Significant Economic Impact on Partners on the Horizon?
The 2015 Bipartisan Budget Act repealed existing TEFRA partnership audit procedures and replaced them with the new Partnership Centralized Audit Regime which takes effect for tax years beginning after 2017, or for any partnership that elects application for tax years beginning after November 2, 2015.
Under current TEFRA rules, if a partnership is audited and there is an adjustment, the IRS has to pass through the adjustment to all of the partners - which can be a time consuming and costly process. This has resulted in a significantly lower percentage of audits of large partnerships compared to their corporate counterparts.
The new partnership audit rules makes it easier for the IRS to audit large partnerships, and has a potentially significant economic impact on partners. For tax years beginning in 2018, the new audit procedures shift the liability for underpayment of tax and the related penalties and interest from the partners to the partnership.
Designating a Partnership Representative Under the New Partnership Tax Audit Rules
Under the new rules, a tax matters partner is no longer relevant.
Instead, partnerships must designate a partnership representative. Congress gave the partnership representative a broad range of authority to act on the partnership’s behalf, and to bind the partnership and the partners without their direct knowledge or involvement.
The proposed regulations on the new rules state that no state law or partnership agreement can limit the authority of the partnership representative. The partnership representative will ultimately decide whether or not to accept a proposed adjustment, to have the partnership pay the tax, or elect to push it out to the partners (discussed in more detail below).
Given that the partnership representative has so much power we expect partnerships to review their operating agreement and decide who should be the partnership representative.
We also expect some partnership agreements to state whether or not to elect out of the new regime, or if not applicable, to push-out the adjustment, or have the tax paid by the partnership. Although it doesn’t appear the IRS would be bound by these provisions in the agreement and would ultimately follow the decision of the partnership representative, this may give partners some recourse against the partnership representative.
If the partnership does not choose a representative the IRS can.
A Partnership Level Tax?
The tax computed from any adjustments resulting from an audit will be multiplied by the highest individual or corporate tax rate in effect for that year. This could result in a significantly higher tax than had the adjustments been pushed out to the partners and computed on their respective returns.
However, partnerships are allowed to show to the IRS that the underpayment would be lower based on certain partner level information including amended returns, tax exempt partners, or a lower tax rate.
If the partnership decides to pay the tax, the current partners effectively bear the economic burden for past liabilities even if they may not have been a partner or received an economic benefit from the partnership.
Pushing Out Tax Adjustments to Partners
The partnership can elect to “push-out” any adjustments resulting from an IRS audit to partners who were in the partnership in the year of the relevant adjustment.
This would effectively shift the economic burden back to partners who were allocated the benefit in the prior year. Those partners take the adjustment into account in the year the statement is furnished.
For example, if the IRS finalized an audit of a 2018 tax year in 2020, the partners would account for the push-out adjustment on their 2020 tax returns. This convenience comes at a cost, the partners will pay interest on any underpayment at a rate that is 2% higher than the normal interest rate.
Further, applying the adjustment on an individual return will likely mean higher tax preparation fees.
Electing out of the New Tax Audit Rules for Partnerships
Partnerships can elect out of the new rules entirely. One reason why partnerships may want to elect out of the rules is because upon notification of any proposed adjustments, any individual partner can protest an adjustment they disagree with. However, under the new rules, a partnership representative has the sole authority to act on behalf of the partnership.
The partnership must notify each of its partners of the election within 30 days of making the election, and the partnership and its partners are bound by the election.
However, only certain partnerships will be eligible for this election.
In order to elect out the partnership must have 100 or fewer eligible partners. An eligible partner is an individual, C or S corporation, foreign entities that would be treated as C corporations if they were domestic, and estates of deceased partners. Each shareholder of an S corporation is counted separately in determining the 100 or fewer partners.
Partnerships, trusts, nominees that hold an interest on behalf of another person, and disregarded entities are all ineligible partners and therefore a partnership with an ineligible partner would not be able to elect out of the new rules.
In order to elect out, an election must be made with a timely filed return (including extensions) each year the partnership wishes to elect out. If you are eligible to elect out, you are going to need to discuss the election with your partners before the return is filed.
Preparing for the New Partnership Tax Audit Regime
There are still many uncertainties related to the new rules as a number of the Regulations remain in proposed form and only the Regulation dealing with the election out has been finalized as of the date of this article.
But we do know many partnerships are not going to be able to elect out of the new centralized audit regime, either because they have more than 100 partners or have an ineligible partner such as a partnership, trust or disregarded entity.
