Congress has recently scrapped the existing procedures for IRS audits of partnerships. The new rules (the “BBA Audit Rules”1) are effective for partnership taxable years beginning on or after January 1, 2018. A partnership that fails to address key concepts of the BBA Audit Rules could make a partner indirectly liable for federal income tax of the partners assessed for a year prior to becoming a partner. Almost all partnership (and LLC operating) agreements will need to be amended at a minimum to clarify which partners will be liable with respect to audit adjustments asserted by the IRS.
Broad Scope: The BBA Audit Rules apply to all partnerships except for a limited category of small and mid-sized partnerships that are eligible to elect-out of the application of these rules.
Default Procedure—Partnership Liable in Adjustment Year: The BBA Audit Rules authorize the IRS to assess the maximum possible tax that could have been due at the partner level, plus applicable penalties and interest, against the partnership itself in the year the audit concludes, subject to certain adjustments.
Alternative Procedures—Reviewed Year Partners Liable: Partnerships desiring to completely avoid the default procedure of adjustment year partnership liability generally have two options:
Partnership (and LLC Operating) Agreements Require Amendment: Almost all partnerships and LLCs will need to amend their partnership agreements to address the following issues:
Small and Mid-Sized Partnerships Should Decide Whether to Elect-Out: Small and mid-sized partnerships should assess in advance whether they qualify to elect-out, and if so whether to do so.
1 New sections 6221 to 6235, and 6241, of the Internal Revenue Code.