In response to audit efficiency issues identified by the Internal Revenue Service (IRS), the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) contained provisions which allowed the IRS to conduct a single administrative proceeding (audit) at the partnership level, adjust the tax treatment of any partnership tax item and determine the applicability of any penalty or other addition to tax at the partnership level (rather than at the level of each of the partners). Once the audit was completed, the tax due from the resulting adjustment was assessed by the IRS against each of the taxpayers who were partners in the tax year in which the change arose. The TEFRA unified partnership audit rules worked reasonably well until the advent of the Limited Liability Company (LLC) form of business organization.  Since the late 1980’s, the LLC form of business organization has significantly grown in popularity as the first choice of entity type for many businesses. Today, most real estate investors will use an LLC to acquire, own and operate real estate holdings more often than any other form of business organization. The popularity of the LLC as the “entity of choice” is primarily due to the fact that the LLC offers its members both protection from creditors and pass-through treatment for income tax purposes. As a result of the popularity of LLC’s, the number of partnership returns filed with the IRS has been steadily increasing every year and the IRS has been faced with an increasing administrative burden when auditing partnerships. In response to the audit efficiency issues, the Bipartisan Budget Act of 2015 (act) which was signed by President Obama on November 2^nd, repeals the TEFRA uniform partnership audit rules and replaces them with a new set of rules that the IRS hopes will allow it to assess and collect tax resulting from partnership Audit adjustments in a more timely and efficient manner. The new rules generally apply to partnership tax years that begin after December 31, 2017 although an election is available in some cases to apply the new rules earlier. The new rules are intended to provide for a more streamlined audit approach. Similar to the TEFRA rules, any adjustment to items of income, gain, loss, deduction or credit of a partnership (and any partner’s share of such adjustment) is determined at the partnership level.  Now, however, any tax attributable to such adjustment will be assessed and collected at the partnership level (see discussion below).  The applicability of any penalty, addition to tax, or additional amount which relates to an adjustment will also be determined at the partnership level. The act introduces the following two new concepts related to implementation of the rules.  The partnership tax year under examination will be known as the “reviewed year.” Any adjustments arising in the reviewed year will be taken into account by the partnership (not the individual partners) in the “adjustment year.”  Generally, the adjustment year is the tax year that the adjustment becomes final  but in practice the determination of the adjustment year will depend on how the adjustment was made (I.e., appeal proceeding, court decision, etc.) Notably, there is a provision in the act that allows a partnership to make an election to issue adjusted information returns (presumably in a form similar to amended Schedules K-1) to the reviewed year partners as an alternative to taking the adjustment into account at the partnership level.  If this election is made, the partners take the adjustment into account on their individual returns in the adjustment year through a simplified amended return process. Thankfully, the new law provides that partnerships with 100 or fewer “qualifying partners” can elect out of the new rules for any tax year. A qualifying partner is, generally an individual, a C corporation, a foreign entity that would be treated as a C corporation if it were a domestic entity, an S corporation or an estate of a deceased partner.  The election must be made with the partnership’s timely filed return for the tax year and must disclose the name and identifying number of each partner in the partnership. Since the act was just signed into law the IRS has yet to issue regulations necessary to implement the act.  We will continue to monitor the situation and report new developments as they arise. Sandy Klein, CPA, is a partner at Shanholt Glassman Klein Kramer & Co., New York, N.Y. Tags: