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New IRS rules could mean more partnership audits in future

Forewarned is forearmed goes the old proverb. Advance knowledge of potential holes in the road makes it easier to avoid hitting them. That’s true for driving, especially here in Minnesota and Wisconsin as the seasons shift from winter to spring. The wisdom also applies to tax issues. Knowing the possible pitfalls associated the IRS tax code makes it easier to avoid disputes over incorrectly filed returns or the resulting audits.

Considering how massive bills that clear Congress can be, it should come as no great surprise that sometimes changes get overlooked. There is one change in the Omnibus Spending Bill that Congress approved last December, however, that those experienced in tax law recognize as deserving particular attention. 

It involves changes in how partnership audits are handled by the IRS. One attorney calls it “A seismic shift” that is going to lead to audit aftershocks for years to come. The specific alteration he’s referring to is in Subchapter K of the 2,009-page spending bill.

Historically, partnerships have been considered pass-through entities. The partnership is not responsible for paying federal income tax, the individual partners are. If a partnership audit were to result in any adjustment in tax liability, that obligation would pass through to the individual partners, as well.

But experts say the rules change with the new budget act. Starting in 2018, if a partnership audit results in an increased tax liability, the IRS will be allowed to hold the partnership responsible for it, not the individual partners. The way to avoid this and retain the pass-through is for the partnership members to formally opt out of the new rule.

Because auditing at the partnership level is easier than auditing each individual partner, the prediction from many experts is that the IRS will step up its partnership audits.

Despite the distant time horizon of 2018, many observers agree partnerships should begin considering the implications of the law now and plan to take appropriate action.

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