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Mitigating the Potential Consequences of Partnership Audit Changes
Partnerships (which, for the purpose of this article, include limited liability companies treated as partnerships for tax purposes) have long been considered a flexible way of structuring investment arrangements and closely held businesses. Partnerships are not subject to entity-level corporate taxation and, unlike S corporations, they have flexibility to use special allocations and preferential distribution arrangements and to have various types of owners. However, partnership audit changes present increased exposure to partnerships and their partners, and future legislation may curtail much of the flexibility associated with partnerships. Now is a good time for partnerships and their partners to take steps to mitigate the potential consequences of the audit changes, and to anticipate potential legislative developments.
The partnership tax rules were intended to promote flexibility. However, that flexibility often results in complexity, which can sometimes allow partners to obtain benefits that were not contemplated by the tax law. The government has historically respected most partnership transactions reflecting that flexibility because adverse partner interests limit opportunities for obtaining unintended benefits. But by the mid-2010s, the IRS had become increasingly frustrated with difficulty in auditing partnerships and their partners. Congress responded by enacting a new audit regime as part of the Bipartisan Budget Act of 2015 (the BBA), and that regime generally became effective in 2018.
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