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Changes to Tax Audit Rules Will Impact Partnerships

How might my partnership be effected by changes to the tax audit laws?

The Internal Revenue Service will soon change the way it audits partnerships.  Starting January of 2018, new audit rules will impact several common types of business partnerships, including general partnerships, limited liability partnerships, and limited liability companies.  Business owners that operate under a partnership will need to make themselves aware of the coming audit changes and consider enacting appropriate changes to their operating agreements and partnership agreements to avoid any tax issues.

Owner vs. Partnership Liability for Audit Adjustments

Under the current laws, if the Internal Revenue Service initiates an audit of a tax return for an entity, it has the power to audit the entity itself or, in some cases, the entity’s owners.  If the IRS determines that there are adjustments to the tax return, these adjustments will be allocated among the partnership’s owners.  When the adjustments along with the owner’s other taxes result in additional tax, then the partnership owner bears the responsibility for paying it.  

As of January 1, 2018, the IRS can still audit the entity, but it will now instead be entitled to collect tax based on any audit adjustments from the entity directly.  In short, under the new rules, the partnership, whether it be a general partnership, limited liability company, or the like, will be liable for any additional taxes, rather than the owners.  

Further, tax rate calculations will also be impacted by new laws.  Instead of calculating taxes based on the tax rates of each owner, the tax from the entity will be calculated by applying  a flat tax rate for audit adjustments.  There are several ways in which the tax payable can be reduced.  Your tax attorney can assist you in utilizing the new tax laws to reduce the amount of tax you may be forced to pay as a result of an audit.

Opting Out of the New Audit Process

Smaller entities with under 100 owners may elect to opt out of the new audit method.  The decision to opt out must be made in an annual election and will need to be included on a timely filed partnership return.  Not all entities will meet the requirements for opting out of the new regime.  

In light of the new audit laws, business owners should consider meeting with a tax and business law attorney to modify partnership agreements to ensure you are protected to the fullest extent.  

Posted in: Tax Audit

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