Partnerships and LLCs have grown in popularity given their governance flexibility, liability protection, special income and deduction allocations, and the single level of taxation they provide to partners. However, due to a lack of resources, the IRS only audits less than 1 percent of partnerships and collects little tax from these audits. To make it easier for the IRS to audit partnerships and collect the tax, the Bipartisan Budget Act of 2015 was signed into law in November 2015, ideally resulting in a significant increase in tax revenue.
While the new partnership audit rules address many longstanding challenges to the IRS’ ability to effectively audit partnerships, they also generate new challenges. These provisions shift the economic burden for past years’ tax liability to the adjustment year, leaving partners potentially responsible for tax attributable to years in which they did not have an ownership interest.
Partnerships will need to take these provisions into account and make appropriate revisions to their partnership agreements. Partnerships, including LLCs and other business entities treated as partnerships for federal tax purposes, should carefully consider today how they will navigate these new rules in the future.