Despite the significant uncertainty surrounding the new partnership audit regime implemented under the 2015 Bipartisan Budget Act (Pub. L. No. 114-74) ("BBA"), the IRS expressed its intention to watch for partners exiting partnerships to avoid tax, during a District of Columbia Bar event on June 23, 2016.
The new rules, effective in 2018, require partnership-level audits of large partnerships, and make it simpler for IRS examiners to undertake an audit because the system will be able to calculate and collect adjustments at the partnership level. Since there can be several years between when a return is filed and when an audit adjustment is levied, however, it leads to the possibility that partners could sell their interest before the commencement of an audit and avoid adjustments that may have been attributable to them.
Although the panel suggested amending partnership agreements so that partners who sell their interests would still be on the hook for any tax due later, it is unclear whether partners intending on exiting partnerships in light of the new rules would agree to such an amendment. Further, because of the vast uncertainty regarding various areas of the partnership audit rules, most partnerships are not amending their agreements at this time.
The IRS intends to issue regulations with an effective date of January 1, 2018, which would address the scope of the rules and how statute of limitations are applied in this context. Many areas of uncertainty with the new rules, however, have not yet been addressed by the IRS.
One major area of uncertainty revolves around the "partnership representative," which is an expanded version of the "tax matters partner" role under prior law. The partnership representative, which is not required to be a partner, will have sole authority to act on behalf of the partnership in an audit proceeding, and will bind both the partnership and the partners by its actions in the audit. The IRS no longer will be required to notify partners of partnership audit proceedings or adjustments, and partners will be bound by determinations made at the partnership level.
It appears that partners neither will have rights to participate in partnership audits or related judicial proceedings, nor standing to bring a judicial action if the partnership representative does not challenge an assessment. Accordingly, the partnership representative is vested with significant responsibility and power under the BBA, and would likely need to devote the majority of his or her time addressing these issues. This raises the possibility that certain individuals might be compensated for this role, and the role might be limited by the provisions of the partnership agreement. At the very least, there should be provisions in place to have a degree of control over elections made at the entity level, or final determinations at the entity level.
Another noteworthy area of concern is how the new rules would impact State tax filings. States have not yet reacted to the new rules, and thus, partners may be reluctant to make amendments until they are aware of both the state and federal implications of the audit rules. The IRS expects to issue guidance in stages to alleviate some of the concerns expressed by practitioners and allow them to move forward with amendments to partnership agreements.
Notwithstanding the uncertainty, it is clear that the IRS is watching for those seeking to take advantage of the new regime to avoid tax.
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