Important: Action Required By All PartnershipsAnd LLCs Filing Partnership Income Tax Returns

 In 2015, IRS released new regulations creating the Centralized Partnership Audit Regime (CPAR).  CPAR changes the way partnership tax returns will be audited, beginning with the tax year 2018 return.  The changes are significant, and can have substantial negative consequences.  (When we refer to partnerships throughout this article, we also mean limited liability companies (LLCs) which file partnership returns with the IRS.)

Certain partnerships may opt out of CPAR, and generally speaking, we recommend doing so if you qualify.  However, a partnership in which an interest is held by any type of trust (including a revocable living trust, which is often used in estate planning), or an LLC (even if it is a disregarded entity) will not qualify to opt out.  Therefore, it’s important to verify the entity type of every partner of your partnership when putting together your tax information every year.

If your partnership cannot opt out, or chooses not to, you must name a Partnership Representative.  This person (or company) does not have to be a partner, but in the case of an audit, they will have sole authority to represent all partners and deal with the IRS, binding the partnership to any audit adjustments.  This is a serious responsibility and should not be taken lightly.  While we are available to represent partnerships before the IRS in an audit as your tax advisor, the Partnership Representative has a much deeper legal relationship with the partnership, and we cannot serve in that capacity.

If audit adjustments are made, the partnership will be required to pay any associated tax at the highest personal tax rate.  It is possible to reduce the tax paid by making a Pull Down or Push Out election requiring each partner to amend their personal returns to pay the tax at the individual level instead, but only the Partnership Representative may do so.  If tax is paid at the partnership level, the current partners will in essence bear the burden, even if they were not in the partnership during the year under audit.  Conversely, any partners who are no longer present but were during the year under audit, will have no financial responsibility.

As a result of the CPAR rules, you should meet with your attorney to update your partnership or operating agreement to address these issues:

• Require, prohibit or specify conditions for opting out of CPAR when eligible
• Consider whether to restrict ownership of partner interests by disqualifying entities
• Name a Partnership Representative (PR) for years subject to CPAR
• Define the PR’s duties to notify and communicate with the partners in an audit
• Require, prohibit or specify conditions for the PR to make Pull Down or Push Out elections when applicable
• Departing partners indemnify all other partners as to any tax liability related to years audited when they were still in the partnership.

This may also be a good time to review and update your partnership or operating agreement for other issues unrelated to CPAR.  For example, adding language to ensure partners may take a deduction for unreimbursed expenses such as mileage, home office, client meals, dues, licenses, etc.  Or perhaps you might add language regarding transfer of deceased partners’ interests to avoid probate and other legal costs.

Please contact your legal counsel to update your documents.  Many attorneys may be unfamiliar with these new rules and the implications of decisions to be made; if that is the case, you should include your tax advisor in those discussions to ensure you make informed decisions that are the most appropriate for your particular situation.

We would be happy to discuss any questions you may have about this or any other tax or business issues, please contact us to schedule an appointment if we may be of service.