Effective for tax returns filed for tax years beginning in 2018, the Centralized Partnership Audit Regime (CPAR) takes effect for IRS audits.
What does this mean for your partnership, or LLC treated as a partnership, for tax purposes?
- Adjustments to a partnership’s tax liability as the result of an IRS audit will be made at the partnership level. Under previous rules, any audit adjustments were passed through to the partners resulting in an increase or decrease to each partner’s taxable income.
- The partnership will pay any tax due at the highest individual or corporate tax rate for the year being audited. This could result in more tax being paid than if the tax was computed at the partner level, as partner-level tax rates could be lower.
- Current partners will shoulder any tax due as a result of an audit, even if they were not partners in the past year being audited. For example, if the year audited is 2017, but the tax liability from this audit is paid in 2019, the 2019 partners will bear the tax burden.
What are a partnership’s options under CPAR?
- An Elect-Out option allows eligible small partnerships with 100 or fewer partners to elect out of the CPAR rules for any tax year. This election must be made when filing your tax return for the corresponding year. However, a partnership with the following entities as partners – trusts, partnerships, disregarded entities, certain foreign entities, and certain estates – is not eligible to make this election.
- A Push-Out Election allows partnerships subject to the CPAR to shift the tax responsibility back to the partners by issuing a statement within 45 days of receiving a notice of adjustment from the IRS.
- A third option allows partnerships subject to the CPAR to amend the partners’ Schedule K-1 so that the partner may file an amended return and pay the tax due in full. This option requires the participation of partners from the year being audited.
What additional steps are required of partnerships subject to the CPAR?
- A Partnership Representative must be designated which replaces the Tax Matters Partner (TMP). The Partnership Representative:
- has sole authority to act on behalf of the partnership in all federal tax assessment matters including the power to bind the partnership and the partners to an IRS audit adjustment, to decide whether to seek judicial review of an IRS determination, and whether to push out the underpayment liability to the audit year partners as described above
- does not have to be a partner
- must have a substantial presence in the U.S.
- is designated each year on the partnership’s tax return and is only effective for that year
- Partnership and operating agreements must be reviewed and updated to ensure that the agreements are consistent with the CPAR’s requirements including the duties of the Personal Representative. Some items to consider are:
- Partnership Representative’s duties
- Designation and removal process for the Partnership Representative
- Indemnification of the Partnership Representative
- Partners’ consent for any elections or settlements made by the Partnership Representative
- Partnership Representative’s ability to seek outside advisors
- Restricting transfers of partnership interests to eligible partners under the elect out rules
- When should a Push-Out Election be required
- Requirements for partners to provide needed tax information
This article briefly summarizes some of the provisions of the CPAR and how it affects your tax situation. Each entity should assess these changes in correlation with their trusted tax and legal advisors, and we are available for consultation.