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Partnership tax audit rules: Is your business ready?

The rules regarding how the Internal Revenue Service (IRS) can conduct tax audits of partnerships have changed. It is important for business owners to review the rules and have a basic understanding of the impact on their business. In some cases, business owners may be wise to take proactive steps to better ensure their business’ interests are protected.

Why did the rules change? The change is the result of the Bipartisan Budget Act of 2015. It went into effect January 1, 2018. This new law changes the rules for federal income tax audits of partnerships, limited liability corporations (LLCs), limited partnerships and S corporations.

How did the rules change? Two specific changes to note include:

  • Tax collection. Previously, the IRS would assess and collect taxes during an audit based on the individual or corporate rate. The new law has changed the applicable tax. The agency can now use the partnership level to apply tax penalties. This is more likely to result in a higher tax after the audit is complete.
  • Terminology. Some of the terms have also changed. For example, the IRS will no longer use the term Tax Matters Partner. The new law replaces this term with Partnership Representative. Not only is the term different, the role has also changed. A Partnership Representative has greater authority and is the main point of contact in the event of an audit by the IRS.

The new law allows for partnerships to elect to opt-out of the new rules.

How can partnerships opt-out of the new rule? The partnership that wishes to pursue this option has three choices. A recent piece in Kiplinger provides a good explanation of these options. Essentially, the first option is a Section 6221(b) election. This option allows partnerships with 100 or less partners to revert to the partner collection as opposed to the partnership level collection. It is generally binding on all partners.

The second option is a Section 6226 election. This election essentially allows each partner to take responsibility for their adjustment tax burden. If chosen, the election notice must be sent within 45 days of receiving an adjustment notice from the IRS.

The third option is Section 6225. This is a valuable choice in situations where the partnership has evolved during the year in question. Determining whether or not to opt-out of the rule as well as which section to choose is difficult. As such, it is wise to seek legal counsel with Goldburd McCone for guidance on the implications of each choice before making a decision.

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