Compliance with New Partnership Audit Rules May Require Amendments to Partnership/LLC Agreements

by Murtha Cullina
Contact

New partnership audit rules (the "New Rules") became effective for tax years beginning on or after January 1, 2018. These rules, which are designed to make it easier for the IRS to audit partnerships and collect additional tax liabilities relating to partnership operations, apply to all partnerships and limited liability companies taxed as partnerships (hereinafter, "partnerships"). The New Rules do not require an amendment to the partnership agreement to be applicable. However, these rules will significantly impact partners/members (hereinafter, "partners"), and not updating the partnership agreement could eliminate the partners’ ability to make certain elections and dictate the manner in which important decisions under the New Rules should be addressed. Moreover, unless certain options under the New Rules are addressed in the partnership agreement, potential investors may be reluctant to become partners.

This client alert provides a high-level summary of the new partnership audit rules and the amendments to partnership agreements that should be considered to address these rules:

Partnership Representative. Under the New Rules, the "partnership representative" is given the sole authority to act on behalf of, and bind, the partnership with respect to a partnership audit and other proceedings. The partnership representative is not legally required to notify the partners of an audit or keep them updated on the status of the audit. Importantly, the partnership representative is not required to be a partner of the partnership and the IRS is permitted to designate a partnership representative if the partnership fails to do so.

Given the broad authority granted to the partnership representative and the significant economic effect audit decisions may have on the partnership and the current partners, consideration should be given to including provisions in the partnership agreement that describe the procedure for electing and removing the partnership representative, require the partnership representative to provide the partners with all communications and updates regarding audits and assessments, and limit the authority of the partnership representative to settle or litigate an audit determination without a threshold percentage of partner consent. The partnership agreement should also address whether the partnership representative will be indemnified by the partnership and what fiduciary obligations, if any, the partnership representative will have to the partners.

If the partnership representative is not a partner, consideration should be given to having the partnership and partnership representative enter into a written agreement which sets forth the terms, compensation, duties, rights, etc. of the partnership representative.

Partnership is Liable for Tax Underpayment. Under the New Rules, the IRS may collect the additional tax liabilities, interest and penalties directly from the partnership in the year the audit concludes. As a consequence, a current partner could be responsible for a share of these liabilities even though the audit related to a prior year in which the partner was not a partner.

Options For Reducing Partnership Liability for Tax Underpayment.

Partner Amended Return. The underpayment amount paid at the partnership level is reduced to the extent a partner files an amended return for the audit year and pays its allocable share of the additional tax assessment.

Push-out Election. The partnership is permitted to make an election to transfer the tax underpayment liability to its partners. The election must be made within 45 days after the final notice of the audit adjustment.

Opt-out Election. A partnership that qualifies as a "small" partnership may annually elect to opt out of the New Rules completely. A "small" partnership is a partnership that has 100 or fewer partners composed entirely of individuals, S and C corporations, certain foreign entities and/or estates of deceased partners. Therefore, a partnership that has other partnerships, disregarded entities (e.g., single member LLCs) and/or trusts as partners is not eligible to elect out of the New Rules. The election is made on the partnership’s timely filed tax return for each taxable year and must identify the name and taxpayer identification number of each partner.

Consideration should be given to including provisions in the partnership agreement that identify the circumstances under which the push-out or opt-out elections may be made, address transfer restrictions with respect to partnership interests if the partnership wishes to maintain its ability to make the opt-out election in future years and describe the recourse (if any) current partners have against former partners if the current partners are required to pay the additional tax, interest and penalties attributable to a year prior to their admission to the partnership (e.g., indemnity provision).

New Rules Elective for Prior Tax Years. While the New Rules are effective for tax years beginning on or after January 1, 2018, partnerships are permitted to apply the New Rules for tax years beginning after November 2, 2015. Consideration should be given as to whether the partnership agreement should include a provision giving the partnership representative the authority to elect to apply the New Rules for tax years after November 2, 2015 and before January 1, 2018.

The New Rules have significantly changed the audit process for partnerships. Therefore, it is important that all existing partnership agreements be reviewed to address these rules. At a minimum, to restrict the otherwise extremely broad authority granted to the partnership representative under the New Rules, partnership agreements should be amended to address the selection of the partnership representative, the authority granted to the partnership representative and the duties and obligations of the partnership representative to the partnership.

On a related note, investment entities, such as private equity funds and hedge funds, will need to consider whether fund offering materials should be updated to include a description of the New Rules and their effects, including that current investors may be liable for additional taxes that relate to a prior year.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Murtha Cullina | Attorney Advertising

Written by:

Murtha Cullina
Contact
more
less

Murtha Cullina on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
Privacy Policy (Updated: October 8, 2015):
hide

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.

Security

JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.