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Partnership Audits in the Hotel California

Gary M. Harden
8/13/16

    “You can opt in anytime you want, but you can never leave.”

    Borrowing a verse from the Eagles’ song “Hotel California” may be the best way to describe temporary regulations released by IRS on the time, form and manner of an election to opt into the new partnership audit regime.  Effective for partnerships/LLCs in 2018, the statute permits an early opt in, with details to be provided by IRS in regulations.  Here they are.  Once a small partnership opts in, it cannot get out even though it may have a perfectly good exemption, unless IRS gives permission, permission unlikely to be given.  Better put this one in the due diligence file when acquiring a partnership/LLC or an interest in one.

    Not the most popular law in history (with IRS as well) one might question why a small partnership would “opt in” unless the person filing the election wants to find someone else to pay their tax. The preamble anticipates “there will not be a substantial number of small entities that will elect in.”  Small as in none?

    The law will treat partnerships like corporations for all audit adjustments, with the entity liable for tax at a high flat rate unless an exception applies.  There are exemptions and different paths that can be taken.  However in this setting, partners who benefit from a mistake in an earlier year might find others to pay the tax on their benefit if they have already withdrawn or their percentage interests have reduced by the time of an audit. 

    IRS also is to provide guidance for partnerships that have one or more tax exempt partners, joint ventures for example.  Will IRS collect a tax on the entire adjustment from partnership assets even though the tax exempt partner received no benefit from the mistake and otherwise has no obligation to pay tax on these earnings?  Will relief favor equity or efficiency?  We will see.

    Should you have any questions regarding these temporary regulations, please contact Gary M. Harden.

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    Disclaimer:  The article in this publication has been prepared by Eastman & Smith Ltd. for informational purposes only and should not be considered legal advice. This information is not intended to create, and receipt of it does not constitute, an attorney/client relationship.

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