changes to operating agreements of limited liability companies taxed as partnerships”Stites & Harbison: “there will need to be
King, Krebs & Jurgens: “A legislative change to partnership tax audit procedures enacted under the Obama administration is set to go into effect as of January 1, 2018. All tax partnerships need to be prepared to make certain amendments to their governance agreements, preferably prior to December 31, 2017. All partnership agreements and operating agreements of LLCs taxed as partnerships will need amendment.”
Bradley Arant Boult Cummings LLP: “the new federal partnership income tax audit rules, which are scheduled to take effect on January 1, 2018, will have significant implications for the taxation of partnerships and their partners. . . . Every partnership agreement must be reviewed–soon . . . . There are a number of items related to the new partnership audit rules that need to be addressed in any new or amended partnership agreement. . . . When should these amendments be made? Now.”
The CPA Journal: “The Bipartisan Budget Act of 2015 (BBA) replaced the existing rules for auditing large partnerships with a new set of streamlined rules that take effect January 1, 2018. The new audit rules also apply to any entity that elects to be treated as a partnership for income tax purposes (i.e., LLC). . . . .These changes are designed to streamline the audit of partnership returns. In general, the audit will take place at, and any adjustment will be taken into account only at, the partnership level; any taxes will be paid by the partnership—not the partners. The new partnership audit rules are examined in detail below.”
Lou Vlahos: “Beginning 2018, the IRS is authorized to collect from a partnership any tax deficiencies arising out of the partnership’s operations for a taxable year, even if the persons who were partners in the year to which the deficiency relates are no longer partners in the year that the deficiency is assessed. Stated differently, the current-year partners will bear the economic burden of the tax liability even though the tax adjustments relate to a prior year in which the composition of the partnership may have been different. How did we get to this, and what should [LLCs taxed as] partnerships and their partners be doing about it?“
Davis Brown Law Firm: “This blog post is intended to identify the most material aspects of the proposed regulations the IRS has introduced to implement the BBA partnership audit rules, and provide guidance on what actions a partnership should consider taking at this time. The proposed regulations (REG-136118-15) consists of a 157-page preamble and 120 pages of regulations; this blog post seeks only to highlight the regulations, rather than provide a comprehensive summary. . . . Congress enacted the Bipartisan Budget Act (the “BBA”) in 2015, which completely revamped the way partnerships (including LLCs taxed as partnerships) will be audited, beginning January 1, 2018. Since the introduction of the BBA, tax professionals have discovered a vast number of problems with the new audit regime and the administrative strain it will place on partnerships.
JD Supra: “Even though such audits [under the new rules] may not occur until years after the January 1 date, partners and their partnerships, ought to begin immediately to consider amendment of partnership [and operating] agreements to reflect the new audit regime. . . . advisors and partners [and members] ought to look to the amendment of partnership [and operating] agreements now in order to, at the very least, name a partnership representative and set forth the parameters of the authority of such person between the partners. January 1, 2018 is not far off.
Entrepreneur: “The IRS will begin a new way of auditing [LLCs taxed as] partnerships starting in the 2018 tax year. Partnerships need to develop a roadmap before venturing into this new frontier. . . . With these new rules comes the potential for a host of new disputes among partners. . . . Like going to the dentist, an update to the . . . [operating] agreement may be a dreaded but necessary task to provide for this roadmap. In this article, I outline the basics of the new rules, their impact on partnerships and actionable steps businesses can take now to prepare. . . . A revised partnership or member agreement is the only way to contractually address and diffuse these potential issues before they arise.”
McDonald Hopkins, a national law firm with offices in Chicago, Cleveland, Columbus, Detroit, Miami and West Palm Beach, announced that it is offering its clients two new services. The services are:
- Partnership and LLC Amendment Program
- Partnership Representative Specialists
This law firm is offering to be the partnership representative for clients for a fee. Since becoming aware of the new partnership tax audit rules and the requirement that entities taxed as partnerships appoint a partnership representative in 2016, I believed that accounting firms and law firms with partnership tax lawyers would offer their services as a partnership representative. It makes sense.
