New partnership audit rules enacted into law on November 2, 2015 (the “New Partnership Audit Rules”) generally call for all determinations of adjustments to income and payments of tax pursuant to a partnership tax audit, which have historically been imposed on the partners, to instead be made at the partnership level. The New Partnership Audit Rules generally apply to all taxable years beginning after December 31, 2017, but partnerships are given the option of electing to apply these rules to any taxable year beginning after November 2, 2015 (the “Early Opt-In Election”). Effective August 5, 2016, the Treasury Department issued temporary and proposed regulations that provide guidance for partnerships choosing to make the Early Opt-In Election.
The temporary regulations and the identical proposed regulations, both issued last week, provide the time, form and manner for a partnership to make an Early Opt-In Election to have the New Partnership Audit Rules apply. These regulations generally condition the ability to make such an election on the partnership first having received written notice from the IRS that a partnership return for an eligible taxable year has been selected for examination and require that the election be made within 30 days of the date of such notice. The Early Opt-In Election must be made in writing, dated and signed by the tax matters partner or other person authorized to sign the partnership return for the year under examination, and include a statement, signed under penalties of perjury, that the partnership is electing to have the New Partnership Audit Rules apply to the partnership return selected for examination. In order to make this Early Opt-In Election, the partnership must represent in such statement that it is not insolvent and does not reasonably anticipate becoming insolvent, it is not in bankruptcy and does not reasonably anticipate being in bankruptcy, and it has sufficient assets and reasonably anticipates having sufficient assets to pay the potential underpayment that might be determined during the examination. An Early Opt-In Election is not valid if it frustrates the purpose of the New Partnership Audit Rules, which is to ease the burden of collecting partners’ underpayments of tax. Additionally, the Early Opt-In Election is not available if the tax matters partner has previously filed for an administrative adjustment request for the partnership under the pre-regulation rules or an amended income tax return has been filed for the partnership for the year under examination. Note also that a partnership that has not been notified by the IRS of an examination may still make an Early Opt-In Election with respect to an eligible year if the partnership files an administrative adjustment request with respect to its tax liability for such year. Administrative adjustment requests for a given return generally can be sought anytime within three years of its filing. However, in this specific case, such administrative adjustment requests must be filed after Jan. 1, 2018.
It is important to note that once a partnership makes an Early Opt-In Election it cannot revoke the election without the consent of the IRS. Therefore, it is important to ensure that any electing partnership is fully prepared to implement all aspects of the changes associated with the New Partnership Audit Rules. At a minimum, the existing partnership agreement will need to be amended to ensure that the appropriate provisions are included.
Given the number of changes created by the New Partnership Audit Rules, the possible tax disadvantages of being taxed at the partnership level, and the current lack of detailed guidance on their application, it is unlikely that many partnerships would find it advantageous to make the Early Opt-In Election. The Treasury Department itself notes in the proposed regulations that it does not expect a substantial number of partnerships to make this election. Although each situation is different, the best course of action for most partnerships may be to wait until the many uncertainties regarding the New Partnership Audit Rules are resolved with more thorough guidance from the IRS, which is expected at some point prior to 2018. However, the publication of these proposed and temporary regulations serves as a reminder to partnerships regarding the need to prepare for the eventual application of the New Partnership Audit Rules. We encourage you to contact your Locke Lord relationship attorney about this Early Opt-In Election and planning for the upcoming new rule changes.