Updated – IRS Ramps Up Partnership Audits. Are You Ready? by Joseph Leocata, JD, CPA, MBA
Significant time has lapsed since Congress introduced new rules for partnership audits under the Bipartisan Budget Act of 2015 (BBA). However, with the benefit of an unprecedented additional $80 billion in funding, the IRS plans to ramp up its enforcement efforts in the years ahead. This will put a growing number of partnerships of all sizes under the microscope and expose them to a heightened risk of complex, lengthy and costly IRS audits. In fact, IRS commissioner Daniel Werfel noted on Sept. 7, 2023, that the agency already identified balance sheet discrepancies for hundreds of hedge funds, real estate investment partnerships, publicly traded partnerships and similar entities with assets of more than $10 million. The IRS expects to begin issuing examination notices to these partnerships as early as October when it also plans to pursue 1,600 millionaires with at least $250,000 in outstanding tax debt.
The BBA ushered in a centralized partnership audit regime (CPAR) effective for tax years beginning January 2018. The law effectively shifts the burden to correct underreported taxes identified by an IRS audit from the individual partners to the partnership entity, which must remit an imputed underpayment (IU) at the highest individual tax rate in effect for the adjustment year (37 percent in 2023), rather than the audit year, plus penalties and interest.
To account for the change in responsibilities for all adjustments of partnership income, gains, losses, deductions, credits, and related penalties and interest, the BBA requires partnerships to follow certain requirements on timely filed tax returns. This includes having in place a partnership operation agreement and designating a partnership representative (PR) to serve as the point person for communicating with the IRS and making decisions on behalf of all the members of the partnership. Additionally, the law allows eligible small partnerships to annually elect out of the CPAR, shifting the audit focus back to its individual partners who can avoid a common BBA risk of finding themselves liable for tax benefits former partners received erroneously in prior years.
How to Respond to an IRS Notice of Examination
There is no cause for alarm when receiving a notice of selection for examination from the IRS, but a timely response is required. Partnerships should contact their accountants who hopefully have experience representing businesses before the IRS in matters of tax controversy. These professional advisors can work closely with the partnership’s PR to determine the appropriate next steps, which often include the timely filing of an administrative adjustment request (AAR) to make adjustments to partnership-related items on an originally filed partnership tax return.
The AAR, which a partnership’s personal representative must file electronically on IRS Form 8082, Notice of Inconsistent Treatment or Administrative Adjustment Request (AAR), replaces the act of filing amended tax returns and reissuing Schedule K-1s to show partners their individual shares of the partnership’s income, losses, deductions and credits.
Instead, the AAR requires the partnership to calculate whether the adjustments requested by the IRS result in an IU that the partnership must report on the AAR and pay along with the AAR filing. It is important to note, however, that payments the partnership makes relating to imputed underpayments, interest or penalties are non-deductible and must be treated as a partnership expense. Moreover, partnerships must recognize that they typically have a mere 30 days after receiving a notice of examination to file an AAR. Once they receive a notice of administrative proceedings indicating that the IRS has initiated an examination, the partnership cannot avail itself to an AAR.
About the Author: Joseph Leocata, JD, CPA, MBA, is a senior manager of Tax Services with Berkowitz Pollack Brant Advisors + CPAs, where he works with individuals and businesses on a broad range of federal, state and local tax issues, including representation before the IRS on tax controversy matters. He can be reached at the CPA firm’s New York City office at (646) 213-7600 or info@bpbcpa.com.
← Previous