Under new legislation and Department of Treasury audit regulations, partners can be stuck paying a higher tax rate or—worse—someone else’s tax liability.
Partnerships and limited liability companies (“LLCs”) that are treated as partnerships for tax purposes are commonly referred to as “pass-through” organizations because the entities do not pay federal income tax. Instead, the partnership’s income is “passed through” to the partners or members, who pay the tax at their own marginal rates. If an IRS examination (audit) determines that a partnership underreported its income, such that the partners underpaid their taxes, the IRS collects the additional tax due from the partners. New partnership audit legislation that will take effect in 2018 will change this fundamental “pass through” feature. Under the new rules, if the IRS determines that tax on a partnership’s income was underpaid, it collects the tax from the partnership itself, not the partners. The partnership generally pays tax at higher rates than its partners do.
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