New regulations published by the IRS and U.S. Treasury in January 2018, provided much-needed guidance for partnerships to determine how they might opt out of the partnership audit regime that went into effect following the Bipartisan Budget Act of 2015.
The 2015 Act overhauled prior rules set in 1982 that governed the taxability of partnerships.
One significant concern addressed by the Bipartisan Act was the lack of a system for addressing any underpaid tax from the partnership entity. The IRS was required (before the Bipartisan Budget regime) to seek collections from individual partners who would have owed the tax had the partnership properly reported the income in the first place.
Although the Bipartisan Budget Act addressed this point to allow for follow-up tax collection at the partnership level, it also offered a provision that allowed some partnerships to annually opt out of the new rule and revert to the rules established in 1982 by the Tax Equity and Fiscal Responsibility Act.
Partnerships that make an appropriate election set up a collection system by which the IRS audits individual partner returns, rather than the return filed by the partnership. In this scenario, the partnership would not be liable for any further taxes or penalties.
The provision went into effect for 2018 and qualifications allowing partnerships to opt out of the Bipartisan Budget regime include:
- The partnership must have had less than 100 partners during the year
- All partners must be “eligible”
The definition of an eligible partner under the new regulations includes any individual, C corporation, S corporation, estate of a deceased partner or eligible foreign entity. An eligible partner does not, by definition, include a partnership, trust, certain foreign entities or nominee who holds an interest on behalf of another individual or a disregarded entity.
The final regulation also defines the process for electing out of the Bipartisan Budget regime:
- The partnership must file a partnership return for the tax year under which it would like to take the election
- The partnership must also provide personal information for each partner including the name, taxpayer identification number, federal tax classification of each partner and each shareholder for S corporation partners)
- Each partner must be informed within 30 days about the decision of the partnership to take the election.
Partnerships considering the election to opt out of the Bipartisan Budget regime for tax collection must carefully consider whether they (and their individual partners) meet the proper eligibility requirements.
Following the successful election of a partnership out of the new regime, the IRS will execute partner-specific level assessments to determine individual tax liability in the event of underpayment of taxes by the partnership.
Now that final regulations have been published by the IRS and Treasury regarding the new audit regime for partnerships, each partnership should have sufficient guidance to make the decision they feel is in their best interest from a tax planning perspective.
Councilor, Buchanan & Mitchell (CBM) has consulted with partnerships and individual partners for many years on recommendations to attain the best tax outcome possible. Please contact one of CBM’s tax professionals now for guidance in this matter.
Councilor, Buchanan & Mitchell (CBM) is a professional services firm delivering tax, accounting and business advisory expertise throughout the Mid-Atlantic region from offices in Bethesda, MD and Washington, DC.