Significant changes to the way partnerships (including multi-member LLCs) are taxed for federal income tax purposes in 2018 affected more partnerships than originally anticipated.
The Bipartisan Budget Act of 2015 allows the Internal Revenue Service to conduct audits of certain “large” partnerships rather than just the individual members and to collect income tax, interest, and penalty fees against the partnership as a whole rather than simply the individuals involved.
The IRS has begun auditing partnerships, and some of its “super auditors” are finally ready to start their education.
We also learned from IRS personnel that a surprising number of smaller partnerships did not use their annual right to opt out of the comprehensive partnership audit regime (CPAR), and so they must comply with the new audit standards whether they like it or not.
Most states do not allow the direct assessment of partnerships since partnerships are pass-through firms with owner-level tax responsibility and are not recognised as taxpayers under state law. State governments face a choice following the CPAR’s implementation:
(1) pass legislation granting them the authority to independently audit and assess specific partnerships;
(2) substantially comply with the new federal CPAR and wait for the IRS to provide information on recent audits of partnerships with ties to that state; or
(3) do nothing and risk losing out on what could be substantial sums of state tax revenue.
Concerned that their partnership clients/members could be exposed to several state audits in addition to an in-depth IRS examination, several professional and business trade associations sought to negotiate a model statute that could be adopted by every state that imposes a net income tax.
Over about two years, the Multistate Tax Commission (MTC), the American Institute of Certified Public Accountants (AICPA), the Council on State Taxation (COST), the American Bar Association Tax Section*, the Tax Executives Institute, and the Institute for Professionals in Taxation met to develop this model.
The MTC Model Statute was ratified by the MTC in January 2019, and it was rapidly backed by other organisations.
Thankfully, the model statute effectively supports the second option, allowing the IRS to conduct partnership audits on its own and then pass along the audit materials to the states so that they can do their own assessments.
Twenty-one states have so far accepted all or large parts of the Model Statute (although at least three need revisions to more closely follow the MTC Model Statute).
A large number of states have approved versions that only apply to partnerships, while the Model Statute addresses reporting federal audit adjustments for all taxpayers.
In light of the anticipated increase in revenue agents as a result of the Inflation Reduction Act of 2022, this model was developed to provide these additional jurisdictions with a uniform, easy-to-understand method for implementing the results of IRS partnership audits.
The Model Statute, on the other hand, provides taxpayers and partnership representatives with a range of state-level options that may differ from their federal choice.
For federal tax purposes, a partnership may “push out” the duty for the assessment to individuals who were partners during the audit period; for state tax purposes, however, the partnership may elect to pay the proportionate amount of the assessment itself.
More than a year ago, the Alabama Department of Revenue (ADOR) and the Alabama State Bar Tax Section collaborated on a project to produce Alabama’s own version of the Model Statute, but they eventually decided to scrap it.
The Alabama Department of Revenue (ADOR) recently announced its intention to revive the project, and the Alabama Society of CPAs and the State Bar Tax Section have already expressed interest in resuming their collaboration on it. F
following this, the ADOR will make any necessary changes to the draught to submit it to the legislature during the Spring 2023 session.
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States with individual income taxes have already adopted all or significant elements of the Model Statute, and the IRS is expected to increase the number of partnership audits in the future years.
President Biden has recently signed into law the Inflation Reduction Act of 2022. To guarantee compliance with the CPAR and related state legislation, all partnerships (including multi-member LLCs) should take advantage of this time to have their tax advisors review their organisational forms.
See if the AICPA has any thoughts on the Model Statute. Here you can find some background on the Model Statute and several related articles that should prove helpful.
