When filing your 2019 partnership tax return you need to remember that IRS procedures for auditing partnerships changed in 2018.
The new audit rules can result in a partnership-level tax of 37 percent.
Summary of Old versus New Rules
Under the old procedures, if the IRS made adjustments to your partnership return, you would amend your individual tax return (Form 1040) to report the changes and pay the tax on those changes.
With the new partnership audit rules, your partnership pays an “imputed adjustment” in the tax year the audit concludes. The adjustment amount is equal to the net adjustment times the highest individual or corporation rate in effect during the adjustment year (currently 37 percent).
The tax and any penalty and interest assessed are now nondeductible partnership expenses.
Say Hello to Partnership Representative
The tax matters partner is being replaced by the partnership representative.
The three major differences with the new partnership representative role are:
- The partnership representative is the only person authorized to act on behalf of the partnership in an audit.
- The partnership representative does not have to be a partner, but must have a substantial presence in the U.S.
- The partnership and partners are bound by the partnership representative’s actions.
Problems That May Arise
There are two ways these new partnership audit rules can create a bad result for you and your partnership:
- The 37 percent tax rate is likely higher than the rate you’d pay on your individual tax return.
- If the current partners differ from the year under audit, then a partner who wasn’t involved at that time might pay tax on the partnership’s prior actions.
However, there’s no need to worry as there are two elections available to you if either of these problems impact you and your partnership.
Election 1: Elect Out of New System
Certain small partnerships may elect out of the new partnership audit rules. If your partnership opts out, you’re subject to the standard partnership audit procedures currently applicable to non-TEFRA partnerships. This generally results in each partner being audited individually with respect to any partnership item.
To qualify for the opt-out election, your partnership must have 100 or fewer eligible partners for the tax year, determined generally by the number of Schedule K-1s issued.
Your partnership makes the opt-out election annually on a timely filed partnership return, including extensions. Your partnership must notify each partner that it has made an opt-out election within 30 days of making the election.
Election 2: Push Tax to Partners
Your partnership can elect, within 45 days of receiving the notice of final partnership adjustment, to “push out” the adjustments to the partners who owned the partnership during the year under audit. Your partnership makes this election using Form 8988.
If your partnership makes the election, it isn’t liable to pay any of the tax; instead, you and the other partners are liable for their share of the adjustments and any tax, penalties, and interest associated with those items.
You won’t file an amended Form 1040 to report the partnership changes. Instead, you’ll compute the net tax change in the audit year (along with any subsequent affected years) and include the total tax adjustment on your Form 1040 in the tax year that you received the push-out statement from the partnership.
Example. In 2018, Lissette is a partner in Dix Hills, LLC. The IRS audits the 2018 partnership tax return and makes adjustments to it. Dix Hills, LLC makes a push-out election and sends Lissette her push-out statement on September 6, 2020.
Lissette determines that the adjustments will result in an additional $4,000 tax in tax due on her 2018 individual return. She will include the tax and any applicable penalty and interest on her 2020 Form 1040.
If you would like more information on how the new partnership audit rules apply to your situation, please contact us at 561-826-9303.