Year-End Tax Planning: Partnership Tax Update
November 1, 2018 - By: SC&H Group
This year saw significant tax legislation and related proposed regulations issued that will affect every partnership. By now you have probably heard of the “Qualified Business Income” or QBI deduction which will provide up to a 20% deduction to many pass-through entities. The deduction is subject to multiple hurdles both at the reporting business level and at the individual level, so it is important that you discuss your situation with your tax advisor to determine if you are eligible and if not, what steps you should take now to become eligible for the deduction.
Another development this year is the manner in which the Internal Revenue Service (IRS) will administer audits of partnerships. The new Centralized Partnership Audit Regime is now in effect for partnerships, including limited liability companies (LLCs) that are treated as partnerships for tax purposes (which we refer to collectively as “partnerships”). The new regime replaces the old TEFRA rules and will make auditing a partnership much more streamlined and easier for the IRS. As a result, conventional wisdom suggests that the streamlined steps will also make partnership audits more frequent.
Under the new audit regime, all taxes and penalties resulting from a partnership audit are assessed and collected at the entity level, which means the partnership itself (rather than the affected partners) is liable for the assessment. This is a very important change which everyone who is contemplating being admitted to an ongoing partnership should consider.
Without prior planning a new partner may find themselves paying for the sins of an old partner if the partnership is subsequently audited. If partners’ interests varied over time, the assessment could create hardship as well.
Push Out Election
A partnership may be eligible to make a “push-out” election as an alternative and require the affected partners of the audit (which may include former partners) to take into account the adjustments and pay any taxes due as a result of those adjustments, provided that the necessary information is provided to the IRS.
Partnerships with 100 or fewer partners, all of which are eligible partners (i.e., individuals, C corporations, eligible foreign entities, S corporations and estates of deceased partners), may be eligible to elect out of the new partnership audit regime. Tiered partnerships with other partners or disregarded entities (grantor trusts, single member LLCs) as partners are not eligible. The election out of the new regime is made annually on the partnership’s tax return.
The new audit regime also changes the old Tax Matter Partner definition and creates the Partnership Representative role. The Partnership Representative has more power and has sole authority to act on behalf of the partnership. All partners are bound by the actions of the partnership representative, and partners have no statutory right to receive notice of or to participate in the partnership-level proceedings. This is a significant change from the TEFRA procedures, under which partners generally retained notification and participation rights in partnership-level proceedings. The Partnership Representative also need not be a partner in the entity under examination.
Steps to Take Before Year-end
With multiple tax law changes affecting this year we believe it is more important than ever to discuss the above changes with your tax advisor to ensure the partnership and its partners are in a position to take advantage of the new tax law changes and mitigate any associated risk related to the new audit rules.
Partnerships should consider discussing with legal counsel whether their partnership agreements need to be amended to reflect the new rules for both the centralized audit rules and the QBI deduction. For example, guaranteed payments received are ineligible for the QBI deduction; and it might be possible to structure profit sharing and distribution allocations to take advantage of the QBI without changing the economics of the deal. For partnerships with more than one trade or business, including one that is not eligible for the deduction, management should look to have separate accounting records to maximize the deduction.
Not all business qualify for the QBI. Some will clearly qualify, and some will not. There will be many businesses which are nuanced as it relates to qualifying and at what level. Discuss your particular situation with your advisor prior to year-end.
The new audit rules should be reviewed prior to any transfer of interests, admission of new partners or any other change which would reflect an ownership change. Partnerships should:
- Share any and all IRS correspondence with their tax advisor immediately to ensure adequate time to consider possible options.
- Consider whether their current choice for tax matters partner is appropriate when selecting a Partnership Representative.
Please contact us before year-end to discuss these points, the new rules, and other impacts of the recent tax law changes.