New IRS Partnership Rules

In 2018, new rules generated by the Bipartisan Budget Act of 2015 took effect that have significant ramifications for A/E firms taxed as partnerships. The new rules expedite the audit process and collect tax more easily and quickly as the IRS moves to significantly expand the volume of partnership audits. 

The new rules affect all partners and partnerships each year. Some items must be addressed annually and prior to an audit. Decisions, definitions and partners’ responsibilities are some items that should be memorialized in partnership agreements now.

  

The rules are complex and require action. There are important choices to be made with the filing of every partnership tax return including choice of rules (old or new) and designating a “partnership representative.”

The biggest change is the choice of rules. There are 3 options: New rules, Elect Out, or Push Out. 

Choice of rules: New rules affect when tax is assessed and who pays and defends an audit. The implications affect existing, new and old partners. They affect buy outs, terminations, sales of partnership interests, etc. 

Under the old rules, audits were at the individual level including the defense and assessments. A 2018 audit completed in 2020 was assessed to 2018 partners. 

The new rules audit, assess, collect tax and is defended by the partnership. The same 2018 audit completed in 2020 yields tax to the partnership: effectively its partners in 2020, not the 2018 partners.

• Each partner must be registered as an individual, a domestic C corporation, a foreign entity taxable as a C corporation, an estate of a deceased partner, or an S corporation (most trusts will disqualify the election)

• The firm must have 100 or fewer Schedule K-1s (atypical potential pitfalls will surprise)

• Tax returns must be filed in a timely manner (on or before the due date)

• The Elect Out option must be made annually.

A third option for firms to avoid the new rules is the “Push Out” election. It essentially adopts the old rules. This is made following the adjustment, but it must be made timely without exception. This option brings an additional interest cost of 2 percent. 

Given the complexity of the new rules, we advise A/E firms to update their partnership agreements without delay. Partners should be held responsible for required information to avoid pitfalls and inadvertent disqualification from Elect Out. 

Partnership Representative: Prior to 2018, partnerships could designate a “tax matters partner.” That is eliminated. It’s replaced with a “partnership representative.” This carries new responsibilities, operates differently, and is a designation made each tax year. 

Consult your professional advisors about these important changes. This is not something to ignore or try to sweep under the rug until an actual audit takes place. Firms should act now. Implications are real.

Reprinted with permission of PSMJ Resources