Major Changes are in Store for the Partnership Audit Rules

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Jason B. Freeman

Jason B. Freeman

Managing Member

214.984.3410
jason@freemanlaw.com

Mr. Freeman is the founding member of Freeman Law, PLLC. He is a dual-credentialed attorney-CPA, author, law professor, and trial attorney.

Mr. Freeman has been named by Chambers & Partners as among the leading tax and litigation attorneys in the United States and to U.S. News and World Report’s Best Lawyers in America list. He is a former recipient of the American Bar Association’s “On the Rise – Top 40 Young Lawyers” in America award. Mr. Freeman was named the “Leading Tax Controversy Litigation Attorney of the Year” for the State of Texas for 2019 and 2020 by AI.

Mr. Freeman has been recognized multiple times by D Magazine , a D Magazine Partner service, as one of the Best Lawyers in Dallas, and as a Super Lawyer by Super Lawyers, a Thomson Reuters service. He has previously been recognized by Super Lawyers as a Top 100 Up-And-Coming Attorney in Texas.

Mr. Freeman currently serves as the chairman of the Texas Society of CPAs (TXCPA). He is a former chairman of the Dallas Society of CPAs (TXCPA-Dallas). Mr. Freeman also served multiple terms as the President of the North Texas chapter of the American Academy of Attorney-CPAs. He has been previously recognized as the Young CPA of the Year in the State of Texas (an award given to only one CPA in the state of Texas under 40).

The partnership audit rules are in for a major overhaul. The recently-enacted Bipartisan Budget Act of 2015 (BBA) is replacing the existing partnership audit framework with a new regime. The new rules, however, are not immediately mandatory—they will generally apply “to returns filed for partnership taxable years beginning after Dec. 31, 2017.” So, for many partnerships, now is the time to review their current agreements and to plan for (or around) the new rules.

While the new legislation affects partnerships generally, it is particularly aimed at addressing the IRS’ struggles to audit large partnerships. Large partnerships (that is, partnerships with 100 or more partners and $100 million or more in assets) have proliferated in recent years, and they have become an increasingly important structure in our economy. However, perhaps surprisingly, they are rarely audited. There are a number of reasons for this, but not least among those reasons is the difficulty presented by the current partnership audit rules.

The current partnership audit framework was largely enacted as part of the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA). Under TEFRA, the IRS generally audits a partnership at the entity level, and then (if the audit results in adjustments) the IRS makes “flow through” assessments to each partner. This procedure, however, has proven extremely difficult and resource-intensive—particularly when it comes to large partnerships with many partners.

The BBA, in an effort to address this challenge, takes a different approach. It generally allows the IRS to directly assess the partnership itself, rather than requiring “flow through” assessments to its partners. That is, the BBA generally allows the IRS to impose entity-level liability where an audit results in adjustments. This entity-level liability is imposed in the year of the adjustment. This represents a major change, and in some cases, this procedure could prove quite inequitable. For instance, if the partnership’s partners have changed (as will often be the case), the new partners may ultimately bear the economic burden of the assessment, even though the old partners may have enjoyed the economic benefit of the partnership’s prior tax treatment.

As this demonstrates, the BBA will dramatically change the nature of many partnership audits in the future. There will be many other changes too, including changes to the “tax matters partner” concept, the ability to “opt-out” of the partnership procedures, and the governing statute of limitations. While the act’s overall impact remains to be seen, practitioners can certainly expect to see an uptick in the audit rate for large partnerships, along with a host of procedural changes.

To read the BBA language, please click here.

To read my recent article, The Evolution of Partnerships and Partnership Audits, click here.

 

For updated and additional posts on this topic, see A Summary of the New IRS Appeals Procedures under the Centralized Partnership Audit RegimeThe New Partnership Audit Rules: An Expansive Scope and Penalty DefensesMajor Changes are in Store for the Partnership Audit RulesWhy (Nearly) Every Partnership Agreement Should be Amended.

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