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New IRS Partnership Tax Audit Rules are Now in Effect

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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The 2015 Bipartisan Budget Act repealed existing TEFRA partnership audit procedures and replaced them with the new Partnership Centralized Audit Regime which takes effect for tax years beginning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.

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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.

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Understand What Will Affect Your FBAR Filings

By: Howard B. Epstein, CPA

world_connected-1.jpgThe Bank Records and Foreign Transactions Act- commonly referred to as the Bank Secrecy Act, became law in 1970 out of a growing complexity of the national and international economy, and technological revolution. Activities increased not just at home but abroad. This allowed the IRS to require citizens or residents of the U.S., or a person in, or doing business in the U.S. to file reports on any financial accounts with aggregate totals valuing $10,000 or more.  But did you know……

As a result of new legislation on foreign tax reporting and disclosure of financial assets, some taxpayers may be required to file the new foreign financial assets disclosure statement (Form 8938) with the income tax return, and the Report of Foreign Bank and Financial Accounts (FBAR) seperately. Filings and returns are due April 15th or June 15th, if living in the U.S. For those living outside the U.S., extensions for October 15th filings can go through December 15th. These reporting requirements will potentially add to both taxpayer roadblocks and the complexity of tax law changes.

On March 18, 2010, the President signed the HIRE Act, containing the Foreign Account Tax Compliance Act, into law. Addressing taxpayer concerns, the law requires individual taxpayers with foreign financial assets with an aggregate balance exceeding stipulated dollar amounts during a taxable year to file a disclosure statement with his or her income tax return for that taxable year. The stipulated dollar amounts can be found in IRS Form 8938. Beginning with 2011 individual tax return filings; the new law requires compliance with filing the disclosure statement (Form 8938) describing the maximum value of the assets during the taxable year. The disclosure statement should also provide the following information in the case of a:

  • Financial account – the name and address of the foreign financial institution in which such accounts are maintained and the number of such account.

  • Stock or security – the name and address of the foreign issuer and such information as is necessary to identify the class or issue of which such stock or security is part of.

  • Contract, interest, or other instrument – such information as is necessary to identify such contract, interest, or other instrument and the name(s) and addresses of all foreign issuers and counterparties with respect to such contact, interest, or other instrument.

What should you do next?

It is important to note that while there are similarities between the FBAR and FATCA filings, there are also a number of differences when filing each of the Forms. Freed Maxick International tax practice professionals are here to assist you with your FBAR filings. We can assess FBAR filing requirements and prepare current and past due FBARs. We can navigate the IRS guidelines and minimize potential penalties through the various IRS Voluntary Disclosure Programs available. Contact us to connect with our experts.



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How to Maximize the Oil & Gas Industry Tax Filing Requirements

Various Tax Credits Available to Industries

Author: Jeff Zawada, CPA

Most of the energy used in the United States comes from Fossil Fuels; petroleum, coal, and natural gas, with crude oil products currently used as the dominant source of energy.

According to the EIA (the United States Energy Information Administration) and OPEC, market fundamentals and expectations strengthened in January 2013; forecasting growth from 110,000 bpd to 1.05 million bpd over the course of the next 22 years. While only a 12% growth rate, compared to the 26% growth from 2004-2012, EIA projections are conservative and likely to increase.

What credits are available?

The IRS has specified tax credits for the oil and gas industry; at the state level legislation varies.  “Fracking” — more formally known as high volume hydraulic fracturing — involves injecting large amounts of sand, water and chemicals deep underground at high pressures to extract natural gas from rock formations. The drilling is concentrated in the Marcellus Shale formation, a deep repository that runs through West Virginia, Ohio, Pennsylvania and New York.  Natural gas drilling, while maintaining certain growth expectations, is still hitting barriers in New York State.  

  • Permit applications for conventional vertical gas well, which are still allowed in NYS, have dropped from roughly 600 in 2008 to below 200 in 2012.

