Partnership IRS Audit Law Changes

Rödl & Partner Tax Matters Vol 2016-7, republished in July 2024

Below please find information regarding the recent changes in tax law relating to IRS audits of partnerships for tax years beginning after December 31, 2017.

In an effort to simplify IRS procedures for auditing partnerships, Congress has enacted legislation that significantly changes partnership tax audit rules. These new rules repeal and replace the current law audit and adjustment procedures for partnerships (commonly referred to as TEFRA) and similar rules for electing large partnerships (ELP) and raise a number of issues that will need to be addressed in partnership agreements. Given that the new rules shift much of the audit burden from the IRS to the audited partnership, the number of partnership audits by the IRS may increase going forward.

While the audit focus will continue to be on the partnership return, the approach to IRS adjustments and tax payments is very different. For tax years beginning after December 31, 2017, audit adjustments are taken into account at the partnership level and adjustments are reflected in the year the audit is completed (as opposed to the year under review). Partnerships will be subject to an entity-level tax, subject to certain exceptions and elections, as a result of any audit adjustments. Therefore, given that the tax must be paid by the partnership, partners will not be jointly and severally liable for this entity-level tax. In addition, given that the economic impact to the partners occurs in the adjustment year and not the year under review, this could create additional economic issues where there has been a change in partner ownership subsequent to the year under IRS examination.

For tax years beginning prior to December 31, 2017, the old laws continue to apply. Entities currently subject to TEFRA and ELP audit rules may elect to adopt the new legislation for tax years beginning November 2, 2016 through December 31, 2017, however, we do not see much advantage in doing so.

As indicated above, consideration needs to be given to how the new rules will impact both existing and new partnership agreements. For new partnership agreements, proper consideration must especially be given to identifying the partnership representative that will have sole authority to act on behalf of the partnership with respect to any audit and adjustment proceedings with the IRS. This representative will replace the partnership’s tax matters partner in that role. Similarly, existing partnership agreements should be amended to reflect these changes.

Other issues requiring consideration are as follows:

Determining whether a partnership can opt-out of the partnership-level audit and collection proceedings including the following:
-Treatment of tiered partnership structures and the eligibility of an upper tier partnership as a “qualified investor” under the new rules for purposes of the opt-out.
-Similarly, the treatment of non-resident, non-citizen partners as “qualified” partners (to opt out every partner must be a qualifying partner)
-Whether the partnership agreement should prevent non-qualifying partners
The requirements for selection of the partnership representative (including substantial presence in the U.S., not required to be a partner, etc.)
Indemnification of partners from the economic impact of an assessment based on a review year when they were not members
The mechanics of providing evidence or substantiating lower tax on an entity level adjustment; timing of adjustment, alternative options for applying adjustment to “reviewed year” partners, specifics of the “simplified amended return process,” etc.

Unfortunately, we cannot recommend specific amendments to existing partnership agreements or provisions for new partnership agreements. We are still waiting on additional guidance from the IRS on how they will approach the enforcement of the new rules before we provide recommendations. As we learn more, we will keep you informed.

Please contact your Rödl & Partner representative with any questions.

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