As a result, there is potentially a significantly different economic impact depending on how a partnership chooses to apply the new rules. We believe different facts and circumstances will lead to different applications of the new rules and each partnership needs to discuss these and identify which is best for them.
Maybe the partnership paying the tax is easier and has less compliance costs than pushing out the adjustment, or maybe the partnership just doesn’t want to burden its investors with the audit adjustment, so paying the tax at the partnership level is the best choice. Others may find that due to ownership changes this unfairly hurts the existing partners and pushing out the adjustment is the best choice.
For new partners it will be more important than ever to address this issue before investing and existing partnerships will be best served to address these rules before an issue arises
Talk to an Expert in Partnership Taxation Issues
One of the consequences of the new audit regime is that elections will need to be discussed, impacts on both the partnership and individual partner level will need to be analyzed, and in all likelihood, partnership agreements will need to be amended.
The Partnership Taxation experts at Freed Maxick can help. We would be happy to help you understand how the new partnership tax audit rules will affect your business so you can make the best decisions for amending your partnership agreement..
To schedule a complimentary review of your situation, click here to submit a form and request a complimentary consultation.
For more insight, observations and guidance on the new Tax Cuts and Jobs Act, visit our Tax Reform webpage.View full article
Author: Robert Wood
Different types of opinions have different implications for understanding the issue of “going concerns”
Accountants reconsider the “going concern” assumption each time they audit a financial statement. When the long-term viability of a borrower is in doubt, it may cause a CPA to issue a qualified audit opinion. And in a worst-case scenario, the accountant may withdraw from the job altogether.
Financial statements are typically prepared with an assumption that the company will remain a going concern. That is, the entity is expected to continue to meet its obligations in the ordinary course of business and generate a positive return on its assets.
Viability Concerns affecting Financial Statements
At times, auditors discover adverse events and conditions that can cast substantial doubt on a company’s ability to continue as a going concern over the next year.
Some possible red flags include:
- Working capital deficiencies,
- Loan defaults and debt restructurings,
- Pending lawsuits and investigations,
- Negative operating cash flow, and
- Labor union conflicts and work stoppages.
When an auditor rejects the going concern assumption, he or she may adjust balance sheet values to liquidation values, instead of historic costs. Footnotes can also report going concern issues. Moreover, the auditor’s opinion letter (which serves as a cover letter to the financial statements) could be downgraded when uncertainties arise.
Understanding an Audit Opinion
An audit opinion can vary depending on available information, errors discovered during audit procedures, financial viability and other limiting factors. The cleanest and most desirable type of audit opinion is known as an “unqualified” one. With this type, the auditor states that the business’s financial condition, operations and position are fairly presented in the financial statements.
If there are any uncertainties regarding the going concern assumption, the auditor will likely issue a “qualified” opinion and disclose the nature of the uncertainties in the footnotes. An auditor may also choose to issue a qualified opinion if the financial statements seem to contain a small deviation from Generally Accepted Accounting Principles (GAAP), but they’re otherwise fairly presented — or if the borrower limits the scope of audit procedures.
But there are much less desirable opinions, known as “adverse opinions.” They indicate that there are material exceptions to GAAP that will affect the financial statements as a whole.
But by far the most alarming opinion is a disclaimer. It occurs when the auditor gives up mid-audit. Reasons for a disclaimer may include significant uncertainties and scope limitations within the subject company itself. Many lenders won’t accept financial statements that have this designation. In addition, lenders are likely to call the loan unless the borrower takes corrective action.
Unexpected change of auditors
Some auditors will pull the plug on long-term audit clients before they even start fieldwork if they believe there’s a need to issue a disclaimer or an adverse opinion. Sometimes the client replaces their auditors if they question long-term viability.
No matter who initiated the switch, a sudden, unexpected change of auditors could lead to going concern issues.
The future of going concern assessments
As of now, an auditor will assess a period of one year beyond the financial statement date when evaluating the going concern assumption. But last summer, the Financial Accounting Standards Board (FASB) proposed a rather controversial change to GAAP that would mandate more frequent going concern assessments and require a longer assessment period.
Under the proposal, a client’s footnotes would discuss when it’s “more likely than not” that a business won’t meet its obligations within a year without taking action outside the normal course of business — or if it’s “known or probable” that it won’t meet these obligations within two years.
Over the last five years, businesses, regulators, auditors and other stakeholders have tried to determine how to reduce diversity in financial reporting about going concern issues. A final amendment to these rules isn’t expected until FASB can work out the problems in its latest proposal.
So, what’s the bottom line? Lenders should pay attention to audit opinion letters. The type of opinion expressed can have serious implications about your client’s ability to operate as a going concern. And downgraded opinions warrant your immediate attention.
