In 2015, Congress repealed the complex and heavily criticized Tax Equity and Fiscal Responsibility Act of 1982 (“TEFRA”) partnership-level audit rules which apply to partnerships and most LLCs. The new audit rules, which Congress adopted in place of the TEFRA rules, go into effect in less than a month (on 1/1/2018). This change in audit rules will have a direct impact on the healthcare industry since many healthcare entities, such as physician practice groups, medical device companies, and diagnostic laboratories, are organized as partnerships or LLCs. Now is the time to update all partnership agreements and LLC operating agreements to include these new IRS audit rules.
Under the new law, a partnership audit will focus on the tax year the IRS selects for review (the “reviewed year”), but any proposed or resulting tax deficiency will generally be payable by the partnership in the year the IRS concludes the audit. As a result, a partner who was admitted to the partnership after the reviewed year might bear the burden of tax deficiencies generated in prior “reviewed years” when he was not yet a partner.
Certain partnerships having 100 or fewer partners may elect out of the new audit rules, but only if all of its partners are individuals, C corporations, foreign entities which would be treated as a C corporation, S corporations, or estates of deceased partners. This “election out” must be made annually by the partnership. A partnership which elects out of the new rules is subject to the pre-TEFRA partnership audit rules, which require separate IRS audits of the partnership and each of its partners.
In addition to the “election out,” a partnership may (within 45 days after the receipt of the notice of final partnership adjustment) elect to “push out” the partnership’s tax deficiencies to each person who was a partner during the reviewed year.
A partnership must also designate a “partnership representative,” who must be a partner or other person with substantial presence in the US. The partnership representative has sole authority to act on behalf of the partnership vis-à-vis the IRS, and the partnership and all partners are bound by the actions taken by the partnership representative.
All existing partnership agreements and LLC operating agreements should be reviewed and updated as soon as possible for the changes highlighted above as well as for other changes from the new audit rules.
For more information on this issue, please see the IRS Bulletin containing the proposed regulations implementing the new partnership audit rules available here.