2018 sounds like a long way away. But if you are an owner in an entity being taxed as a partnership (like a limited partnership or a limited liability company), it really isn’t. Under the Bipartisan Budget Act from 2015 passed by Congress last Fall, significant changes were enacted as to how partnership tax audits are conducted and back taxes are paid and who may represent the entity before the IRS. The reason for these changes is that the IRS got tired of tracking down partners under the current audit rules, particularly with multi-tier ownership structures and then trying to collect from those ultimate owners. The goal appears to be to force more simplified ownership structures or life will get more complex for owners of partnerships and limited liability companies.
In the past, partnership tax audits were conducted at the partner level and not at the entity level generally speaking. Back taxes were collected from the entity owners for the year under audit and were collected directly from them. Now all of that will be changing commencing 2018. The IRS will audit the entity itself and collect back-due tax, interest and any penalties from the entity and not from the owners in the year the audit is completed. So if a limited liability company is audited in 2018 for the calendar year 2015, payment will have to be made by the limited liability company itself from current assets, even though many or most of the owners have changed during that period of time.
This is going to be a problem. How are current members of a limited liability company going to collect from the former owners of that limited liability company? I don’t see the old members coughing up money without a fight. And to top it off, the partnership or limited liability company could be taxed at the highest individual tax rate, which is currently 39.6%.
There will be an exception from the new rules called the “small partnership” election. The Bipartisan Budget Act permits small partnerships with under 100 partners to elect out of the new rules. But the IRS attached more strings to this. If there are partners who are limited liability companies or trusts, then the opt-out is not available. And the election will have to be made each year following Section 6221 rules. There are other points and exceptions that will be dealt with in a subsequent blog.
The old “Tax Matters Partner,“ which is referenced in just about every limited liability company operating agreement, will now be called the “Partnership Representative.” This is the only person the IRS will deal with in connection with an audit. This person should have tax expertise and need not be a partner or member of the entity in order to be so appointed, but will have more obligations to perform than the old Tax Matters Partner.
While the effective date is a ways off, it is never too soon to meet with your accountant and lawyer to review this significant change and determine how the partnership agreement or limited liability company’s operating agreement should be amended in light of these new rules. There are a number of issues that should be addressed, and I’ll do so in Part Two of this blog.
Michael W. Margrave
Disclaimer: This blog is for information purposes only. Legal advice is provided only through a formal, written attorney/client agreement.