New Centralized Partnership Audit Rules and Its Impact on Foreign Partners
Changes to the rules on IRS audits of partnerships will require the partnership (which can include LLCs) rather than the partners to pay any additional tax as the result of adjustments made at the partnership level. The tax is to be paid at the highest tax rate of the partner.
There is also a change in who represents the partnership from a “tax matters partner” to a “partnership representative”, with much more authority to bind the partnership and agree to IRS adjustments that might even be opposed by the partners. These new rules are effective for calendar year 2018 partnerships
These changes are supposed to make it easier for the IRS to audit larger partnerships or those with tiered structures, where it was often difficult to contact and deal with multiple, ultimate partners. The change is to raise approximately $7.5 billion of additional tax revenue through 2025, so would not be considered taxpayer friendly.
Partnerships with 100 or fewer “eligible partners” can elect out of these new rules. However, a partnership that is the partner of a lower tier partnership is not an eligible partner. Foreign entities that are treated as corporations under US rules would be an eligible partner. The election out is filed on an annual basis. If no election is made, the procedures will use the “default” ones mentioned above.
The Tax Matters partner is replaced by the Partnership Representative (PR), who has sole authority to act on behalf of and bind the partnership. No state law, partnership agreement or other agreement may limit the authority of the PR between the partnership and the IRS. The PR need not be a partner in the partnership, but must have a substantial US presence. The partnership must designate a PR for each year. The IRS is even given power to designate a PR in certain situations.
Partnership agreements will need to address this new relationship, and PRs will probably want to have indemnity protection before agreeing to accept this responsibility.
The Push Out Election
An alternative to the “default” procedures is for the partnership to make an election within 45 days of the notice of final adjustment to “push out” the adjustments to all of the Reviewed Year partners. This just means that the partnership level calculation (at the highest rates) is pushed out, and not that the adjustments are pushed out to be calculated at the partner level. Also, the Reviewed Year partners must bear an additional interest charge of 2% over and above the interest that would otherwise be applicable.
Foreign partners already have withholding at the partnership level under Chapter 3 and 4 of the Code on passive income and effectively connected income (ECI). Therefore, coordination between these current requirements and the new centralized partnership audit regime is required to avoid double withholding situations. These just issued regulations set forth procedures to avoid this double withholding issue and address situations where (1) a partnership fails to withhold the correct rate on an item of income and (2) a partnership fails to report an item of income and, therefore, fails to withhold on the additional income.
The new regulations allow withholding under Chapters 3 and 4 proceedings to cover any withholding that might be required under the centralized partnership audit regime. If the administrative proceedings have been initiated under the centralized partnership audit regime, then the payments can be paid under those rules and there is no further requirement to withhold under Chapters 3 and 4. Examples have been issued to provide guidance.
If you have questions about how these tax issues might impact your situation, contact us, or call 248.244.3060.
Victor (Sandy) Jose, CPA
For more than 35 years, Victor (Sandy) Jose has assisted clients with their inbound and outbound investments, Foreign Account Tax Compliance Act (FATCA) compliance, Offshore Voluntary Disclosure Program projects, as well as other withholding and reporting projects. Sandy has extensive and broad based global experience in the automotive and manufacturing industries. Contact Sandy at email@example.com or (248) 244-3082.