Currently, partnerships are considered pass-through entities for taxation purposes. As a result, when a partnership is audited, the partners themselves are responsible for any unpaid tax liabilities, penalties and interest. However, with the rise of multi-tiered partnerships, the IRS found significant lack of compliance among partnerships. Furthermore, the IRS was auditing fewer partnerships relative to other types of business entities.
Starting in 2018, the way partnerships are audited will change dramatically. To wit, the partnership itself, rather than individual partners, will be responsible for tax liabilities. It is likely this change will lead to increased numbers of partnership audits.
This Tax Shift Will Have Potentially Interesting Consequences
Individuals considering joining a partnership must carefully consider potential tax liabilities before joining an existing partnership. For example, say that partners A and B accumulated unpaid tax bills in 2015 and 2016 and Partner C joins the partnership in 2017. If the IRS audits the partnership in 2018 and assesses an unpaid tax liability, all partners could be liable, even though Partner C was not part of the partnership when the tax debts were accumulated. While partners will be responsible for self-assessing their own specific tax liabilities, it is easy to see how this new tax regime could be a source of serious disagreements between partners.
Partners Can Opt Out of These Rules
The new partnership audit laws replace the partnership audit provisions of the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA). However, a partnership can decide to opt out of the new partnership audit laws. In order to do that, however, the partners must affirmatively state they wish to opt out. Furthermore, they must make this decision every year.
In sum, partnerships need to plan ahead in order to make decisions that best fit their specific business needs. Waiting to act until these rules become law could have deleterious consequences, both to the individual partners and the underlying partnership.
For decades, partnerships and businesses of all types across New York and beyond have relied on the lawyers of Goldburd McCone LLP. Our attorneys provide experienced, skilled counsel and advocacy in tax audits, tax collection issues, tax planning and other critical tax matters.
Source: A 'Seismic Shift' in the Partnership Audit Rules, Accounting Today, October 18, 2016, by Roger Russell