SAN DIEGO—The IRS's proposed regulations on the implementation of its new centralized partnership audit regime impact every partnership and LLC nationwide, Phil Jelsma, a partner and chair of the tax practice team at CRE law firm Crosbie Gliner Schiffman Southard & Swanson LLP, tells GlobeSt.com. On June 14, the IRS re-released its proposed regulations on the regime, with the intention to decrease the administrative burden on the IRS by allowing it to assess and collect tax at the partnership level. In general, the proposed regulations provide rules for entities subject to the new centralized partnership audit regime and procedures for electing out, filing administrative adjustment request and determining the amounts owed by the entity or its owners attributable to IRS adjustments

We spoke with Jelsma—whose practice focuses on LLCs, partnership business and tax planning and who is also co-author of the book, The Limited Liability Company—about the implications of and potential impact of these regulations on LLCs and partnerships.

GlobeSt.com: What do the new regulations entail?

Jelsma: The proposed regulations are extremely broad, but when finalized affect all partnerships and LLCs after Dec. 31, 2017, and any partnership or LLC that elects the application after Nov. 2, 2015, before January 1, 2018. Generally, all items shown or reflected on the partnership's return and information on the partnership's or LLC's books are subject to determination and adjustment at the entity level. In addition, any tax resulting from the adjustments is assessed and collected at the entity level. Any penalty, addition to tax or additional amount that relates to any adjustment is also determined at the entity level.

Generally, these rules require the partnership or LLC pay any tax deficiency, penalty and interest.

The new rules also generally require that each partner's or member's treatment of each item of income, gain, loss, deduction or credit be consistent with the treatment of those items on the entity's return, including the amount, timing and characterization. This means that the partner or member must treat an item consistently with the partnership or LLC return filed with the IRS and not with reference to any schedule or other information provided by the partnership or the LLC, such as a Schedule K-1, unless an election regarding incorrect statements or information is made.

GlobeSt.com: Why have the rules changed?

Jelsma: They replace the prior rules, which had been adopted in the Tax Equity and Fiscal Responsibility Act of 1982, which were repealed in the Bipartisan Budget Act of 2015. Initially, these rules had been released on Jan. 18, but two days later the new Trump administration announced a freeze on all new and proposed regulations, and the IRS withdrew its regulations. After a five-month wait, the IRS issued new proposed regulations almost identical to the Jan. 18 proposed regulations.

GlobeSt.com: Do these rules impact every partnership agreement and LLC operating agreement?

Jelsma: Yes. In general, these new rules will require that every partnership agreement and LLC operating agreement be amended to take into account these new centralized partnership audit rules.

GlobeSt.com: Who can elect out of the new centralized rules?

Jelsma: Only certain partnerships and LLCs may elect out of this new centralized audit regime. For most California businesses, the exception is extremely important. If a partnership or LLC has 100 or fewer owners during the year and at all times the owners are eligible partners, the entity may make an annual election out of the centralized partnership audit rules. By electing out, the adjustments will be made at the partnership or LLC level, consistent with existing law. Generally, if a partnership or LLC can elect out, it should elect out. For most, the cost of annually electing out is much less than the cost of doing nothing and being subject to these often expensive and complicated new requirements.

GlobeSt.com: How are the adjustments are actually made at the partnership or LLC level?

Jelsma: Under the new rules, any adjustment to income, gain, loss, deduction or credit of a partnership or LLC or any adjustment to a partner's or member's distributable share of income, gain, loss, deduction or credit is determined at the partnership or LLC level. If the adjustment results in an underpayment of tax, the partnership or LLC is required to pay the imputed underpayment in the year of the adjustment. The net adjustment is taxed at the highest marginal rate (39.6% for individuals and 35% for corporations). The normal interest rate charged by the IRS for underpayments is increased by 2 percentage points.

GlobeSt.com: What else should our readers know about these changes?

Jelsma: The election out of the centralized partnership audit regime must be made on a timely filed partnership return, including extensions, i.e., a Form 1065, for the partnership year to which the election is effective. Thus, a partnership cannot make an election on a return filed after the due date for a tax year. An election may only be revoked with the IRS's consent.

The form of election requires the partnership or LLC to disclose to the IRS the names, correct taxpayer identification numbers and tax classifications of the partners of the partnership or members of the LLC. If there is an S corporation partner, it must describe the names, correct taxpayer identification numbers and federal tax classifications of all persons to whom the S corporation partner is required to furnish Schedules K-1 during the year.

A partnership or LLC that elects out of the centralized partnership audit regime must notify each partner or member that the partnership or LLC has made the election within 30 days after making the election. The notice can be in writing, electronic means, such as email, or another form chosen by the partnership or the LLC.

In general, the IRS may rely on the election for all purposes unless it determines that the election is invalid. Even if the election is done improperly, it can still be relied on by the partnership or LLC unless challenged by the IRS, and the IRS may also rely on the election in determining whether the partnership or LLC is subject to the centralized partnership rules.

Instant Insights /

What the New Tax Regs Could Mean for LLCs and Partnerships

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