New Rules for Entities Taxed as Partnerships and New Partnership Tax Return (Form 1065)
Important statutory changes are now in effect concerning entities taxed as partnerships, including general partnerships, limited partnerships, and most multi-member limited liability companies (referred to below as “Partnerships”), and the Internal Revenue Service (the “Service”) recently released new Form 1065 (the tax return for Partnerships) to take into account the statutory changes.
All Partnerships have had to designate a “tax matters partner” (the “TMP”). Most Partnership agreements designated such a person, and if not, the law recognized the partner with the largest percentage interest as the TMP.
The concept of a TMP is now replaced by a “partnership representative” (the “PR”). Contrary to the old rules regarding TMPs, the PR need not be a partner of the Partnership. For tax years beginning on or after January 1, 2018, all Partnerships must designate the PR on their annual tax return. Thus, a Partnership can have a different PR for different tax years.
The PR has much greater authority and responsibility than the TMP. Under the old rules, the TMP acted primarily as a liaison between the Service and the Partnership with respect to an audit, but an individual partner could always opt out of a partnership level proceeding and enter into a settlement agreement with the Service with respect to the determination of the partner’s partnership items. Under the new rules, however, the PR has the sole authority to act on behalf of a partnership with respect to an audit, and all partners are bound by the actions and decisions of the PR.
At the end of 2018, the IRS released the 2018 Form 1065 (tax return for Partnerships), and that Form requires that the Partnership designate its PR for the 2018 tax year.
Procedure for Collecting Additional Taxes, Interest, and Penalties
Under the old rules, for tax years beginning before January 1, 2018 for Partnerships with more than ten partners, or Partnerships with another Partnership or S corporation as a partner, the Service audits a Partnership by conducting a unified audit at the Partnership level resulting in adjustments to Partnership items at the Partnership level. Once the adjustments at the Partnership level are finalized, the Service then makes corresponding adjustments to each partner’s tax return, and the Service then collects taxes, penalties, and interest from each partner. The Service finds this method of auditing Partnerships to be inefficient because the Service must assess each partner for any deficiencies and ultimately must collect tax from each partner. The inefficiency is even greater with respect to small partnerships (those having ten or fewer partners and not having another partnership or S corporation as a partner), for which the Service is required to conduct separate audits at the partner level rather than a unified audit at the Partnership level.
In an effort to reduce these inefficiencies, for taxable years beginning on or after January 1, 2018, the Service will change the manner in which it collects additional taxes, interest, and penalties resulting from Partnership audits. Under the new rules, unless a Partnership “opts-out” as described below, the Service will still conduct the audit at the Partnership level, but now may assess and collect additional taxes, interest, and penalties directly from the Partnership. Thus, a Partnership may now be subject to an entity-level income tax. It would then be up to the Partnership to either absorb the burden of the payments (which would tend to burden current partners), or to seek reimbursement of the payments from the persons and entities who were partners in the year under audit, who may be different than the current partners.
The ability of a Partnership to seek reimbursement for taxes, interest, and penalties paid by the Partnership is a matter that should now be addressed in partnership agreements.
Opting Out from the Unified Audit
Partnerships with no more than 100 partners (none of which themselves are partnerships or single-member limited liability companies) are able to opt-out of the new unified audit rules, thereby requiring the Service to conduct audits at the partner level. If this opt-out election is made, the Service must collect any additional taxes, interest, and penalties at the partner level and not the Partnership level.
The recently-released Form 1065, referred to above, asks whether a Partnership is opting out of the new unified audit rules, and if so, Form 1065 contains a new schedule in which the Partnership must list the names and taxpayer identification numbers of all of its partners to certify that the Partnership has no more than 100 eligible partners and is, therefore, eligible to opt out.
Pushing Out Audit Adjustments
Partnerships that are not able to opt-out of the new unified audit rules on Form 1065 still have the ability to avoid an entity-level tax by making an election to “push-out” any audit adjustments to the persons and entities that were partners of the Partnership in the taxable year under audit. If this “push-out” election is made, the Partnership will not have liability for any increased taxes, interest, or penalties, which must be paid by the persons and entities that were partners of the Partnership in the taxable year under audit.
A Partnership’s election to “push-out” any audit adjustments need not be made until 45 days after the Partnership receives the final audit report from the Service. The decision would be made by the PR in the PR’s discretion unless the partnership agreement somehow modifies that discretion, for example, by pre-determining that election or requiring the PR to follow the instructions of certain partners or the Partnership’s accountant.
As a result of recent statutory changes and new Form 1065, Partnerships should do the following promptly:
- All Partnerships must identify a PR and advise their tax preparers so that the PR can be listed on the 2018 Form 1065.
- All Partnerships must determine whether they are eligible to opt-out of the new unified audit rules and, if so and if opt-out is desired, provide their tax preparers the necessary partner information to prepare the new schedule on the 2018 Form 1065.
- Partnerships may wish to amend their partnership agreements, or other governing documents, in several respects in light of the new rules, including (i) the selection of the PR, (ii) the authority of the PR to make an election to “push-out” any audit adjustments to the partners, and (iii) the responsibility of a partner to reimburse the Partnership for the partner’s proportionate share of any assessment of additional taxes, interest, or penalties paid by the Partnership with respect to a year in which the partner had an interest in the Partnership.