Freed Maxick’s Asset Based Lending Team works with dozens of asset based lenders across the country. We can help you reduce the risk of lending or assist your clients with our business advisory, audit, fraud detection and prevention, and tax services.
For more information about our business advisory, audit, and other accounting services contact us here, or call us at 716-847-2651.
By Chris Piedici
Auditor comments within a management letter help address deficiencies with financial reporting so that board members and management can make informed and timely business decisions; with the ultimate goal being to strengthen the collection of data for financial reporting.
With the understanding that charter school boards vary in size and qualifications, the average board comprises 10 people and at least one person with a background in financial management. Charter boards have a fiduciary responsibility over budgeting and financial reporting, but are less likely to oversee the day to day control over human resources and financial processes. These challenges can make it difficult to obtain the right staffing to reduce deficiencies that are of high importance to remediate. Incorrect reporting of financial data can impede the progress of the future success of the educational system. With the source of funds from state aid flowing through Public School Districts to the Charter Schools, it’s especially important that Charter Schools are being fiscally responsible. The benefits of a consultant with backgrounds in Public Schools and Charter Schools can help reduce the burden of meeting the fiscal recommendations of management letters.
Consulting firms can assist with:
- Quarterly reviews of the financial data,
- Being an intermediate level of oversight between the auditor, internal finance positions and the board,
- Analysis of contract costs,
- Assessment reviews and recommendations of internal operations and,
- Development of Financial projections.
We understand the challenges that charter schools face with staffing limitations and can help provide remediation. For further information on the most recent audit guidelines please visit the NYS Department of Education:
Charter schools are part of a broad movement in public education toward results based accountability. Charter Schools began operating in New York through the New York Charter School Act of 1998. Although charter schools have been in operation across the U.S. for nearly 15 years and in New York for ten, much of the current knowledge base is about the setup, financing, and funding of charter schools. This includes state charter school finance systems and education metrics for the students, all of which are important pieces but leave a gap in ensuring a proper financial management system is in place within these schools.
Author: Amanda Roth, CPA
What does this image make you think of? It makes me think of all the recent sales tax audits I have been involved in. The most dreaded letter to get in the mail is the one that reads “We’ve scheduled an audit of your New York State sales and use tax records”. Even if all your records are in order and all your sales tax has been paid, the process can be overwhelming and you may not know what to expect. If you feel anxious, terrified, or even a little nauseous at the prospect of an audit, you are not alone, many feel as you do. It can be a daunting task to get organized for an audit. But don’t panic, these tips may help your audit go more smoothly.
Surviving a Sales Tax Audit
- Locate all your records – Make sure you can find all the records the auditor is asking for, if not try to obtain them from other sources (tax returns from your CPA, bank statements from online or from your local branch, etc.)
- Get Organized – Organize all your records according to the request list and present them in an organized manner (i.e.: by year or alphabetically). As a CPA I recommend setting up a binder, printing the request list and setting up tabs that correspond to each item requested. Some items, such as invoices, are too large to put in the binder. For these types of documents, a box will suffice, and then reference their location in the binder. Purchase invoices should be grouped together per vendor and listed in date order. This is usually done to make it easier to pull out the applicable invoices if a test period is chosen, or to search a particular vendor file quickly if the auditor wants to view certain expenses.
- Be prepared - Always make sure you have what the auditor has requested before scheduling an appointment. No one likes wasting time and it will make the audit move along more quickly.
- Put your best foot forward – Always look at everything you provide an auditor and ensure all work papers tie out to reports and/or returns provided. Present and retain records as organized as possible and ensure the records you print agree to reports or returns. Sometimes if you rush and just gather the information, errors can occur.
- Make sure you have your “A Team” - Decide if you will be representing yourself or if you will be getting your CPA involved to help in the process. Most businesses feel they can handle an audit on their own to save on costs. However, there are times where having a representative saves money in the long run. A representative allows your employees to focus their time on what they are best at (usually the operations of the company). Some considerations in deciding whether to go it alone or get your CPA involved are as follows: cost, resources, capacity, technical knowledge, business needs, condition of record or lack thereof, and knowledge of audit procedures.
These five basic tips will help make any audit go more smoothly. I always recommend getting your CPA firm involved; they are accustomed to the many obstacles of audits and might be able to help clear a path to a smoother audit; alleviating that anxious and overwhelming feeling that many get.
Contact Our Sales Tax Professionals
If you are not sure what steps to take next, contact Freed Maxick. We can help you navigate through a sales tax audit, and help get you organized. Please contact us for more information.