The procedures by which the Internal Revenue Service (IRS) will audit partnership returns have been thoroughly overhauled, and these changes have important substantive consequences to partners. In order for partners to protect their interests, it is critical to understand the new procedures, consider electing out if eligible, and revise governance documents in order to provide processes that would apply in the event of an audit.

In general, the IRS will assess and collect tax at the partnership level effective for tax years beginning after Dec. 31, 2017. The new procedures apply to partnerships and other entities taxed as partnerships, such as multi-member limited liability companies. A few key aspects are discussed below.

• Partnership Representative Has Sole Authority. The “tax matters partner” has become the partnership representative (PR). The PR may be an individual or an entity, but if it is an entity, a designated individual must be appointed. The PR must be designated annually on the partnership tax return, and the IRS may designate a PR if the IRS determines that a designation of PR is not in effect.

The PR has the sole authority to act on behalf of the partnership during an audit, and all partners and the partnership will be bound by such actions taken by the PR. Partners will have no statutory right to participate in the audit without the permission of the IRS. There is no requirement that the IRS notify the other partners of audit communications.

The PR must have “substantial presence” in the United States, which is defined as making oneself available to the IRS, and having a U.S. tax identification number (TIN), U.S. address and telephone number.

• Current Partners Bear Liability … and the “Push-Out” Election. In general, any adjustment to a partnership-related item, and any tax, interest and penalty attributable thereto, is determined at the partnership level. This means that the partners at the time the final adjustment is made bear the economic burden of such adjustment in proportion to their respective interests in the partnership at that time, even if those partners were not partners in the year to which the audit relates or previously owned a lesser or greater interest in the partnership.

However, even where the new audit procedures apply, the PR may make what is referred to as a “push-out” election. If such election is made, each of the “reviewed year partners,” that is, those partners for the tax year under audit review, will separately take into account their own share of the partnership adjustments, and the partnership will not be liable for the imputed underpayment.

• Election Out. Certain smaller partnerships may elect out of the new procedures. In order to qualify for electing out, a partnership must have 100 or fewer partners during the year, as defined by the Internal Revenue Code and Treasury Regulations, and all partners must be “eligible” partners (which are individuals, C corporations, foreign entities per se or taxable as C corporations, S corporations or estates of a deceased partner). Therefore, the election is unavailable where there is a partner that is a trust, partnership, disregarded entity or a foreign entity that is not taxed as a C corporation.

The election is available annually by timely filing (including extensions) IRS Form 1065 and providing all information required by the IRS about each partner, including each partner's name, TIN (or alternative identification permitted by the IRS) and Federal tax classification.