In the News: Guidance on Partnership Audits
August 8, 2016
Bankers may be indirectly affected by the new rules for IRS audits of partnerships and limited liability companies (LLCs) that are treated as partnerships for tax purposes. (For simplicity, we use the term “partnership” in this article to refer to partnerships and LLCs that are treated as partnerships for tax purposes. The term “partner” will be used to refer to an owner of either of these entities.) Here’s a brief summary of how the federal partnership audit rules have recently changed.
The new rules replace the old-law unified partnership audit rules, which apply to most partnerships with more than 10 partners. Under the old rules that are generally still in effect, the treatment of partnership tax items is generally determined at the partnership level, even though those tax items are passed through to the partners on their own returns.
Under the old rules, after an audit is completed and the resulting adjustments to tax items are determined, the IRS generally recalculates the tax liability of each partner. Then it hands out bills for additional taxes and penalties to the individual partners.
The new partnership audit regime calls for auditing partnerships with more than 100 partners at the partnership level. The big difference under the new rules is that, subject to certain exceptions, any resulting additions to tax for affected partners and any related penalties are generally determined, assessed and collected at the partnership level. In other words, additional taxes and penalties owed by the partners are collected from the partnership. This is a new financial risk that bankers should consider.
An alternative procedure allows the partnership to issue revised tax information returns (using Schedule K-1) to affected partners. The partners then take the IRS-imposed adjustments to partnership tax items into account on their own returns. Under this option, the partnership isn’t financially responsible for additional taxes and penalties owed by partners. However, the partnership will have to pay the additional cost of issuing new Schedules K-1 to affected partners.
Exception for small partnerships
One silver lining is that eligible partnerships with 100 or fewer partners can opt out of the new rules. In that case, the partnership and its partners would be audited separately, and the partnership wouldn’t be financially liable for IRS-imposed tax increases and penalties on affected partners.
The new partnership audit rules won’t take effect until tax years beginning in 2018, unless the partnership chooses to follow them sooner. In the meantime, bankers should consider the potential impact of the new rules on their partnership and LLC borrowers.
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