
In addition, when purchasing a partnership or selling a partnership interest you need to negotiate for indemnities, escrows, etc.
These new procedures are complex and should be considered by all partnerships prior to their January 1, 2018 effective date (although partnerships can elect to apply the new procedures sooner).
To better understand how these rules affect your partnership, contact: Gary or 215.569.2800.

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