Last week the Senate passed H.R. 1314 (The Bipartisan Budget Act of 2015), which will completely change the way partnerships (and LLCs taxed as partnerships) are audited.  The House passed the legislation on Wednesday and it is reported that President Obama will sign the legislation as soon as it reaches his desk.  As discussed in Tuesday’s blog, this legislation will make it much easier for the IRS to audit partnerships and will also allow the IRS to assess and collect the proposed additional tax against the partnership itself as opposed to being required to assess the individual partners.  Although the legislation implies it is only applicable to partnerships with over 100 partners, it can apply to even a two-partner partnership if one of those partners is itself a partnership.  Although the legislation has a two-year delayed effective date, it is important to plan for this immediately in terms of drafting partnership agreements.  For example, because the IRS will no longer notify the individual partners of an audit, the partners may insist in the partnership agreement that the partnership notify them of an audit and obtain partner consents relating to certain audit elections or IRS settlements.  The legislation’s section-by-section summary provides a general overview of the new rules.

Note that the legislation also removes Section 704(e)(1) to eliminate the presumption that one is a partner for tax purposes merely because they have a capital interest in the partnership.  This change was likely in response to the taxpayer arguments found in the 2012 Castle Harbour decision discussed in our 2012 blog where a debt-like partnership interest was argued to qualify as partnership equity based on this Section 704(e)(1) language.  Now the Section 704(e) rules are more clearly limited to the context of gifted partnership interest.