The Bipartisan Budget Act of 2015 (the BBA), which was signed into law in November 2015, significantly changes how the IRS will audit partnerships beginning in 2018. These changes will also have far-reaching effects on how members of many limited liability companies must prepare for potential tax liability resulting from an IRS audit. Under the BBA, the Tax Equity and Fiscal Responsibility Act (TEFRA) audit rules that have been in place for more than 30 years were repealed and replaced with new “streamlined” entity-level audit rules. These new rules will almost certainly affect the healthcare industry, because many healthcare limited liability companies and professional limited liability companies are relatively small entities (fewer than ten members) and taxed as partnerships.
Summary of Prior Provisions
Under TEFRA rules, a “small partnership” was automatically exempt from an entity-level audit by the IRS. To be a “small partnership,” an LLC must generally have had fewer than ten members, none of which were an LLC or corporation. The small partnership qualification was determined annually, and it was possible for a partnership to be covered by the TEFRA entity-level audit rules in one year and not in a subsequent year.
Tax liability resulting from an IRS audit under TEFRA also passed through to the ultimate individual member’s tax returns. This requirement often caused significant difficulty for the IRS in determining each partner’s share of the tax liability adjustment and in collecting the tax owed from each member. The difficulty in collecting outstanding amounts owed was further complicated by the IRS being unable to apply any tax liability to the entity, even though members of an LLC could change multiple times during the period being audited.
Summary of New Rules
Although the new audit rules under the BBA were designed to make the IRS’s collection of tax liabilities simpler, this simplification will require a significant redesign of the way members must look at their relationship with their company, and with the company’s current and former members. The key features of the new audit rules are as follows:
- Rather than assessing a tax to individual partners, the IRS will assess the partnership an “imputed underpayment,” which will be subject to the individual or corporate tax rate regardless of the actual tax rate applicable to individual members.
- Any tax liability from an audit will be assessed at the company level in the year of the adjustment (when the audit occurs) rather than in the tax year under audit. As a result, subject to two exceptions, current members may be liable for tax errors that benefited the company’s prior members.
- The new law requires an LLC to appoint a “Partnership Representative.” It is not yet known whether the IRS will treat this person the same as the Tax Matters Member.
Small Partnership Exception
LLCs with fewer than 100 members may opt out of the new audit rule if they do not have any members that are a separate LLC or C-Corporation. A member can be an S-Corporation. To opt out, an LLC must:
- Elect the opt-out each year on its 1065;
- Inform each partner of the election;
- Submit to the IRS the names and TINs of each of the members, including the names of each of the shareholders of an S-Corp member.
Implications for Healthcare LLCs
As a result of the BBA, each healthcare LLC will need to update its operating agreement to remain in compliance with the law, protect its members, and ensure that any tax liability is allocated equitably. These changes should include:
- Requiring managers of companies that meet the small partnership exception to elect out of the audit rules on an annual basis and comply with the member notification requirements;
- Creating rules limiting who can be a member for those companies wishing to remain eligible to opt-out as a small partnership;
- Establishing rules for electing a Partnership Representative, as well as defining actions the Partnership Representative may take;
- Allocating any assessed tax liabilities in accordance with agreed upon measures; and
- Providing procedures that members must follow to allow the company to qualify for one of the two exceptions to the entity level tax assessment.
Even though the new rules will not take effect until January 1, 2018, the BBA will have a substantive impact on tax planning for healthcare limited liability companies being taxed as partnerships, regardless of whether or not they meet the small partnership exception. As a result, companies need to take proactive steps to prepare for the new IRS audit requirements by reviewing their operating agreements to determine what changes are needed.
Please contact Peter Domas at 248-433-7595, Ralph Levy, at 615-972-0608 or any member of Dickinson Wright’s Healthcare Practice Group, for assistance with preparing your LLC for the new audit rules.
FTC Mobile Health Guidance
On April 5, 2016, the Federal Trade Commission (FTC) released new guidance for mobile apps directed towards providing health-related services and information. This guidance was developed with numerous other agencies, including the Office for Civil Rights (OCR), to assist app developers in complying with federal healthcare law.
One of the paramount concerns with mobile apps is the protection of patient protected health information (PHI) under the Health Insurance Portability and Accountability Act (HIPAA).
The guidance is provided in the form of a web-based interactive tool. For more information, see https://www.ftc.gov/tips-advice/business-center/guidance/mobile-health-apps-interactive-tool.