Few members of an LLC have any knowledge of partnership tax law. Which would you rather have be your LLC’s partnership representative who will be the only party that interacts with the IRS and fights a proposed tax assessment – a CPA or tax lawyer with experience representing clients before the IRS with respect to partnership tax law or a member of your LLC who knows nothing about partnership tax law or audits? Seems like a no brainer.
McDonald Hopkins says “Every partnership and LLC should amend their governing documents to:
- Designate a partnership representative who will have the sole authority to make binding decisions in audit proceedings. The IRS will designate a partnership representative if one is not appointed.
- Authorize selections regarding complex set of elections under the new audit rules.”
I agree. I don’t offer partnership representative services, but I do provide a state of the art “Tax Audit Agreement” for LLCs taxed as partnerships in which the members address the issues raised by the new partnership tax audit rules effective January 1, 2018. If your LLC is taxed as a partnership it will be a big mistake in my opinion as a tax lawyer for the members to fail to enter into an agreement with the LLC’s partnership representative that sets the ground rules for the partnership representative’s duties representing the LLC in a partnership tax audit.
How to Purchase a Tax Audit Agreement for Your LLC
I’ve made it very easy for LLCs taxed as partnerships to hire me to prepare a state of the art Tax Audit Agreement. All you need to do is complete and submit my “Tax Audit Agreement Questionnaire.” The fee is $497 unless you want to purchase the optional DocuSign digital signature for all the members for an additional $100. Divide the $497 by the number of members in your LLC and you will see that the per member cost is worth the risk to the LLC in being audited by the IRS and not being prepared for the audit.
DLA Piper, LLP: “The IRS recently issued proposed regulations implementing the BBA Rules. Because these new rules are likely to cause an increase in the number of partnership audits, we urge tax partnerships, and their partners or members, to consider the effect of the BBA Rules and amend their partnership/operating agreements as necessary before the rules become effective. This alert provides a high-level summary of the changes effectuated by the BBA Rules and outlines some of the implications of these changes for entities taxed as partnerships.”
von Briesen: “Significant changes to the way entities taxed as partnerships are audited by the Internal Revenue Service, and to the way any resulting tax is collected, will become effective January 1, 2018. The new rules will affect most businesses operated as general partnerships, limited partnerships, limited liability partnerships and limited liability companies. Such entities will need to consider changes to partnership agreements, operating agreements, buy-sell agreements and other documents.
JD Supra: “On November 2, 2015, Congress passed the new centralized partnership audit regime as part of the Bipartisan Budget Act of 2015 (BBA) which is set to take effect for the tax years beginning on or after January 1, 2018. The intent and purpose of the new regime is to allow the Internal Revenue Service (IRS) to more effectively and efficiently audit partnerships by (1) allowing the IRS to collect from the partnership any partnership tax adjustment; and (2) requiring the appointment of a “partnership representative” to act as the point-person and binding decision maker with respect to any IRS audit procedures and related matters.”
National Law Review: “The new federal partnership income tax audit rules, scheduled to take effect on January 1, 2018, will have significant implications for the state and local taxation of partnerships and their partners. Most, but not all, states that impose a net income-based tax adopt by reference the federal definition of taxable income, but those that do typically adjust that income to reflect differences between state and federal tax policies. Moreover, state revenue departments generally do not regard themselves as being bound by Internal Revenue Service interpretations of the Internal Revenue Code even when substantive Code provisions are incorporated into state law by reference. The federal statutory rules relating to partnership audits are procedural rules and not ones of substantive tax law, so they will not be automatically adopted by states that generally conform to Internal Revenue Code provisions relating to taxable income.”
by Elizabeth C. Crouse: “New partnership audit rules will be effective for audits of tax years beginning in 2018. Proposed Treasury Regulations have been released and are expected to be finalized in the next few months. These rules significantly change partners’ information and payment expectations upon audit of a partnership and should be considered sooner rather than later. . . . Partnership agreements should be reviewed and revised now to account for, at minimum, the new partnership representative requirements (appointment of any required designated individual would generally be better handled through internal processes of the partnership representative).”
