The Bipartisan Budget Act of 2015 (the “BBA”) enacted a new partnership tax audit regime that applies to all partnership audits for tax years commencing January 1, 2018 or later. The new regime includes many provisions that are unfavorable to taxpayers undergoing an audit. However, certain taxpayers may enjoy a tax audit benefit under the new rules.
One of the benefits provided to taxpayers is the ability of eligible partnerships to elect out of the new rules. If a partnership elects out of the new rules, the IRS is required to audit each partner individually. In other words, these partnerships would be immune from some of the annoyances of a tax audit. Additionally, in the case of a partnership with a large number of partners (or at least a large number of partners relative to the total income or loss of the partnership), the IRS would be unlikely to pursue each partner to collect a small amount of additional tax. Therefore, partners and partnerships electing out of the new rules should be less likely to be drawn into time consuming audits of minor issues. Note, however, the IRS has stated that a partnership’s decision to elect out of the new centralized audit rules will not deter the IRS from pursuing an audit of the partnership’s income.
Eligible partnerships are those partnerships that have 100 or less direct or indirect eligible partners. Generally speaking, each of the partners must be either a real live human being (i.e., disregarded entities owned by individuals are excluded from the definition of eligible partners) or a corporation. If an S Corporation is a partner, then the shareholders of the S Corporation are also counted towards the 100 partner limit.
Given the benefits of electing out of the new rules, eligible partnerships may want to ensure that they remain eligible for electing out by including transfer restrictions in their operating agreement.