New question number 25 on Schedule B of the partnership tax reporting Form 1065 is a reminder that for taxable years beginning after December 31, 2017, the way the IRS will audit a partnership for making adjustments of reported taxable items has changed.
The new question asks, “Is the partnership electing out of the centralized partnership regime…?” Why ask this question? Well, a partnership with 100 or fewer partners can make an election to “opt out” of the new IRS audit rules, which require any partnership that has return adjustments to be made at the partnership level, including payments related to those adjustments, rather than having them done at the partner level. However, it should be noted that determining the number of partners in a partnership isn’t as easy as just counting them. A partnership that has an S corporation as a partner counts each shareholder in the S corporation as a partner. A partnership cannot make the annual election out if it has any of the following types of partners: another partnership, a trust, or a disregarded entity.
Other partnerships, those that don’t qualify for the annual election, can still elect to have the partners, rather than the partnership, pay any tax liability by making such election no later than forty-five days after the date of an IRS notice of final partnership return adjustments is made.
While the question as to whether the partnership will elect out or not seems rather simple, in application, it can present differences of opinion among partners. The cost associated with the partnership having the administrative burden for handling the IRS adjustments and resulting payments could prove extremely difficult for some partnerships. Therefore, the decision to elect out should be addressed with the partners, and the decision reached regarding the election in or out should be memorialized in a new partnership agreement provision. Also, considering that for the next few years both the old and new IRS audit rules could apply, having both potential audit regimes covered in the partnership agreement would be desirable.
For a more complete analysis and discussion of the new partnership audit rules and consequences, which all partners of any partnership should be aware of, see our previously published insight or contact Adam Sweet, (509.252.4019) Director of the Eide Bailly National Tax Office Pass-Through Consulting Group, Todd Laney (208.383.4733) or Larry Evans (405.594.2028).