The Bipartisan Budget Act of 2015 (later amended by the Protecting Americans from Tax Hikes Act of 2015) substantially changed the rules governing IRS audits of partnerships (including limited liability companies taxed as partnerships). These rules became applicable to partnership tax returns filed for tax years beginning after December 31, 2017.
Although the vast majority of partnerships are affected, the new rules were primarily designed to make it easier for the IRS to assess and collect tax on large partnerships (i.e., partnerships with more than 100 partners) by shifting the tax liability for partnership audits from the partners to the partnership. A partnership with 100 or fewer partners may elect out of the new regime, unless one or more of the partners is a partnership or trust. Most partnerships (and limited liability companies taxed as partnerships) need to amend the audit provisions set forth in their current partnership agreements (or operating agreements) to ensure that such agreements account for the procedural requirements under the current audit regime.
Additionally, the new law replaced the prior concept of a Tax Matters Partner (“TMP”) with a “Partnership Representative.” Because the authority of a Partnership Representative goes far beyond that of a TMP, partnerships (again including limited liability companies taxed as partnerships) need to consider how this change should be reflected in the partnership agreement (or operating agreement, as the case may be); specifically, by having the agreement address the Partnership Representative’s status, authority, and the limitations imposed on the exercise of said authority.
For this purpose, a partnership agreement (or operating agreement) should now include provisions:
- requiring that some percentage of the partners agree to certain actions taken by the Partnership Representative;
- delineating how a Partnership Representative is to be elected and removed, and how a successor Partnership Representative is to be appointed; and
- imposing some level of duty on the Partnership Representative to make an unbiased decision, or at least provide for the possible appointment of a successor Partnership Representative if it appears that there is a conflict of interest.
A Partnership Representative can be any U.S. person or entity. If a partnership does not name a Partnership Representative, the IRS has the power to name one for the partnership. These changes enable the IRS to audit additional partnerships each year, thereby increasing the audit risk associated with partnerships.
In order to address these changes and the numerous complicated elections and exceptions provided under the new law, every partnership agreement, multi-member limited liability company operating agreement, etc., must be amended. If an agreement is not amended to address these changes, the partnership may neglect to take advantage of potentially beneficial elections under this law and may shift the tax burden of an audit to current partners even if such partners were not partners in the year under audit. If you have not already amended your agreements, please contact us at your convenience.
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