Partnerships have been a very popular and useful entity for distributing shares of ownership in businesses or investments of various types for many years. They provide a suitable framework that is easy for most to understand and even the tax treatment and regulatory requirements can be a bit more straightforward compared to other entity types. However, late this year, congress passed new legislation and within that legislation were new rules which directly affect partnerships and how they operate.
The new rules do not immediately go into effect and only apply to partnership tax returns that are filed for 2017 and beyond. However, your actions and documentation habits now will determine your options in how you deal with the changes so it is a good idea to know ahead of time what is required. This will allow you to help your partnership plan more effectively for the future.
The rules will replace current audit regulations in place contained within sections 6221 through 6234. Additionally, sections 771 through 777 of Subchapter K, Part IV are repealed with the passage of the latest legislation as well as sections 6240 through 6255 of Subchapter D of Chapter 63. These areas of regulation pertained directly to the election of large partnerships and the special rules involved.
The changes introduced are designed to address the inner workings of partnership level adjustments. The new rules require adjustments are collected from the partnership entity itself instead of being collected from the partners. This situation generally applies to large partnerships and was a recommendation made by the U.S. GAO (Government Accountability Office) as a potential improvement in audit efficiency.
The new rules for section 6221 state that all adjustments to gains, losses, income, and credits or deductions for partnerships within a tax year that result in a penalty or additional tax will be collected and assessed at a partnership level, although it is inclusive of any distributive shares to the partners as well. The exact language of the new regulation expands the current language and provides a more comprehensive allowance for assessing and collecting fees as a result of adjustments on various levels.
There are partnerships that may choose to opt out of this particular provision if they have one hundred partners or less. Additionally, the new rules in Section 6221 also coincide with changes to Section 6225 which give the IRS the authority to seek collection of taxes due directly from partnerships in the year assessed and it may be assessed at the highest rate that is applicable to individuals.
The new rules for Section 6222 are applicable to how partners deal with gains/losses, income, deductions as well as credits. The rules clearly state a partner must treat these items in the same fashion on their tax return reporting as the partnership treated them within its tax filings. Basically, reporting of these items and any calculations involved must remain consistent. However, if a partner knows an inconsistency is necessary they must notify the IRS ahead of time before they file their personal tax return.
Section 6223 now stipulates that partnerships must have a designated partnership representative who is authorized to act and operate on the partnership’s behalf.
The new rules for partnerships also include new regulations for procedures including official proceedings, adjustments, collection efforts, assessment of penalties and/or interest payments as well as the time periods in which all of these may or may not occur.
Taking the time to understand the current tax rules that apply to your specific entity type is an important part of ensuring your organization does not end up paying unnecessary fines, penalties, and taxes. In the view of the IRS any organization that is not incorporated but contains more than a single member is normally considered a partnership for tax purposes. This definition is specific to organizations that are involved with running a business of some sort and it does not apply to partnership organizations that are purely investment related.
Corporations both C corps. And S corps.
Insurance Companies
Particular Banking or Lending Institutions
Government Entities
Particular Foreign Based Entities
Not For Profit Groups or Tax Exempt Entities
REITs (Real Estate Investment Trusts)
All partnerships should maintain a Partnership Operating Agreement upon forming. Partnership agreements should be straightforward and easy for the partners to understand. Additionally, it should contain all agreements and changes to those agreements by all of its partners. Technically, modifications may be oral and are not always required to be in writing. However, it is highly recommended that all modifications are documented for not only purposes of handling tax requirements with the IRS but also for a partnership’s own purposes as well.
A partnership is a business arrangement whereby the partners share in the capital and services provided, plus they share the profits that result from their partnership. According to the IRS, "an unincorporated organization with two or more members is generally classified as a partnership for federal tax purposes if its members carry on a trade, business, financial operation, or venture and divide its profits." A partnership where all the partners do is invest money and then expect profits to come out isn’t really a partnership. In the eyes of the IRS, you not only have to invest the money, but also perform the services that you are offering through this partnership.
The rules governing the creation of a partnership changed in 1996. Any partnerships before 1997 don’t have to adhere to these changes only if they have at least two partners and don’t elect to fill out the form 8832 to become a corporation.
There are some organizations that can’t become partnerships according to the IRS. They are the following:
Any other organization that elects to be classified as a corporation by filing Form 8832.
A partnership agreement that is simple to follow and understand should be established by every organization with two or more partners and it should include the original agreement and any modifications that have been made. The IRS asks that all partners must agree to all modifications and adopt them in any other manner provided by the partnership agreement. The agreement or modifications can be oral or written.
The rules for partnerships among family member (spouses, ancestors, and lineal descendants [or a trust for the primary benefit of those persons]) are a little different. They have to meet one of the following two conditions as outlined by Uncle Sam:
A good example to consider for the first condition is a grocery store. Joe, the owner of the store, decides to give his son Mike 50% of the business. The profit from the business is $50,000. Joe is the one who performs the services, and they are estimated to be around $20,000. Mike doesn’t perform any services. Come tax time, the IRS is only going to look at $30,000 worth of profits. The services performed by Joe cut into the profit and the leave the remaining partnership profit at $30,000. The money is split right down the middle and Mike ends up with $15,000. Because he didn’t share the services, they went 100% to his father.
Husband/wife partnerships also have their own rules. Husband/wife partnerships can survive without partnership agreements as long as they have an understanding about the profits and losses. Each spouse has to file a form 1065, not a schedule C for form 1040. Each has to carry over their share of the profits and the losses to the form 1065 and attach to there joint or separate form 1040. They also have to file a separate form for self-employment taxes, schedule SE with form 1040.
