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Substantial Changes to Partnership Tax Audit Procedures will Severely Impact Partner Liability and Rights Before the IRS

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Does your client own an interest in a partnership or an entity treated as a partnership for US tax purposes?  If so, you better take notice because the new partnership tax audit rules are making drastic changes as of January 1, 2018.  The new rules, known as “BBA,” will administer a tax deficiency at  the partnership level, unless certain elections are made.  These rules are a significant departure from the old rules, known as “TEFRA”, which administered a tax deficiency at the individual partner level.  All partnerships will need to amend their respective partnership agreements to take the BBA changes into consideration.  What should a partnership or its partners be concerned about?

Below is a non-exhaustive list of some of the major concerns of these new procedures:

Have you chosen a Partnership Representative (“PR”) under the BBA rules? If so, have you set forth the limitations and obligations of the PR?

  • Once the BBA Rules are effective, all authority over the partnership tax audit lies with the PR
  • The BBA procedures give the PR statutory authority to bind all partners with respect to all actions taken by the partnership in the BBA administrative proceeding and in any judicial proceeding
  • Since the PR is the exclusive party to act on behalf of the partnership, the PR may also, in effect, bind all partners to extensions of the statute of limitations, settlements and available elections

Does your existing partnership agreement require the partnership or the PR to provide notice to all partners of a IRS audit?

  • The BBA procedures abolish all partner-level notices of IRS actions that existed under TEFRA
  • Unlike the TEFRA rules, under BBA there is no affirmative obligation for the Internal Revenue Service, the partnership or the PR to send a notice of an IRS audit to each partner
  • Without revising the partnership agreement, a partnership audit could occur and be resolved without the partners’ knowledge

Does your existing partnership agreement contemplate who will be responsible for tax deficiencies?

  • Under the BBA procedures, unless the PR takes certain actions, tax deficiencies are assessed against the partnership in the year the controversy is resolved (known as the adjustment year) and not in the year which generated the tax deficiency (known as the reviewed year)
  • In effect, the economic burden of a tax deficiency could be borne by partners who had no interest in the partnership when the income/deduction was generated

Does your existing partnership agreement provide for opting-out of the BBA procedures?  If so, does the PR have an affirmative obligation to opt-out?

  • The BBA procedures allow smaller partnerships (with fewer than 100 partners) to elect to opt-out of the BBA rules and have the audit be administered at the partner rather than partnership level
  • Do you desire to have the audit administered at the partner level?  Are you concerned about the IRS expanding the audit to other parts of your business?
  • Are you willing to continue to be responsible for tax deficiencies for the years in which you held an interest in a partnership, even if you later sell such interest.

Does your existing partnership agreement provide for pushing-out tax deficiencies to the reviewed year partners?

  • The push-out election allows the partnership to pass on an adjustment to a former partner without providing them an opportunity to comment, contest, or even receive notice of the adjustment
  • If you exit a partnership are you willing to leave this decision up to the current PR?
  • As a former partner would you desire some control over these decision for which you are ultimately responsible?

The above items address some of the questions partnerships and partners should be thinking about before the BBA procedures go into effect on January 1, 2018.  It is recommended that all partnerships work with their tax counsel to perform a thoughtful and thorough review of their partnership agreements.  The only way to control the results of these new procedures is to be pro-active now before the rules go into effect.

Please contact Jeff Erney at jeffry.erney@dentons.com or Sunny Dhaliwal at sunny.dhaliwal@dentons.com

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