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Goering Center news

What your business needs to do to get ready for partnership audits

By Kelvin M. Lawrence, Esq.

The Bipartisan Budget Act of 2015 (BBA) changed how the Internal Revenue Service audits businesses taxed as partnerships (referred to in this article generically as partnerships) for tax years beginning on Jan. 1, 2018. Ohio conformed to these rules in the recent biennial budget, Am. Sub. H.B. 166 (H.B. 166), and other states are adopting similar tax laws. Businesses should amend their governing documents now to be prepared to respond to these audits, if and when they come.

The BBA audit rules allow the IRS to more easily identify an individual authorized to act on behalf of the audited entity by requiring every partnership to have a “partnership representative” with broad authority to bind the partnership and its partners, and by allowing the IRS to appoint one, if a partnership does not. The new rules also make multi-tier partnerships easier to audit by defaulting to assessment of tax at the partnership level rather than the partner level. Partnerships with certain types of partners and that issue fewer than 100 federal Schedules K-1 may opt out of the BBA rules, but this election must be properly requested every year.

Under the new rules, if an audit increases the tax due for a “reviewed year” under audit, the partnership generally must pay it as an additional tax for the “adjustment year” in which the audit concludes. This may burden partners in a later year for taxes attributable to an earlier year. An audited partnership may instead elect to push out the tax liability to its partners in the reviewed years, who may no longer be associated with the business. If the tax is pushed out, the BBA allows these partners to report the additional tax in the year the partnership sent a valid notice electing to push the tax out, without amending their reviewed-year federal tax returns.

Federal audit changes generally mean state income tax changes for a partnership and its partners. For large, multi-state businesses, a federal audit adjustment could mean amended state tax filings in dozens of states. As this article goes to press, 12 states, including Ohio, have adopted laws to address new federal partnership audit adjustments, and more are considering legislation. 

Ohio’s new partnership audit rules default to a procedure requiring an audited partnership to:

  1. File a report of the federal adjustments with the state;
  2. File statements notifying directly invested partners of their respective shares of the tax due; and
  3. File an amended composite return, paying the tax due on behalf of its nonresident partners.

Partners directly invested in the audited partnership must file original or amended Ohio returns for the reviewed year, and pay any remaining tax due after the partnership’s payment. 

Alternatively, the partnership may notify Ohio and notify its partners of their share of the tax, and elect to file a return and pay tax on behalf of all of its partners at the highest Ohio income tax rate. By complying with this election, the partnership may satisfy the obligation of its directly invested partners to file amended Ohio tax returns. Under Ohio’s rules, the partners can file individual returns to claim refunds, if any, of tax the partnership overpaid by making this election. Under Ohio’s default option, partners that are themselves pass-through entities must also decide whether to pay the tax themselves or push it out to their own partners.

Every business taxed as a partnership should amend its governing documents with both federal and state tax rules in mind. Controls on appointment, removal, and control of the partnership representative are essential, as are methods for opting out and collecting amounts due from former partners. At the state level, many states have partnership audit rules that differ from one another, and from the federal rules. Partnerships must make hard choices about whether to push out a federal audit liability, and whether they can or should make the same choice in each state. These choices are particularly important if partners are considering moving, retiring, or making family members future owners of the business. Putting structures in place now to manage these complex audits can help avoid disagreements over how to handle future audit liabilities.

Kelvin M. Lawrence is a business and tax attorney with Dinsmore & Shohl LLP. Reach Kelvin at 614-628-6964 or at kelvin.lawrence@dinsmore.com.

About the Goering Center for Family & Private Business
Established in 1989, the Goering Center serves more than 400 member companies, making it North America’s largest university-based educational non-profit center for family and private businesses. The Center’s mission is to nurture and educate family and private businesses to drive a vibrant economy. Affiliation with the Carl H. Lindner College of Business at the University of Cincinnati provides access to a vast resource of business programing and expertise. Goering Center members receive real-world insights that enlighten, strengthen and prolong family and private business success. For more information on the Center, participation and membership visit goering.uc.edu.

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February 12, 2020

It’s a new year, filled with new plans, hopes, dreams and expectations. As a business owner and leader, you’ve invested the time and energy to create annual business plans, strategies and budgets, and now the hard work is behind you, right? Wrong. In reality, the single biggest factor of whether you achieve your annual plan is based on one thing: Execution. The discipline to execute and get the right things done separates great teams from good teams. Sadly, Cincinnati Bengals fans know this all too well after the 2019 football season. Well-conceived game plans don’t win football games, consistent execution does. Or as Mike Tyson said, “Everyone has a plan until they get punched in the mouth.” In his book The 12 Week Year, author Brian Morgan writes, “The marketplace only rewards those ideas that get implemented. Leaders can be smart and have access to lots of information and great ideas; they can be well connected, work hard, and have lots of natural talent, but in the end, they have to execute. Execution is the single greatest market differentiator. Great companies and individuals execute better than their competition.” Organizations that consistently achieve their plans typically focus their efforts on a handful of mission-critical initiatives and break them down into bite-sized chunks. In his bestselling book, Traction, Gino Wickman refers to these shorter-term priorities as “Rocks.” The concept of rocks actually comes from Stephen Covey’s book First Things First. Picture a glass cylinder on a table. Next to the cylinder are rocks, gravel, sand and a glass of water. Imagine the glass cylinder as all the time you have in a day. The rocks are your main priorities, the gravel represents your day-to-day responsibilities, the sand represents interruptions and the water is everything else that you get hit with during your workday. By putting the big stuff in first (rocks), the daily responsibilities second (gravel), the interruptions third (sand) and then everything else (water), it all fits. Most importantly the rocks get your first and best attention to complete. A leadership team that utilizes Rocks operates in a 90-Day World as Wickman describes it; evaluating, establishing and achieving business priorities every 90 days. This exercise of giving weight to the most important things drives clarity and alignment of the leaders and the organization. Each Rock is assigned to a single person to own the responsibility for ensuring it gets done. This shorter-term agreement and focus on the most important items dramatically increases the probability of achieving the desired outcome, in turn, achieving the annual plan. Organizations that utilize the methodology in Traction, called the Entrepreneurial Operating System or EOS®, focus on just three to seven 90-day Company Rocks. Each Rock must be SMART (specific, measurable, attainable, realistic and timely). Leadership teams review and discuss the Rocks each week to determine whether they’re “on track” or “off track.” This creates awareness and accountability among the team so that people don’t get distracted by the day-to-day stuff and forget to focus on what’s really important. This year, consider how focusing on less might actually help you accomplish more. Break your organization’s annual plan down into prioritized, bite-sized chunks and hold yourself and your leaders accountable every week for 90 days to execute the plan.

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