Partnerships and limited liability companies should begin thinking about addressing the issues presented by the new partnership law in their agreements, even if further changes will be necessary once regulations are issued.
Many partnership and limited liability agreements provide that the partnership or limited liability company taxed as a partnership will deliver K-1s electronically. Some provide that partners and members are consenting to this delivery by signing the agreement. Is this sufficient to comply with the requirements to deliver a K-1 to partners and members?
Unfortunately, it is not. In order to avoid the significant penalties that may apply if K-1s are not delivered to partners of partnerships and members of limited liability companies, the partnership or limited liability company must receive consent electronically to the electronic delivery of K-1s. That electronic consent must demonstrate that the partner or member can access the electronic format in which the K-1s are delivered. If consent to electronic delivery is received in paper form, then an additional confirmation of that consent must be received in a manner that demonstrates that the partner or member can access the electronic format in which the K-1s will be delivered.
Thus, if consent to electronic delivery is received in paper form, then an additional electronic confirmation of that consent is still needed. Based on the rules, it appears that a consent given when accessing the secure website to download or print the K-1s should be sufficient.
The rules also require that, if the electronic method of delivery changes materially, new consent to electronic delivery is required in a manner that demonstrates that the partner or member can access the new method. It is not clear what amounts to a material change, but, if the partnership or limited liability company is in any doubt regarding it, obtaining a new consent when accessing the system makes sense. It may be more practical to simply obtain consent each year. The partnership or limited liability company must also inform the partners or members of how to print the K-1s and of the date when the K-1s will no longer be available on the website.
Additionally, the rules require that partners or members be able to withdraw consent and that the partnership or limited liability company will then be required to deliver paper K-1s. Partners and members must be informed that, if they do not consent or if they withdraw consent, paper K-1s will be provided. Even electronic K-1s must provide all required information and comply with all the instructions and rules applicable to substitute K-1s. Further, the partnership or limited liability company must provide notice when the K-1s are available. If the notice is delivered via email and is returned as undeliverable, paper notice must be provided within 30 days.
Therefore, although electronic delivery of K-1s is permitted, certain rules must be followed in order to avoid penalties for failing to deliver K-1s.
New Audit Rules
Beginning in 2018, new audit rules will apply to partnerships and limited liability companies taxed as partnerships. The default under these new rules will be that the partnership or limited liability company will pay any tax assessed on audit. We have been waiting for the regulations implementing this new law, and many of those proposed regulations were issued in late January. However, the proposed regulations were then promptly withdrawn as part of the Trump administration’s freeze on new regulations. At this time, it is unclear when those regulations will be reissued or if replacement regulations will be issued.
One item that the proposed regulations reserved on, and sought comments regarding, was whether partnerships could elect to issue “statements” that are essentially amended K-1s through multiple tiers of partnerships. If these types of “statements” were allowed and a partnership undergoes an audit resulting in an assessed adjustment, that partnership could elect to issue statements to its partners, rather than paying the tax due at the partnership level. One potential result of this method is that the partners would pay a higher tax. However, if that partnership has other partnerships or limited liability companies as its partners, the now-withdrawn proposed regulations did not permit the partnership-partner to itself issue statements. Instead, comments were being sought regarding this issue. The IRS and the Department of the Treasury are concerned about the costs and effects on compliance of permitting statements to be issued through tiers of passthrough entities. Thus, this remains an issue for tiered partnership structures.
As it is not clear when proposed regulations will be issued, and the effective date of the law is fast approaching, partnerships and limited liability companies should begin thinking about addressing the issues presented by the new partnership law in their agreements, even if further changes will be necessary once regulations are issued. One way to deal with the partnership’s or limited liability company’s paying the tax may be through the same mechanism that the entity currently uses to deal with required withholding taxes. It may make sense to wait a few more months before implementing any changes, however, in the hope that regulations will be issued in that time period, unless the entities subject to the new law are already in the process of creating or amending their agreements.