In 2015, The Bipartisan Budget Act of 2015 (BBA) was enacted to replace the existing rules for auditing partnerships/LLCs (the “partnership”) with more than 100 partners, or partnerships with 100 or fewer partners that have only individuals, corporations or an estate of a deceased partner as partners/members and which elect out of the new audit rules, with a new set of rules that took effect for taxable years beginning on or after January 1, 2018.  In general, under these rules, audits will take place at the partnership level.  This is consistent with the “tax matter partner” audit rules still effective for taxable years beginning before January 1, 2018.  Among the major differences, however, subject to a “push-out” election, any adjustment will be taken into account only at the partnership level, and any taxes will be paid by the partnership, not by the partners.

Under the BBA, each partnership must designate a partner (or other person or entity, which does not have to be a partner) as the “Partnership Representative”  The Partnership Representative in turn will appoint an individual (a “Designated Individual”).  It is this Designated Individual who will have the sole authority to deal with the IRS, and act on behalf of the partnership for the audit, and to make all decisions, including those pertaining to any settlement or litigation.  All partners, as well as the partnership, are bound by the actions taken by the Designated Individual at any time during the audit, as well as any final decision during any audit-related proceedings.  The partnership agreement can place contractual limitations on what the Partnership Representative and Designated Individual can agree to; although not binding on the IRS, these limitations place a contractual limitation on such actions and decisions.  Significantly, under the BBA, if the partnership does not designate a representative the IRS is allowed to select “any person” with a substantial presence in the United States as representative.  Thus, it is important for the partnership/operating agreement to designate a Partnership Representative. 

Another significant difference under the BBA is that any adjustment for a tax year of the partnership (a “Reviewed Year”), and the resultant tax, is determined at the partnership level (an “Underpayment”), and the payment is determined using the highest individual or corporate rate of tax.  Any penalties are also determined at the partnership level.  Thus, effectively, the partners in the audit year would bear the cost of any assessment at the partnership level even if they were not partners in, or their partnership interest changed from, the Reviewed Year being audited.

However, the BBA may allow the partnership to elect (a “Push-Out Election”) to provide amended Schedule K-1s to its partners during the Reviewed Year instead of being subject to payment by the partnership.  If so elected, each partner during the Reviewed Year takes into account its share of the adjustment.  If the Push-Out Election is not made, or not permitted to be made, and it is desired that each person who was a partner bear its share of the Imputed Underpayment, the partnership agreement can provide that any person who was a partner during the Reviewed Year, including those no longer partners in the year in which a Partnership Adjustment is made, or whose interest in the partnership has changed, shall be required to make a contribution to the partnership in proportion to its share of such adjustment in the Reviewed Year, thus providing funds from those partners to allow the partnership to pay any Imputed Underpayment due by it.

These rules are subject to further review and guidance by the IRS and may continue to evolve.  However, it is important that each partnership strongly consider amending its partnership agreement to incorporate language dealing with these new audit rules, such as naming a Partnership Representative and a Designated Individual, with respect to taxable years beginning on or after January 1, 2018, providing any desired contractual limitations on their powers, addressing if a Push-Out Election is desired, and providing for contribution to the partnership by the partners during the Reviewed Year to contribute any monies the partnership might require to pay the IRS at that level.  For partnerships that existed before 2018, its agreement should also have tax matters partner language since those rules continue to apply to pre-2018 taxable years.