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Bipartisan Budget Act of 2015 Changes Tax Treatment of Partnerships
Signed by President Obama, November 2, 2015, the Bipartisan Budget Act of 2015 made fundamental changes to tax treatment of partnerships.
Tax Representative Replaces the Tax Matters Partner.
Under current law (TEFRA), a partnership (or LLC reporting as a partnership) is represented by a “Tax Matters Partner” (TMP). The partnership may designate the TMP who must be a general partner (or member) with a profit interest. If no TMP is designated, the IRS will treat the partner with the largest profit interest as TMP. The Bipartisan Budget Act of 2015 eliminated the Tax Matters Partner and replaced it with the “partnership representative.” A partnership or LLC is now free to designate a partner or any other person as its Partnership Representative. No income or equity interest is required. The Partnership Representative can bind the partnership and the partners.
Audit Procedures under TEFRA Repealed - Partnership Itself Taxed:
Generally speaking, the Bipartisan Budget Act will impose a tax liability for tax increases from an audit on the partnership itself rather than passing that increased liability through to the partners.
The Internal Revenue Code treats a partnership as a “flow through” entity. The partnership itself is not taxed. A partnership reports each partner’s or member’s “distributive share” of income or losses using a Form 1065 K-1 which is similar to a W-2. The partners or members report their “distributive share” of income or losses from the partnership and pay taxes accordingly. The partnership pays no taxes on its income. Its partners pay taxes on their distributive shares.
The Statute of Limitations for each partner’s tax liabilities are frozen during the partnership audit. Once that audit is completed, the IRS issues a Final Partnership Administrative Adjustment (FPAA). The TMP may appeal the FPAA to the Tax Court on behalf of the partnership within 90 days. If the TMP does not file an appeal, any notice partner may appeal within the next 60 days.
Each partner’s individual taxes are adjusted in accordance with the adjustments from FPAA or any Tax Court appeal. This process matches income and losses attributable to the partnership with the partners at the time of the tax return.
The Bipartisan Budget Act of 2015 repealed TEFRA for years beginning after December 31, 2017. In the case of an adjustment to income, gain, loss, deduction, or to a partner’s distributive share:
– The partnership must pay the tax on any underpayment of tax and
– Any adjustment that does no result in an underpayment is made in the year of the Final Partnership Adjustment (FPA).
Any audit adjustment shall be determined at the partnership level. Any tax, penalties, and interest from any adjustment shall be assessed and collected at the partnership level. In the case of an partnership audit, the IRS issues a Final Partnership Adjustment (FPA) to the Partnership Representative. The tax liability will be based upon the “imputed underpayment” at the highest individual or corporate tax rate for the year in issue.
The partnership may appeal the FPA to the Tax Court, US District Court, and The Claims Court. In the case of the District Court and the Claims Court, the partnership must make a deposit of the amount of tax per the FPA with the IRS prior to filing suit.
Opt Out Provisions:
Partnerships or LLCs which meet the following requirements may opt out of the partnership audit procedures under the 2015, the Bipartisan Budget Act of 2015:
– Fewer than 100 K-1's ,
– Each partner or member is an individual, a C-Corp, a foreign entity that would be treated as a C-Corp, an S-Corp, or an estate of a deceased partner,
– Election must be made annually for each tax year,
– Partnership must notify each partner of the election, and
– Each partner must treat each item of income his, her, or its tax return consistent with the treatment on the partnership return.
The IRS may assess tax for any failure by an individual partner to treat an item in a consistent manner may as a mathematical error. Thus there is no notice of deficiency procedure.
Impact of the Act:
The Bipartisan Budget Act of 2015 makes fundamental changes to the treatment of partnerships under audit. There are a host of issues that affect any business partnership or LLC taxed as a partnership. Among others, these stand out. Unless the partnership or LLC taxed as a partnership opts out, there is no pass through of adjustments from an audit to the partners at the time of the original return. Instead, the partnership itself is taxed at the highest tax rate of its members. If there has been a change in partners, the new partners rather than the original partners bear the burden. Since the opt out provisions are conditional and must be made annually, it is imperative that buyers and sellers of any partnership interest address this risk. Partners and LLC members should review the partnership or organizational agreement to address designation of Tax Representative.
H.R.1314 - Bipartisan Budget Act of 2015
© 2016 Daniel L. Britt, Jr., Britt & Associates Attorneys, LLC, http://www.brittanda.com/
Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA).
Subchapter K, of Internal Revenue Code.
 Section 6621 of the Budget Act,