IRS Partnership Audit Rules for Private Equity and Hedge Funds

Description

For partnerships, including LLCs taxed as partnerships, the audit rules introduced under the Bipartisan Budget Act of 2015 were a game-changer. Beginning in 2018, the rules have impacted most partnerships, regardless of size. Partnership audits are expected to increase as a result of these rules and the IRS’ increased focus on partnership audits and more funding. The IRS now assesses and collects taxes at the partnership level as opposed to the individual partner level. Any adjustments to the partnership's income, gains, losses, or deductions will be assessed in the year in which the tax audit concludes.

For private equity and hedge funds--where ownership changes may occur due to redemptions, investor defaults, or other events--the assessment of a partnership-level tax in the year in which an audit concludes may subject current partners to tax liability for periods they may not have been partners or held a different ownership percentage.

To avoid the wrong partners bearing tax liability in the wrong amount, PE funds can request modifications to the partnership tax or make a “push-out” election within 45 days of a final adjustment. PE funds may need to amend their partnership agreements to address these contingencies, and partners may want side letter agreements that impose obligations on PE funds during a partnership audit.

PE funds must select a partnership representative with broad authority to bind the partnership and its partners to agreements with the IRS. Partners no longer have the right to participate in a partnership audit. LLC agreements must clearly define the responsibilities and indemnities available to this representative.

Listen as our authoritative panel discusses current partnership audit rules with a particular focus on their impact on private equity and other investment funds. The panel will discuss provisions in partnership or LLC agreements to address the new audit regime and the opt-outs and exclusions available.