The new Bipartisan Budget Act of 2015 could have massive tax implications for partnerships
Congress recently revamped the rules by which the IRS examines partnerships for tax purposes with the repeal of the Tax Equity and Fiscal Responsibility Act of 1982. TEFRA rules, otherwise known as unified audit and litigation procedures. The TEFRA rules were replaced under the Bipartisan Budget Act of 2015. The new rules to simplify the IRS's examination of partnerships, assessment and the collection of taxes from them. The essence of this change is that it will permit the IRS to collect more tax without increasing staff. These new tax rules will be applied to certain partnerships on Jan. 1, 2018.
The new Bipartisan Budget Act of 2015 rules
With the repeal of TEFRA rules, the IRS now requires entities to designate a powerful partnership representative rather than a tax matters partner. The rules also removed partners of notice and participation rights for partnership-level examination and litigation. In addition, IRS will switch to default collection procedures from the partnership for any additional taxes or penalties that exist at the partnership level. What this means for partners is that they should review the provisions of their partnership agreements and adjust their tax representation and procedures accordingly.
A notable example of these changes under the new rules involves smaller partnerships. Specifically, any partnership with fewer than 100 partners can opt out of the tax examination and collection regime under the Bipartisan Budget Act. But to qualify for this opt-out clause, those partnerships need to consist either solely of individuals, C corporation, foreign entities that are treated as C-corps, S corporations or estates of deceased partners.
It is important to note though, while grantor trusts and limited liability companies with only one member are currently treated as individuals for tax purposes, the new rules deem them as a partnership. That means they are ineligible for the opt-out provision. This is an indirect attack on planning techniques that are not favored by this administration.
These strict stipulations under the new rules are meant to simplify IRS tax treatment of partnerships by clearly defining them. But for those unaware of the new rules or the statutory opt-out provisions, the IRS is seeking comment for possible further regulations to resolve issues of interpretation.
Why the IRS seeks comment
The intentions of the Bipartisan Budget Act of 2015 rules have been well known for some time, but the bill was quickly drafted. Congress also followed this bill with the enactment of the Protecting Americans from Tax Hikes (PATH) Act of 2015 to address technical issues and ambiguities. So there were concerns over whether the IRS would fill in gaps in the legislation.
This is why the IRS then issued Notice 2016-23 to seek comments about the new tax collection regime under the bill. As the potential tax ramifications are significant for partnerships and limited liability companies, the IRS seeks comment on several specific stipulations. The most notable listed on the IRS website include:
- Partnership representatives.
- Tax calculations at the partnership level.
- Revised K-1 and push-out procedures.
- Administrative adjustment requests at the partnership level.
- General procedural rules.
The significance of the bill for existing partnerships
The Bipartisan Budget Act's new tax audit and collection regime has understandably caused some concern among partnerships and limited liability companies. This is primarily due to the favorable state and federal income tax rules that existed for both partnership and limited liability companies. But as there are several new legal ramifications involved in the regime that could affect post-adjustment tax items, existing partnerships should examine their partnership agreements to accommodate the new rules. In fact, one way these entities can proactively adjust is to modify their partnership agreements to align with the new rules prior to the deadline. This would retroactively adjust to the tax ramifications before the enactment date, thereby avoiding any penalties or additional taxes.