With significant changes to the tax law taking effect in 2018, now is the time to review your partnership and LLC agreements. Two major areas to consider are the new partnership audit rules and tax distributions.
Some agreements may not take into account the new partnership audit rules, which are effective for tax years beginning after 2017. Although the rules were first enacted in 2015 with a delayed effective date, they were amended as recently as last month. Under the new rules, the tax matters partner has no authority. Rather, the partnership representative (or individual designee), who does not have to be a partner, has the sole authority to deal with the IRS and can bind all partners. Moreover, the affected partner, no matter how large an interest he has in the partnership, no longer has the right to attend meetings with the IRS or to enter into his own settlement agreement. The determination of the partnership representative binds all partners in connection with any transaction involving the partnership, even with respect to items that do not necessarily affect the partnership (e.g., the partner’s basis in property sold to the partnership). Because of the dramatically increased power of a partnership representative, as compared with the tax matters partner, anyone not affiliated with the partnership representative will want protections, and the place for such protections is in the partnership agreement. And the partnership representative needs to sign the agreement in order to be bound to provide such protections.
Agreements should also be reviewed with respect to tax distributions. Although tax distributions are intended only to assist the partners in paying their taxes attributable to their share of the partnership’s income, partners hate having to reach into their pockets to pay any portion of such taxes. Some partnership agreements use a fixed rate for paying tax distributions. Some use a formula that assumes state and local taxes are deductible for the partners.. But tax rates changed as a result of the TCJA and the deduction for state and local taxes was limited to $10,000 through 2025. Should the new pass-through deduction be taken into account in computing tax distributions? Although the deduction is based on the partnership, it is a partner level deduction and may be affected by the partner’s other tax attributes.