Blank Rome, LLC: “as a result of the new rules, careful consideration will have to be given in drafting the operative provisions of the governing documents, including but not limited to the expansion of the role and powers of the partnership representative, and the manner in which the various elections available to the entity will be dealt with . . . . the new rules present new challenges for [LLCs taxed as] partnerships. [LLCs taxed as] Partnerships should review their partnership agreements before the end of the year, and consider amending their agreements in anticipation of the new rules taking effect in 2018.”
Winston & Strawn LLP: “On June 13, 2017, the U.S. Treasury Department and Internal Revenue Service (“IRS”) re-released proposed regulations (the “Proposed Regulations”) governing the new centralized partnership audit regime that is scheduled to become effective for partnership taxable years beginning on or after January 1, 2018. . . . The Proposed Regulations provide, among other things, rules and procedures for (i) electing out of the centralized partnership audit regime, (ii) designating and replacing the partnership representative, (iii) determining amounts owed by the partnership or partners attributable to adjustments that arise out of a partnership audit, and (iv) “pushing out” partnership adjustments to the persons that were partners in the partnership in the taxable year under audit (the “review year”). . . . Partnerships . . . should be considering appropriate amendments to their partnership agreements to address a number of the issues discussed above, including
(i) the designation and removal of the partnership representative,
(ii) partners’ notice and participation rights in connection with audits,
(iii) appropriate indemnification protection for the partnership representative, and
(iv) how to ensure that imputed underpayments are economically borne by the appropriate partners (or former partners).
JD Supra: “many partnerships and limited liability companies (LLCs) have not yet delved into significant IRS audit rule changes that are certain to go into effect next year [January 1, 2018]. The changes, which will impact the 2018 tax year for partnerships and LLCs, will present owners with new decisions about how to handle IRS audits and any adjustments that may be required. . . . What Partnerships and LLCs need to do: Every partnership and LLC [taxed as a partnership] should consider revising their agreements to adapt to these new rules. For example, they must determine who will have decision-making authority over the elections that can be made, such as opting out of the new audit regime, or electing to push out adjustments to the partners. In addition, current partnership agreements do not provide for reserves for taxes, indemnifications, or holdbacks or clawbacks if there are any assessments. Failure to address these important issues may lead to disputes among partners, and could also impact buyers and sellers of partnership interests.”
JD Supra: “The updated IRS audit rules include new terminology, and will require such steps as new elections and changes to partnership agreements to account for a new audit landscape. The legislation driving the rule changes was passed two years ago. The new rules, embodied in proposed regulations re-issued last week, require changes in partnership agreements and LLC operating agreements. Starting with partnership returns for the 2018 tax year, partnerships will experience changes in how IRS audit adjustments are made to its partners’ returns.”
Bloomberg BNA: “There is good news for partnerships and their counsel who spent the last five months studying proposed centralized partnership audit regulations that the IRS issued on January 18 and withdrew on January 20: the proposed regulations reissued on June 14 (REG-136118-15) are essentially the same as those published in January. The proposed regulations implement the new centralized partnership audit regime enacted as part of the Bipartisan Budget Act of 2015 (BBA). The new regime and the proposed regulations generally apply to returns filed for partnership tax years beginning after December 31, 2017 . . . .
Preparing for the New Regime
Many partnerships (and limited liability companies taxed as partnerships) will find it necessary or desirable to amend the partnership (or operating) agreement in response to the new audit rules. For example, partnerships should carefully choose their representative and evaluate how the partnership agreement might be amended to provide guidance for the exercise of the representative’s broad statutory authority. Partnerships also should consider the ramifications of various partnership actions and elections, including the push out election, that affect both the partnership’s own financial condition and the tax attributes passed through to the partners. As well, the new rules provide that partners generally may not participate in or contest the results of an examination or other partnership proceeding without permission of the IRS. Therefore, the partnership should consider what safeguards might be appropriate to protect its own and its partners’ interests in the event of an audit.”
