Ok, so maybe – just maybe – the title is a bit facetious. But what’s not funny is the new partnership audit rules.

First, let’s review the old audit rules, the ones that were in place until 2017 (and which themselves drove auditors crazy):

Under the old rules, the IRS would audit the partnership return. Then, if changes were made to the return, the adjustments were passed through to the partners. If the change resulted in tax due, the IRS would collect from the partners their respective share. As you might guess, this got to be problematic, especially when a large partnership was the target of the audit. It’s tough to collect from 1,400 partners, and when the individual partner’s liability might be small, not very cost-effective, either. To compensate, Congress or the IRS would tweak the rules, making a cumbersome process confusing at best (thus driving auditors crazy, as they tried to figure out what rules applied to each audit).

Fine. A change was needed.

And so a change was made. Partnerships would still be audited at the partnership level (a lesson learned under the old, old rules, where individual partners were audited, and inconsistent results arose as a result). But that was where the similarities ended.

Under the new rules, partners don’t have to be notified that the partnership is under audit. Furthermore, the partnership can elect to whom the changes are passed – the parties who held partnership interests during the year under audit, or the parties who currently hold partnership interests. Consequently, a partner who bought a partnership interest in 2019 could find themselves on the hook for a liability that arose in 2018 – when they didn’t own the interest – a nasty surprise. On the upside, the partnership no longer has a Tax Matters Partner, but a Partnership Representative – and they don’t have to be a partner. But be careful – if you don’t tell the IRS who your representative is, the IRS can pick someone for you!

So what are you to do if you are a partner in a partnership?

Here are a few suggestions:

1. If you haven’t invested yet, make sure you clarify whether the partnership is under audit or has any potential tax liabilities. You don’t want to be buying a tax liability.
2. Make sure you also clarify that the partnership can elect to pass through changes to old partners (commonly called a push out” election). Partnerships with less than 100 partners can do this with certain exceptions.
3. Make sure the partnership actually makes the election (it’s an annual one, so keep checking back).
4. Make sure you know who the Partnership Representative is.
5. If you’re already in the partnership, consider amending the partnership agreement if possible.

That last one – amending the partnership agreement (you do have one, right?) is the best course of action to protect the partners. Of course, you may not have the authority to change the agreement, or the ability to do so, but if you do, you should definitely give it some thought. Among the things to consider adding or changing:

1. Requiring the partnership to notify the partners of any audits. You may want to also consider to what extent partners are to be updated, and if/how a partner can influence the audit.
2. For partnerships than can make the push-out election, requiring the partnership to restrict transfers of ownership to only those parties that will not disqualify the partnership from the election. Note that this could potentially mean forcing a partner to divest their interest when they cease to qualify.
3. Who gets to be the Partnership Representative, how they are chosen and how/when to change a representative.

This is just a small sampling of the total impact of the change in partnership audit rules (if it had been a full report, you would be asleep by now). If you’re invested in, or a general partner in, a partnership, and you want to know the full impact of these changes (or what you should do), don’t hesitate to call us. We’re happy to help.