I’d like to introduce you to my colleague, Libby Yeargin, the Co-Chair of the Corporate & Securities Practice Group at Brouse McDowell. By day, she enjoys serving as outside general counsel and trusted advisor to businesses of varying size, scope and industry. By night, she’s the master at escape rooms, having successfully solved nearly every escape room in Northeast Ohio. Ask her about that sometime and maybe she will share her secrets! Today she’s a guest author for Compliance Checkup to tell you about the revised partnership audit rules for limited liability companies (LLCs). If your organization is an LLC, be sure to read on!
1. A Shift in Tax Burden
New partnership audit rules became effective on January 1, 2018, and affect LLCs in every state. The rules shifted liability for taxes assessed as a result of an audit of a limited liability company taxed as a partnership. Before the new rules took effect, the IRS was required to collect any underpayment of federal income tax resulting from an audit directly from the members individually and not the LLC itself. After January 1, 2018, the LLC is the party responsible for such federal income tax underpayment. The change swings the IRS’ burden of having to pursue individual members to collect taxes assessed as a result of an audit. This change is important to understand because now the members of the LLC at the time of the audit are responsible for the payment of the tax imputed for the past tax year being audited, even if they were not members during the tax year reviewed by the IRS. This could present a discrepancy relating to the tax burden among the members for that period. LLCs may wish to address liabilities arising from the new rules by adding indemnity obligations between current and former members of the LLC.
2. New “Partnership Representative”
Further, the new rules require LLCs taxed as partnerships to designate a representative to act on their behalf with the IRS. Prior to January 1, 2018, LLCs were required to appoint a “tax matters partner” to represent the LLC in connection with federal income tax matters. The new rules eliminate this requirement and now require that each LLC name a “partnership representative,” with the lone authority to act on behalf of the partnership with respect to an IRS audit or judicial procedures without needing any consent of the individual members. Another notable change is that unlike the former tax matters partner, the partnership representative need not be a member of the LLC, but rather must merely maintain a “substantial presence” within the U.S. In light of these alterations, we recommend that the members of an LLC taxed as a partnership amend their operating agreements to include contractual provisions specifically documenting issues that may arise in connection with IRS income tax audits or judicial procedures. For example, the operating agreement may require the partnership representative to provide notice to the members if he or she receives any communications relating to income tax audits, or mandate that he or she obtains written consent from the members of the LLC before acting in any way that could bind the LLC or the members.
3. But Wait — You May Be Able to Opt Out or Shift Obligations!
An exception does, however, exist for certain eligible LLCs to opt-out of the new IRS rules. The ability to opt out is contingent on the following requirements: (i) the LLC has 100 or fewer members; and (ii) each of the members is one of the following: (a) an individual, (b) a decedent’s estate, (c) an S corporation, or (d) a C corporation (or a foreign entity that would be treated as a C corporation if it was domestic). LLCs that have an entity taxed as a partnership or as a single-member are not eligible to opt out. An eligible LLC may opt-out for a tax year by designating this election on its tax return and providing all members with notification of the same within 30-days of the election.
LLCs may also elect to push out the obligations. This means that the LLC may shift the obligation to pay an underpayment to those who were members of the LLC during the reviewed year. The LLC must elect the push-out within 45-days of the date of a notice of final adjustment from the IRS. An LLC that elects the push-out must then provide an amended K-1 to the members from the review year. The operating agreement should include language requiring members to cooperate with a push-out election by filing amended returns and paying any taxes, interest, and penalties regardless of whether or not they are current members of the LLC.
4. What to do Now?
The new rules have a hefty impact on LLCs taxed as partnerships, so be sure to review these new rules and determine how they impact your company if you haven’t already. If needed, be sure to revise your existing operating agreement to take into account the changes discussed above.
This blog is intended to provide information generally and to identify general legal requirements. It is not intended as a form of, or as a substitute for legal advice. Such advice should always come from in-house or retained counsel. Moreover, if this Blog in any way seems to contradict advice of counsel, counsel's opinion should control over anything written herein. No attorney client relationship is created or implied by this Blog. © 2019 Brouse McDowell. All rights reserved