Many complex estate plans, especially those focused on asset protection, employ the use of limited liability companies, limited partnerships, and other non-corporate entities. However, effective for tax years starting after January 1, 2018, the procedure for auditing businesses taxed as partnerships, such as family limited liability companies and limited partnerships, has been dramatically changed. As a result, all of these family entities need to update their operating or partnership agreements to ensure that they are prepared for a future audit. Not doing so will reduce the members’ ability to participate in the audit process.
The new audit regime makes two (among other) significant changes that could negatively impact a company if not addressed:
1) The company, not the members, will now be liable for tax adjustments determined during any audit and such adjustments will be determined based on the highest current tax rate (currently 37%) regardless of the rate paid by the individual members. While these changes simplify the audit process for the IRS, the overall burden on the entity, and its members, has been significantly increased. In particular, this change actually shifts the tax burden to the current members even if those persons were not members in the tax year actually under audit.
2) The company will now be represented before the IRS during an audit by a “partnership representative,” who will have full power to bind the company. The partnership representative can generally be any person or entity that has a substantial presence in the United States. This person will then have the sole power to represent and bind the company before the IRS during an audit. Thus, if the company’s operating or partnership agreement does not provide any restrictions on the actions of a partnership representative, the members and managers will have little control over the audit process. Furthermore, if the company does not name a partnership representative, the IRS has the power to name a partnership representative for the company.
Nonetheless, the above issues, and other issues raised by the new law, can be addressed in a company’s operating or partnership agreement. More specifically, provisions can be added that bind former members to the outcome of any audit proceedings, that limit a partnership representative’s ability to bind the company without first consulting with the members and managers, and can provide internal procedures for dealing with the numerous exceptions to and exemptions from the new audit regime contained in the law.
Individuals using limited liability companies or partnerships in conjunction with their estate plan need to ensure that their operating or partnership agreement properly addresses these new tax law changes. While many operating businesses have already prepared for this new audit regime, many individuals using non-corporate entities for other purposes may not realize the significant impact these changes can have on their companies. As a result, all non-corporate entities should verify whether the new audit regime will apply to them and, if it does, ensure that each affected entities’ operating or partnership agreement adequately addresses the issues raised by the new audit regime.