Partnerships have always been looked at in a good light due to its tax advantages. However, those times have changed due to the new Bipartisan Budget Act of 2015. This new law is set to take place in the year of 2018. Bipartisan Budget Act will override the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA). The IRS will now be allowed to collect taxes on the partnership level, instead of going through individual partners to pass adjustments.
This is bound to force partnerships to plan ahead of time to protect their interests the best way they can. The act basically enforces entity-level tax on partnerships, which will totally cause a shift in how interests are protected and valued. Small sized partnerships may think that they are in the safe zone. However, the new audit regime is applied to all partnerships regardless of size.
The good news is, some partnerships with 100 or fewer partners can choose to not abide by the rules only if the partners are actual; individuals, deceased partner estates, s corporations, c corporations, etc. Some partnerships may even have partners who may be a part of another partnership or trust. If this is the case, you’re not allowed to elect out of the new rules.
Good news, right? Wrong. Although you may be eligible to opt out of the new partnership rules, the process to actually fulfill this wish is a huge pain.
In order to officially finalize this process, the following must happen;
- They must officially elect out of the new partnership rules
- Each partner must be informed of this decision
- The legal names, and taxpayer identification number of the partners, or anyone whose treated as partners, must be submitted
Taxing at the entity level
The partnerships will be assessed for “imputed underpayment” and this will be based on the corporate or individual tax rate. This may seem unfair, which is why partners who should have lower tax rates are accommodated by the IRS and Treasury.
On another good note, the partnership is allowed 2 possible exceptions in order for prior tax year partners to pay their part of the tax liabilities on the partnership level. This is due to the new law requiring the IRS to assess the partnership on the year of adjustment, instead of the year under audit. That way, current partners won’t be held liable for tax errors of the previous partners.
Exception 1: The imputed underpayment will be reduced based on the amount paid by a partner. All partners should file amended tax returns in order to show their distributive shares of the adjustments. They must also make sure all taxes are paid within 270 days. This exception requires that the partnership;
- Discuss the effects of the adjustments
- Inform all partners of the adjustments being made
- Make sure all partners agree to file amended tax returns and all applicable payments that reflect the new k-1s, even the years that are not directly affected by it
Exception 2: This exception requires the partnership to be very responsive. If the partnership is given notice of an adjustment, they have 45 days to decide whether or not they will choose to issue statements to the partners concerning the share of partnership items.
If the selection process goes through, interest on underpayments from the adjustment year, along with taxes in the year of the K-1 must be paid.
Partnerships now requiring representatives
Another catch that comes with this new law is the appointment of a person or entity as a representative for the partnership. If the partnership representative (PR) is an estate, association, company, corporation, or partnership, someone else such as; a corporate officer, partner, or trustee has to act on behalf of the PR. However, the IRS will gladly appoint a PR if one is not chosen by the partnership.
Creating Appropriate Partnership Agreements
To make things easier, it would be wise to make sure that all of the following are in the agreement between partners.
- Procedures for selecting a representative for the partnership and rules on actions that the PR may or may not engage in.
- Rules that forces the partnership to inform all partners of; an IRS audit, IRS adjustments, and up to date information on the audit.
- How tax payments are going to be divided among partners
- Whether or not the partners would like to elect out of the new entity-level assessment
- Provisions concerning the amended tax returns of partner
- The required indemnification and escrow provisions for partners who may sell their interest
- Provisions that allow small-sized partnerships to opt-out
There’s no doubt that Bipartisan Budget Act is definitely a curveball thrown at partnerships. It’s extremely important for partnerships to take into consideration the changes that need to be made. All decisions should be based upon the new IRS partnership audit rules.