United States

Strategic planning for partnership audits

INVESTMENT INDUSTRY INSIGHTS  | 

New rules giving partnerships discretion in assigning liability for tax audit adjustments could make it easier to attract new partners, while increasing the importance of the partnerships’ audit representative.

Partnerships are given the discretion in assigning responsibility for tax adjustments, reducing the threat of liability for new partners.

For instance, a partner who joins a partnership in 2020 would not necessarily be assessed for adjustments related to a 2018 return, as the partnership can push out adjustments to the individuals who were partners in the affected year.

The ruling could help partnerships attract new partners more easily, although the situation for investors in offshore feeder funds that invest in a U.S. partnership remains unclear.

Individual amended filings

The rules give the partnership representative broad discretion in deciding whether to fight an adjustment, pay it with partnership funds or pass it along to individual investors.

If the representative decides to pass along responsibility for an adjustment, individual partners for the affected year would file amended returns addressing the specific items of the adjustment, thereby relieving the partnership and themselves of liability.

If individual partners decide to fight the adjustment, the partnership representative has several options:

  1. Agree to fight on their behalf, but require them to pay costs
  2. Pay the adjustment with partnership funds
  3. Dispute the matter at the entity level with partnership funds

Partnership representative

Taking advantage of the leeway provided by the rule requires amending the partnership agreement to specify who will act on the partnership’s behalf in audits. This is a very vital designation, and careful consideration should be given to the selection.

Because the partnership representative could potentially exercise so much discretion, the amendment to the partnership agreement should carefully define the scope of their duties and authority. The following ground rules are examples of defining the scope and ways that will aid the drafting process:

  • The partnership representative should not trade interests of former partners for better deals for current partners (i.e., no self-dealing).
  • The partnership representative should not defend partners against positions lacking a specific level of merit.
  • The partnership representative should not give former partners an opportunity to participate and/or pay the costs of a defense disproportionately valuable to them.
  • The partnership representative should establish procedures for multiple partnership tiers, if applicable.
  • The partnership representative should specify what happens if the partnership liquidates or ceases to exist.