  • Site specific special assessment reviews have to be done on an individual basis.

  • Currently Governor Cuomo is expected to announce a formal decision after the Geisinger Health System study, launched in Pennsylvania by Degenstein Foundation, is finished.

State by State Analysis: Quick snapshot

  • Pennsylvania has created over 140,000 jobs in the last few years in the drilling industry. With the launch of the Geisinger Health study, PA will provide deeper insight into drilling impact and incentives across the board.

  • Ohio’s Knox and Stark Counties saw the most drilling activity since 2010, at 43 wells drilled. In total Ohio currently has 11 counties reporting drilling. The state of Ohio also maintains a cost recovery assessment, as per law 1509.50. All money collected, pursuant to section C of this law, shall be deposited in Ohio state treasury to the credit of the oil and gas well fund.

  • In New York State, the NYS Energy Research and Development Authority (NYSERDA) has recently provided incentives for alternative fuel trucks. Credits such as: vouchers of up to $40,000 for the purchase of compressed natural gas, hybrid electric and all-electric Class 3 through 8 trucks operating in New York City, and vouchers that cover up to 80% of the cost of purchasing and installing emission reduction equipment for medium- and heavy-duty diesel vehicles operating primarily in New York City; requests for pre-qualification are now being accepted- currently there is a wait list. E85, compressed natural gas, and hydrogen fuel that is used exclusively to operate a motor vehicle engine is exempt from state sales and use taxes. Additionally, NY cities and counties may reduce the sales and use tax imposed on 20% biodiesel blends (B20) to 80% of the diesel fuel tax rate. The exemption and rate reduction are in effect until September 1, 2014 (Reference from: New York Tax Law 1111 and 1115).

What credits are available to your business? Have you maximized your IDC planning? Learn more HERE.

Freed Maxick understands the growing complexity and nature of the oil and gas industry.  We can navigate industry tax filing requirements, locate tax credits, and help with financial statement audits, reviews and compilations. Still have questions?  Contact us to connect with our experts, or call us at 716-847-2651.

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"Snowbird" Tax Info: Canadians Filing U.S. Tax Residency

By: Howard Epstein, CPA

Are you a Canadian “snowbird” spending winters in the United States? You may not realize it, but you could be considered a U.S. tax resident. If this is the case, the basis on which tax residency is determined is through the IRS “Substantial Presence Test.”

For this purpose, you will be considered a U.S. tax resident if you meet the following requirements:

  • Physically present in the United States at least 31 days in the current year, and

  • 183 days during the 3 year period that includes the current year and the 2 years immediately before that.

If you fall into this category, don’t panic! There is potential relief available to Canadian citizens that are caught by this Substantial Presence Test:

  • You are present in the U.S. for fewer than 183 days in the current year.

  • You maintain a “tax home” in a foreign country during the year.

  • You have a “closer connection” to the foreign country where your “tax home” is than to the U.S.

Are there exceptions to the rule?

There are exceptions to the substantial presence test. The following are a few examples:

  • Days you are in the United States for less than 24 hours- when you are in transit between two places outside the United States.

  • Days you are in the United States as a crew member of a foreign vessel.

  • Days you can classify “exempt individual.”

The term “exempt individual” does not refer to someone exempt from U.S. taxes, but to anyone that claims exemption from counting days of presence in the United States. For example- a teacher or trainee temporarily in the United States under a “J” or “Q” visa, who substantially complies with the requirements of the visa. For a full list of exemptions and exceptions, please refer to the IRS substantial presence test.

What should you do next?

If you exclude days of presence in the United States because you fall under a special category, you must file Form 8840 (Closer Connection Statement) or Form 8843 (Statement of exempt individuals and individuals with a medical condition).

Freed Maxick International tax practice professionals can help you determine if you qualify as a U.S. tax resident, and assist you with Substantial Presence Test filings. We can navigate the IRS guidelines and minimize potential penalties. Contact us to connect with our experts. 

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