The Internal Revenue Service (IRS) has changed its methodology for auditing partnerships. Previously, any taxable income changes arising from an audit were reported on the partner, or member, personal income tax returns. The new methodology assesses the partnership at the highest statutory personal income tax rate of 37%. Depending on the personal tax rates of the partners/members, more tax may need to be paid at the partnership level than if the assessment was on the individual partners or members.
The first option is to execute an “opt out” election which is filed with the partnership tax return. The “opt out” decision can be made by the personal representative (formerly tax matters partner), who has to notify all other partners or members within 30 days of the partnership making the annual election.
The second option is to execute a “push out” election, which is filed within 45 days of an actual IRS audit adjustment on Form 8988.
These options are not available to partnerships with more than 100 partners and partnerships that have certain categories as partners.
The new partnership audit regime is effective for partnership tax years beginning after December 31, 2017. The regime requires the partnership to pay tax and related interest and penalties on any IRS audit adjustments unless certain elections are made. The elections are the “opt out” election and the “push out” election. Both elections allow the partners in the partnership at the time of the audit to pay taxes on IRS audit adjustments. However, the “push out” election requires the partners to pay a 2% higher interest rate on any underpayment.
The “opt out” election is made on a timely filed partnership tax return. Only certain partnerships are eligible to make the “opt out” election. An eligible partnership is one where:
- the partnership is required to furnish 100 or fewer statements to partners or nominees for the year, treating each statement that must be furnished to an S corporation shareholder as a separate statement and,
- each statement the partnership is required to furnish for the year is furnished to an individual, a C corporation, a foreign entity treated as a C corporation if it were a domestic entity, an S corporation, or an estate of a deceased partner.
Any partnership with single member limited liability companies, partnerships, trusts including grantor trusts and revocable trusts, other foreign entities not described above, disregarded entities, estates of individuals other than a deceased partner, or a nominee as partners are not eligible to make the election. Partners must be notified of the election within 30 days of the partnership making the election.
The “push out” election is made within 45 days of the date the final IRS audit adjustment is made by IRS. The 45 day period cannot be extended, and once made, the election may only be revoked with the consent of IRS.
The election may be made regarding one or more of the IRS audit adjustments.
A partnership making the “push out” election must furnish statements to the partners of the partnership during the IRS audit year within 60 days after the final IRS audit adjustment. The statement would include the IRS audit adjustments that would affect the partners’ return. Form 8988 is the form to make the “push out” election.
The election to revoke the “push out” election is made on Form 8989. The revocation election must be made before the partnership furnishes the required statements to the partners. The IRS must consent to the revocation.