Taxes aren’t exactly anyone’s favorite topic, but if you’re an entrepreneur running a partnership, S corporation, or LLC, understanding some key tax rules can save you from major headaches down the road. One big change you need to know about comes from the Bipartisan Budget Act of 2015 (BBA).
Let’s break down what this means for your business and how you can navigate these new audit and tax collection rules.
How Audits Worked Before
In the past, if the IRS audited a partnership and found an error in the tax return for, say, 2018, they would go after the partners who were part of the partnership in 2018. These partners would each be responsible for paying their share of any taxes, penalties, or interest owed.
This approach made sense because it matched the tax liability to the people who actually benefited in the tax year being reviewed (the “reviewed year”).
What Changed Under the BBA?
Starting with tax years after December 31, 2017, the IRS now audits partnerships at the entity level, meaning they look at the partnership as a whole. If there’s an adjustment (like more taxes owed), the partnership itself pays the taxes in the year the adjustment becomes final (the “adjustment year”).
Here’s the kicker: the current partners are responsible for the taxes, even if they weren’t part of the partnership in the reviewed year.
Example:
- Your partnership, ABC Ventures, had three partners in 2018: Alice, Bob, and Charlie.
- In 2022, the IRS audits the 2018 tax return and finds an underpayment of $20,000.
- By 2022, Alice has left, and Dana has joined the partnership.
- Under the new rules, Dana, Bob, and Charlie (the partners in 2022) are now responsible for paying the $20,000, even though Dana wasn’t a partner in 2018.
This rule can create some tricky situations, especially for partnerships with frequent changes in ownership.
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How Can You Avoid This?
Thankfully, the IRS offers two options to help partnerships manage or avoid this liability shift:
1. Electing Out of the New Rules
If your partnership meets certain criteria, you can opt out of the new audit rules and stick with the old system.
Eligibility Requirements:
- The partnership must issue 100 or fewer Schedule K-1s (tax forms for partners).
- All partners must be:
- Individuals, C corporations, or estates of deceased partners.
- Certain S corporations (but you must count all the shareholders of those S corporations toward the 100-K-1 limit).
- The election must be made with a timely filed partnership return, and all partners must be notified.
Example:
- XYZ LLC has 75 individual partners in 2022. It qualifies to elect out of the new rules.
- By filing the election with its 2022 tax return, any IRS audit will target the partners who were part of the partnership during the reviewed year, ensuring current partners aren’t stuck with someone else’s tax bill.
2. Pushing Out Adjustments to Reviewed-Year Partners
If your partnership doesn’t or can’t elect out, there’s another option: the push-out election.
This means the partnership doesn’t pay the adjustment itself. Instead, it sends adjusted tax forms (like corrected Schedule K-1s) to the partners who were in the partnership during the reviewed year. These partners are then responsible for paying their share of the adjustment.
Example:
- ABC Ventures (our earlier example) doesn’t qualify to elect out of the new rules.
- After the 2018 audit is completed in 2022, the partnership makes a push-out election.
- Alice, Bob, and Charlie (the partners from 2018) receive adjusted tax forms showing their share of the $20,000 adjustment. Each pays their portion directly to the IRS, leaving Dana (the 2022 partner) unaffected.
Which Option Is Right for You?
Here’s a quick decision guide:
- Elect out if you’re eligible and want to keep things simple. This ensures taxes are tied to the people who benefited during the reviewed year.
- Push out adjustments if you can’t elect out but want to avoid burdening current partners with past liabilities.
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Why This Matters for Entrepreneurs
If you’re running a business structured as a partnership, S corporation, or LLC, these rules could affect:
- Changes in ownership could saddle new partners with unexpected liabilities.
- Knowing your options can help you minimize risks and protect your business relationships.
- It’s essential to keep partners informed about potential tax liabilities and elections.
In Sum
The new BBA audit rules shift some major responsibilities onto partnerships and their partners. But with the right elections and strategies, you can stay ahead of these changes and avoid nasty surprises. If you’re unsure which option makes the most sense for your business, it’s a good idea to talk to a tax professional who can help you navigate the rules and make the best decision for your partnership. After all, no one wants to pay someone else’s tax bill!
Disclaimer: This article is for informational purposes only and does not constitute legal or tax advice. Consult a qualified attorney or tax professional for advice specific to your business situation.
