The Bipartisan Budget Act of 2015 had provisions for changing the rules for the Internal Revenue Service audits of partnerships. These rules just became effective with the start of the new year. In general the rules make it easier to collect taxes from a partnership after an audit. They make any taxes due after an audit payable by the partnership instead of passing the liability to the partners.
Another provision makes the changes effective the year of the audit rather than the tax year audited. This provision means current partners, through the partnership, would pay any back taxes even if they weren’t partners for the tax year audited. These changes are mainly aimed at partnerships with over 100 partners, but they also affect smaller partnerships. Fortunately, there’s plenty of time to consider options.
One possible action is to elect to opt out of the new audit rules. Section 6221 of the tax code allows for partnerships with fewer than 100 eligible partners to opt out. The election to opt out must be made each year and filed with the partnership tax return. Unfortunately, the IRS has gone by the letter of the law and will not include trusts as eligible partners. This includes family revocable living trusts. Any club with trusts as partners will not be able to use Section 6221 to opt out.
Another option that partnerships with trusts as members can use is Section 6225. This section allows a partnership to file an amended return to report any changes to income determined by an audit. It would also require all partners from the audited tax year to file amended personal returns.
BetterInvesting-style investment partnerships should not have a high audit rate. Investment clubs don’t have employees or business operations that generate tax liability. Keeping good records of your investment activities and filing timely partnership tax returns will limit the possibility of an audit.
A provision of the new rules may affect all partnerships. This is the requirement to have a partnership representative. This individual is authorized to be the sole representative of the partnership to the IRS in the event of an audit. If a partnership doesn’t have a designated representative, the law allows the IRS to appoint one. This representative isn’t the designated tax matters partner listed on Form 1065. In fact, the representative need not be a partner.
All articles I’ve seen from law firms explaining the new rules have recommended amending partnership agreements to include provisions for selecting a representative, informing the partnership of audit proceedings and setting limits on this person’s authority to bind the partnership to audit deals with the IRS.
Fortunately, the first returns that can be audited under the new rules are for tax year 2018, giving most clubs more than a year to plan. The exception is clubs that disband in 2018 and file a short-year tax return. The short-year return will be covered by the new rules. These clubs will need to make decisions before disbanding.
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