In 2015, the Bipartisan Budget Act completely overhauled the IRS audit rules for partnerships, which include limited liability companies (LLCs) taxed as partnerships and their partners.
Those rules will go into full effect for tax returns filed for the 2018 tax year. While there is uncertainty on the application of these rules until we receive more guidance from the IRS, the important aspect of these new partnership audit rules is that if there is a tax deficiency or adjustment by the IRS to a partnership return, the partnership itself will be liable for any tax due, rather than passing that liability to the individual partners.
This may have an impact on the purchase and sale of partnership interests, since the liability for tax adjustments will remain with a partnership following the sale of one or more partners.
Who is affected?
Entities that are taxed as partnership for US federal income tax purposes, e.g., partnerships and certain LLCs.
Importantly, certain small partnerships may make an election to “opt out” if the partnership has 100 or fewer partners. This is an option that smaller partnerships may want to consider with their tax advisors. If a partnership has another partnership as a partner, the partnership may be prohibited from opting out of these new rules despite having 100 or fewer partners.
This is how to opt out:
Partnerships that can and want to opt out, must make an affirmative election to opt-out annually on a timely filed return and must include information regarding each partner’s name and Taxpayer Identification Number.
Current and future partnership and LLC operating agreement issues Partnerships and LLCs can proactively address issues which may arise related to the new partnership audit rules, by reviewing and potentially amending their partnership agreements or LLC operating agreements to include provisions that address the following:
- The new rules no longer use the term “Tax Matters Partner” instead entities will need to designate a partnership representative;
- Assignments of partner interests to persons (or entities) that would preclude the ability of the partnership to opt-out (if the partnership wants to preserve the ability to elect to opt-out) should be disallowed
- A mechanism to determine which partner(s) will determine if the entity should elect to opt-out or stay in the new partnership regime;
- How an entity-level tax liability will be paid (including who should bear the liability if the partnership is unable to pay such tax obligation);
- In the event of an audit adjustment, committing to making certain partnership elections.
These items should also be discussed and negotiated during the transfer, sale and formation of such entities. Particularly, partners should consider who should bear the burden of historic liabilities, if the partnership itself is now liable for audit adjustments under the new rules.
How Blalock Walters can help:
Blalock Walters can review your current partnership or LLC operating agreement and make any needed amendments. Email these tax law attorneys for more information: Jenifer Schembri at firstname.lastname@example.org or Kristen Ehrlich at email@example.com.