Beware New IRS Partnership/LLC Audit and Assessment Rules
Federal Tax Alert
You may have heard that the IRS’s ability to audit partnerships (including multi-member LLCs) will be greatly enhanced due to changes made by the recent Bipartisan Budget Act of 2015. The new rules apply to tax years beginning after 2017, which may sound far off, but partnerships need to use this time to prepare for the changes by amending their agreements, selecting a new Partnership Representative (PR), and making decisions that will affect internal operations for years to come. The IRS will be ramping up its partnership audit efforts and training auditors. Congress projects these new procedures to generate more than $9.3 billion in new revenue over a 10-year period.
Currently, few partnerships are audited by the IRS, in large part because the agency cannot assess partnerships directly, but instead must pursue each partner for its share of any assessment, often through multiple tiers. The default rule under the Budget Act requires the IRS to assess the partnership if filing errors are detected during an audit, and the PR must then quickly decide whether the partnership itself (the current partners, indirectly) or those who were partners during the audit period should pay the assessment.
First and foremost, a PR should be designated well before the end of 2017. The PR will be the sole contact person with the IRS auditor and is authorized to make all decisions regarding how to handle the audit, whether to appeal the assessment or settle, and whether the partnership will “push out” the assessment to the former partners or pay the assessment itself. The partnership and all its partners will be bound by actions taken by the PR in connection with partnership audits.
Initially, the PR (we think) makes the decision about whether the partnership can opt-out of the new rules, and the first step is determining whether that option is available based on head count. The partnership must have 100 or fewer partners, and all partners must be either individuals, S corporations, C corporations, or estates of deceased partners. If you have an S corporation partner, then you must count each of its shareholders for this purpose. And if even one of the partners is another partnership/LLC, a disregarded single-member LLC (unless future guidance says otherwise) or a trust, the partnership is automatically thrown into the new regime. No opt-out.
Your company’s current tax matters partner or tax matters member is automatically fired for tax years after 2017, and if a new PR hasn’t been designated, the IRS will have the authority to designate one for you. So start thinking about (1) who the new PR should be, (2) what level of indemnification will be afforded to them against any costs or liabilities that may be incurred in acting in that role, and (3) the level of accountability they will have to the company and its partners. The PR need not be a partner.
A final warning: If you’re contemplating a new business venture that will be classified as a partnership for tax purposes (including an LLC or joint venture) or if you need to amend an existing agreement, then these changes should be incorporated into the new or revised agreement immediately, even though detailed guidance from the IRS on many aspects of the Budget Act isn’t expected to be released until later this year. If you have any questions regarding these changes or wish for us to review current partnership/operating agreements and make suggestions for changes, please contact one of us (email@example.com, firstname.lastname@example.org or email@example.com).