New rules governing how partnerships will be audited beginning in 2018 were issued Thursday by the IRS.
Aimed at making it easier for the IRS to audit and collect taxes from partnerships, the new approach shifts responsibility to the partnership from individual partners.
The new audit regime will allow the IRS to examine a partnership's income, gains, losses, deductions and credits, and make the partnership responsible for adjusting any of those items. The burden for past years' tax liability will shift to the adjustment year, so partners that might not have had an ownership interest at the time may still be liable for underpayments. Any additional taxes due would be collected directly from the partnership at the top individual rate, unless some income can be allocated to a tax-exempt partner.
An exemption for entities with 100 or fewer partners does not apply to investment funds that have other partnership investors, such as a fund of funds. The IRS will take into account the tax-exempt status of partners, such as pension funds and endowments, but even tax-exempt investors could be affected if an audit adjustment affects the investment fund's economics, and ongoing audits could make it harder to transfer an interest.
A white paper by the lobbying group Real Estate Roundtable predicted the new audit regime “may trigger a wave of modifications to real estate partnership agreements” to protect investors.
The new audit rules were part of the Bipartisan Budget Act of 2015, which President Barack Obama said during the signing was partly paid for “in a balanced way ... (by) ensuring investors in hedge funds, private equity funds and other large partnerships pay what they owe in taxes.”
The new partnership audit regime applies to all partnerships regardless of size. Partnerships with 100 or fewer partners can elect out of the new audit rules only if the partners are individuals, C corporations, foreign entities that would be treated as C corporations were they domestic, S corporations, or estates of deceased partners.
In 2014, a Government Accountability Office study found the IRS audited just 0.8% of large partnerships vs. 27.1% for similar-size corporations. Large partnerships, defined as those with 100 or more direct and indirect partners and $100 million or more in assets, have increased dramatically in recent years, and in 2012 held $7.5 trillion in assets. Almost two-thirds had more than 1,000 direct or indirect partners, six or more tiers and were in the finance or insurance sectors, the GAO found.
The rules were issued in advance to allow partnerships to elect into the new regime before it becomes mandatory, and further regulations are expected.
