Included as a revenue offset in the budget legislation (H.R. 1314) signed by President Obama are provisions that simplify the procedure for the Internal Revenue Service to audit and collect adjustments from partnerships. The new rules, which are generally effective beginning 2018, permit the IRS to send the bill for a prior year’s tax deficiency to the partnership, which would then have the obligation to pay the deficiency, unless the partnership elects an alternative payment procedure. The alternative payment procedure permits partnerships to pass the adjustments and related taxes back to the applicable partners, who will pay this additional tax in the year they are notified of the deficiency and will not be required to amend their prior years’ federal returns. (Partners will still be obligated to report the adjustments on amended state tax returns, unless the applicable state adopts similar procedures.) The details for making this election will be set forth in forthcoming US Treasury regulations.

It is expected that hedge funds will elect to make this election, so that current partners do not bear the cost of taxes associated with income and gain earned by other partners in prior years. Investment funds should review their fund documents to determine whether they provide the necessary flexibility to permit the funds to make and implement this election.

Partnerships with fewer than 100 partners each of which is either an individual, a C corporation, an S corporation or an estate of a deceased partner, may elect out of these new rules. Most hedge funds have trusts (e.g. pension trusts) or other partnerships as partners, and therefore will be subject to the new audit procedures.

The IRS is expected to issue guidance implementing the new rules.