I. Introduction
A. Existing Rules. Currently, federal tax audits of partnerships (and their partners) for tax years after 1982 are subject to one of the following procedural rules: (i) partnerships with more than 100 partners that elect the large partnership audit rules of Sections 6240 through 6255 and Sections 771 through 777 of the Internal Revenue Code of 1986, as amended (“IRC”), are subject to electing large partnership tax rules, (ii) partnerships that are not electing large partnerships and have more than ten partners are subject to IRC Sections 6221 through 6234, which were enacted as part of the Tax Equity and Fiscal Responsibility Tax Act of 1982 (“TEFRA”) (the “TEFRA Audit Rules”), and (iii) all other partnerships (those with 10 or fewer partners that have not elected the TEFRA Audit Rules) are subject to the general audit rules, whereby the tax treatment of an adjustment to partnership items of income, gain, loss, deduction, or credit is determined for each partner in separate administrative and judicial proceedings.
B. New Rules. The enactment of Section 1101 of the Bipartisan Budget Act of 2015 (the “2015 Act”) on November 2, 2015 drastically changed the rules relating to federal tax audits of partnership. The new audit rules, which are effective for partnership tax years beginning after December 31, 2017 and apply to all partnerships, completely overhaul the partnership tax audit procedures and raise numerous difficult questions regarding application of
the provisions of the 2015 Act. Effective for partnership returns for tax years beginning after December 31, 2017, these sweeping new rules (i) repeal the TEFRA Audit Rules and the electing large partnership rules, (ii) replace the “tax matters partner” provisions of IRC Section 6231(a)(7) with different “partnership representative” rules, and (iii) provide new procedures for determining and collecting partnership tax assessments. The 2015 Act seeks to streamline the procedures relating to IRS audits of entities taxed as partnerships, thus increasing the number of partnership audits, which historically had been very low due in part to the cost and complexity of dealing with numerous partners.
For simplicity and administrative convenience, the 2015 Act introduces a radically new mechanism that imposes the collection of tax, interest, and penalties resulting from the audit adjustments directly on the partnership. Under the new audit rules, tax from partnership audits is assessed and collected at the partnership level at the highest individual income tax rate,10 unless the partnership qualifies for and elects special procedures that either reduce such tax rate or shift the payment of tax to its partners. Significantly, such tax is imposed on the partnership during the year the audit is resolved, rather than for the year being audited, thus indirectly burdening those persons who are partners for the year the audit is resolved (even though the adjustments relate to partners for the year being audited).
