New Partnership Tax Audit Rules Effective 2018

New Partnership Tax Audit Rules Effective 2018

We are hosting a seminar discussing the new tax audit rules effective January 1, 2018. The seminar will be hosted in our Lyndhurst, NJ office on October 24, 2017. The new procedure is the Centralized Partnership Audit Regime (CPAR).

The CPAR default rule applies to all partnerships, LLC’s taxed as partnerships, and joint ventures.  The consequences of these new rules are significant and can adversely affect your partnership, LLC or joint venture should it have an audit which results in a tax liability.

Under the CPAR All partnership tax adjustments will be made at the partnership level (not at partner lever as under traditional flow-through principles)

The economic burden of an IRS adjustment will be borne by partners at time adjustments finalized even though there may have been changes in ownership subsequent to year under audit (hence need to consider contractual indemnification):

• The CPAR is intended to raise revenue – it will increase partnership audit rates.  Partnerships and LLCs are now targets for audits.
• The partnership/LLC tax calculation will be at the highest tax rate levied against the partnership.
• No more “tax matters partner” – new concept “partnership representatives” (PR).
• The PR has exclusive power to deal with IRS for audit/appeals/litigation, etc.

No grandfather rules – CPAR rules apply to all existing partnerships and new partnerships formed between now and 2018 and thereafter.

Election out of CPAR

This election is available only if partnership is required to furnish less than 100 K-1s or has all eligible partners.  This can results in separate audits at the partner lever (same as under pre-1982 law and for “small partnerships” not subject to TEFRA rules under 1982-2017 law).

Opt-out election for partnerships taxable years beginning after 1/1/2018. If “eligible,” partnership can opt-out of the CPAR; the key is whether the partnership consists of all eligible partners.

Who is Eligible?

Only eligible partnerships may opt out of new partnership audit procedures. The partnership required to furnish less than 100 “statements” (i.e., Schedules K-1) or any other partnership with only eligible partners.

Eligible Partners (those who can opt-out):

• Individual
• C corp.
• S corp.
• Deceased partner’s estate
• Foreign entity taxable as C corp. if it were domestic
• Each shareholder of an S corp. partner counts as one “statement.
• S corp. itself also counts as one “statement.

Who is Ineligible?

Ineligible Partnership (those who cannot opt-out):

The term “eligible partner” does not include:

• partnerships;
• trusts;
• foreign entities that are not eligible foreign entities;
• disregarded entities;
• nominees, other similar persons that hold an interest on 
• behalf of another person; and
• estates that are not estates of a deceased partner

Hence, for example, a two-member LLC/Partnership is subject to the CPAR.  A partnership/LLC with a trust is subject to the CPAR:

Effect on Partnership

Example:

Partnership is formed in 2018 with eight (8) partners.  In 2021, years 2018, 2019 and 2020 are subject to audit. In 2021, there are four (4) partners.  If tax assessment is made in 2021, the four (4) existing partners have the economic burden of paying the tax at the highest in the dividend rate.

Push-out election (after partnership assessment has been made). Instead of default rule – partnerships can elect to “push out” audit adjustments for the audit year(s) to those persons who were partners in the year subject to audit, however interest rate on deficiencies in two points higher than the assessed rate.

New Partnership Tax Audit Rules:  Impact on Business Deals

Significant impact on preparation of partnership agreements

• Designation of partnership representative
• Partner approval of certain decisions made by partnership representative
• Contractual notice/participation rights
• Indemnification by current and former partners of partnership tax liability under default rule (including method of allocating liability among partners) 

Significant impact on partnership transactions

• Acquisitions of partnership interests
• Partnership M&A transactions
• Due diligence / representations / indemnification

Planning ahead for 2018

All existing and newly-formed partnerships should be considering provisions to be included in amended or new partnership agreements.

Our seminar will be hosted on October 24, 2017. Seating is limited to 30. If you cannot make the seminar, if you have any questions or if you wish to discuss these new rules and changes, please contact me, Frank Brunetti, at 201-806-3364.