The reduction in the corporate income tax from a maximum rate of 35% to a flat rate of 21% as a result of the Tax Cuts and Job Act (TCJA) has caused many taxpayers to re-evaluate their choice of entity. However, in the real estate arena, partnerships and LLCs taxed as partnerships continue to be the “right” choice of entity for most taxpayers. Many factors weigh into this determination, but the most significant factor is the ability of investors to use mortgage financing to increase their tax basis, allowing them to deduct the significant tax losses that are usually generated in the early years of a rental property’s operation as a result of accelerated tax depreciation.
Wipfli previously provided information regarding the IRS’ new partnership audit rules, which became effective for partnership tax years beginning after December 31, 2017. These new audit rules were designed with one goal in mind – to make it easier for the IRS to audit partnerships and collect any additional tax due as a result of those audits. Prior to these new rules, the audit and collection of tax was complex and administratively burdensome on the IRS. As a result of that inefficiency, there was an extremely low rate of partnership audits being completed – good for taxpayers but not so good for the U.S. Treasury.
Now the IRS has devised another tool to increase their partnership audit efficiency. Recently-issued drafts of the 2019 partnership Form 1065, Schedule K-1, and the accompanying draft instructions indicate that partnerships are now going to be required to report a significant amount of additional information about both the partnership and its partners when they file these forms for 2019 as compared to 2018. It is no secret that these new disclosure requirements are going to be useful to the IRS when identifying taxpayers for audit. So not only will the IRS be able to increase the number of partnership audits they perform, they will now be better able to select those taxpayers that might be incorrectly allocating or claiming losses, resulting in increased likelihood of those taxpayers having to write checks to the IRS upon conclusion of their audits. And just a reminder that under the new partnership audit rules, it is the partnership itself that will likely write that check, not the individual partners.
There is a significant lobby at work to request a delay in some of these new disclosure requirements. Unfortunately, we can’t determine at this point whether the lobbyists will be successful. Therefore, partnerships and their accountants need to immediately assess these new requirements and determine whether the information the IRS is now requesting is already available or will need to be re-created prior to the filing of the partnership income tax return. The information will then also need to be tracked and updated going forward as well.
The TCJA, in addition to providing taxpayers with new opportunities for tax reduction and deferral, also added a significant amount of additional work and disclosure requirements with respect to 2018 partnership tax filings. Clearly, these new 2019 disclosure requirements are going to further increase the compliance burden on partnerships and their accounting firms.