Thanks to a change in the Internal Revenue Service’s (IRS) partnership audit procedure, business’ filing a partnership return may be at a greater risk for an IRS audit because of the partnership agreement itself.
Under the new audit plan, effective January 1, 2018, partnerships are audited at the entity level and any tax due is to be paid by the partnership instead of the partners. This streamlines the audit process for the IRS and reduces the need to open audits for each individual partner, but it leaves the IRS expecting to have to audit a lot more returns because of filing errors.
The partnership representative and possible election use are two provisions that have partnerships considering whether they need to amend their partnership agreement.
Some partnerships were required to name a Tax Matters Partner under prior law. That has been eliminated and now all partnerships are required to designate a Partnership Representative. This representative acts on behalf of the partnership and has the power to bind all the partners to his or her decisions. The assumed role has several other significant powers during an IRS audit. For example, the IRS will only correspond to the partnership via the representative who then has to communicate with the rest of the partners. The representative does not have to be a partner of the partnership. The only requirement is the representative has to have a “substantial presence in the United States.” If the partnership does not designate a representative within a year, the IRS will designate one. Since the representative has very broad and meaningful powers during an IRS audit, it would serve to limit the representative’s power in the partnership agreement to help control the final decision made. To help curtail some of the representative’s power, the agreement should include a statement how a majority of the partners must agree to accept the adjustments or appeal the IRS findings and not just be the sole decision of the representative.
Consider the following when amending your partnership agreement:
- Designate a Partnership Representative and create guidelines on how they should be able to operate and communicate with other partners during an IRS audit
- Consider if the partnership will want to make any of the elections available under the new partnership audit regime
- Determine if the partners prefer the partnership to be liable for any tax due during an audit or if it would be preferable to have the tax due at the partner level
- Calculate the partnership’s portion of tax due should the partner leave
A similar election is possible in the middle of the audit. Partnerships should consider whether or not they want to make these elections as they have a significant impact on the tax due and the agreement should include if the election is mandatory or not.
Before any changes are made to the partnership representative or elections sections of the partnership agreement, or in any other areas, reach out to your tax advisor or contact us at PBMares to fully understand how those changes can affect your chance of an IRS audit.