“It’s really important to have an annual conversation, discussion, with your tax advisor on what is the [] best, you know, route to proceed with [the BBA Rules] because it’s not a one-size-fits-all. [] Businesses are complicated and, certainly, opting out may seem great, but there could be reasons why it doesn’t make sense to do that.”
The Bipartisan Budget Act of 2015 (BBA) changed the IRS’s audit rules for partnerships for years beginning January 1, 2018. But with everything else going on in the world and in business, including the Tax Cuts & Jobs Act (TCJA) and other tax reform, these changes have flown a bit under the radar. And even though they may seem like subtle changes on the outside, the new BBA audit rules really have far reaching implications to members of partnerships.
The IRS initiated the change in audit procedures for partnerships to streamline the audit and tax collect process. The new BBA rules create a default rule in which the IRS is going to come in and make an assessment, and the partnership is going to pay the tax at the highest marginal rate. The new procedure can be problematic for partnerships because taxes are paid at the highest marginal tax rate. And, when you get down to the individual returns, there are other income deductions and credits that could ultimately reduce that tax liability.
One thing the IRS did when they passed these new BBA rules is provide some flexibility that allows partnerships to elect out of the new rules and continue to use the existing partnership audit rules. The election is made on an annual basis. In order to qualify to make the election you need to have fewer than 100 partners. Eligible partners include individuals, C corporations, S corporations, and tax exempt entities. So having partners that are other partnerships, LLCs, or trusts, even if you hold a trust as a revocable trust, disqualifies you from this election. If you do not opt out, it’s equally essential to review and update your operating agreement accordingly.
Under the old rules, the tax is collected by the partners of that tax year. So it allows the partners to use other tax attributes at their own personal level to potentially reduce the tax. On the other hand, the default BBA rule is very penalizing, as you could have potential issues where the partnership gets audited and you may have a different set of partners that are paying for the tax. It also restricts your ability to amend returns, kind of old school style, you know, amend the partnership returns issue amended K-1s because you have to go through this new procedure.
In a pushout election, there is really no substantial tax savings. The reason you may want to do the pushout election is if you had a different ownership in the year that the audit covers versus the tax year the IRS is auditing. One downside to the pushout election is that, when the partner does pay the tax on their personal return, there is a 2% interest charge with it.
Contact Albin, Randall & Bennett
Partnerships need to understand the pros and cons of electing out, using the preexisting IRS audit rules, or the pushout provision. The best route to proceed is not a one-size-fits-all solution, but ARB’s Business Tax Team is here to help. Contact John Hadwen for more information
