Dear [CLIENT NAME]:
You are receiving this letter because there are special rules pertaining to the way the IRS audits all partnerships (and LLCs taxed as partnerships). These rules are referred to as the Centralized Partnership Audit Regime (CPAR) or BBA partnership rules by the IRS.
Additional taxes assessed due to an audit will be owed by the partnership or LLC directly and will be assessed in the “adjustment year” based on adjustments found in the “reviewed year.” This effectively shifts the economic burden of the additional tax liability from those persons who were partners for the year under audit (the reviewed year) to the current partners in the partnership or LLC. In order to address potential partner inequities resulting from these new partnership audit rules, we recommend discussing amendments to your partnership agreement with your partnership attorney.
In general, all adjustments resulting from the audit will be netted, and if an “imputed underpayment” for the adjustment year is calculated, then it is assessed using the highest tax bracket for individuals. In 2023, the highest tax rate for individuals is 37% for ordinary income.
The new rules allow partnerships to elect out of the new partnership audit process annually on your partnership’s income tax return, but only if certain requirements are met. You can’t wait until you are selected for audit to elect out of the CPAR rules. For partnerships that are eligible to elect out of the CPAR rules, doing so is often the most appropriate course of action.
Also under the CPAR rules, partnerships must elect a partnership representative. This representative does not need to be a partner and is the only party authorized to act on behalf of the partnership and all of its partners during the course of an IRS audit. All agreements made by the partnership representative and the IRS are binding on the partnership and its partners. The election of a partnership representative should be accomplished by amending your partnership agreement and is made on the partnership’s income tax return each year.
Further information
This is a simplified overview of the complex CPAR rules. Please contact our office to discuss how these new rules will affect your partnership and the changes you should consider making to your partnership agreement to address these new audit rules.
Sincerely,
Your tax professional