The Bipartisan Budget Act (“BBA”) enacted legislation that impact partnership audit rules which took effect on January 1, 2018. Most partnerships and limited liability companies (“LLC”) will now need to amend their partnership and operating agreements for tax compliance and strategic cash flow reasons.
Under the new BBA rules, LLC and partnership audits will be centralized at the partnership level and partners will have no statutory right, as they currently do, to receive notice of or to participate in any audit, appeal or judicial proceeding. The new regime could also impact partnership cash flow and distributions. For tax periods 2018 and beyond, if an audit yields additional tax, the partnership itself would be responsible for the additional adjustments, rather than the individual partners. This can lead to potentially inequitable results.
What LLCs or Partnerships Will be Impacted?
While certain LLCs and partnerships may be able to elect out of the new regime, many partnerships will be impacted. The new rules affect:
- Any LLC or partnership that have partners or members that are:
- a trust
- a partnership or LLC
- a single member LLC; or
- a grantor trust
- Any LLC or partnership with more than 100 partners
Any LLC or partnership affected by these rules should amend its partnership agreement or operating agreement to provide for basic communication and fiduciary duties between the partners and the partnership representative.
What Protective Steps Should Partners or Members Take?
Ignoring the new partnership audit rules is a choice to apply the default rules to future audits and adjustments. Partners or Members should strongly consider taking the following steps to amend their governing documents:
- Designate a Partnership Representative
- Decide on the level of communication the Partnership Representative will have with the other partners and members
- Ensure that the governing documents address certain key controls over the Partnership Representative including:
- the selection and removal of the Partnership Representative,
- the fiduciary duties of the Personal Representative to the other members, and
- the level of approval required by the other partners before entering into any agreements with the IRS
- Specify whether future audit adjustments will be paid by the partnership or the partners
- Decide whether former partners will be obligated to pay a pro rata share of additional tax resulting from an audit for a period when they were a partner?
Many tax commentators believe that the IRS will now focus more attention on the audit of partnerships and LLCs. The new rules have taken a somewhat benign event – the designation of the tax matters partner – and have created a whole new regime for tax partnerships (and their partners) to navigate. Partners and members will need to proactively amend their governing documents or risk losing control in an audit scenario.