I have been saying for some time that LLCs that are taxed as partnerships must amend or adopt an Operating Agreement that contains well-drafted language that deals with the new partnership tax audit rules that become effective on January 1, 2017. Here are some pertinent quotations taken from an article written by Vidya Kauri of the firm Friedman, LLP:
“the need for robust and all-encompassing partnership agreements that can curtail representatives’ powers and hold them legally accountable.”
“Partnership agreements will have to be very specific about the decision-making powers of partnership representatives and the process for designating and terminating them”
“partnership representative might also require insurance coverage to defend against allegations of wrongdoing by disgruntled partners”
The bottom line is that LLCs taxed as partnerships MUST amend their Operating Agreements to include well-drafted provisions that deal designate an initial partnership representative and his or her replacement and that address other important issues that arise under the new tax audit rules. If your LLC is taxed as a partnership and it does not have an Operating Agreement, the members will be foolish if they don’t sign an Operating Agreement that appoints a partnership representative and deals with the new tax audit rules.
Hire the Keyts to Prepare or Amend an Operating Agreement
I have a masters degree in federal income tax law from New York University School of Law. I have also prepared 5,800+ LLC Operating Agreements. Since 2016 I have included partnership representative language in my multi-member LLC Operating Agreements.
We’ve made it very easy to hire us to amend an existing LLC Operating Agreement or prepare a new Operating Agreement with partnership tax audit provisions. The first step to hire us is to go to our Buy an Operating Agreement page.
If you have questions about adopting or amending an LLC Operating Agreement, call LLC attorney Richard Keyt at 480-664-7478 or send an email to Richard at email@example.com. You may also call Richard’s son LLC attorney and former CPA Richard C. Keyt at 480-664-7472 and email at firstname.lastname@example.org.
Question 1: My multi-member LLC is taxed as a partnership. Does it need to amend its Operating Agreement because of the new partnership tax rules that become effective on January 1, 2018?
Question 2: My multi-member LLC is taxed as a partnership. It does not have an Operating Agreement. Do the members of my LLC need to sign an Operating Agreement because of the new partnership tax rules that become effective on January 1, 2018?
Answer: Yes, yes and yes until I am blue in the face. All LLCs taxed as partnerships should amend their Operating Agreements or better yet adopt a stand alone Tax Audit Agreement drafted to deal with the new tax audit rules that take effect on January 1, 2018. The new partnership audit rules created by Section 1101 of the Bipartisan Budget Act of 2015, P.L. 114-74, and amended by the Protecting Americans From Tax Hikes Act of 2015, P.L. 114-113 affect all multi-member LLCs taxed as partnerships for federal income tax purposes.
I am an LLC attorney with a masters degree in federal income tax law from New York University School of Law who has prepared 5,800+ Operating Agreements. As a partnership tax law attorney I recommend:
- All LLCs taxed as partnerships amend their Operating Agreements to include language that deals with issues that may arise under the new partnership tax audit rules that take effect on January 1, 2018.
- All multi-member LLCs taxed as a partnership that do not have an Operating Agreement signed by the members should adopt an Operating Agreement that includes language that deals with issues that may arise under the new partnership tax audit rules that take effect on January 1, 2018.
The members of an LLC taxed as a partnership risk substantial economic harm if the IRS audits their LLC and they have not adopted an agreement that properly addresses the issues that arise under the new tax audit rules that apply to tax years after December 31, 2017.
If you don’t believe me then read “LLCs Taxed as Partnerships Must Adopt a Tax Audit Agreement” in which 34 attorneys and CPAs recommend that LLCs taxed as partnerships amend their Operating Agreements for the new tax audit rules.
For more on this important topic see my tax audit agreement blog posts.
Hire Me to Prepare a Tax Audit Agreement for Your LLC that Has Partnership Tax Audit Provisions & Names a Partnership Representative
I’ve made it very easy to hire me for to prepare an agreement that contains the language your LLC taxed as a partnership needs for the new tax audit rules effective January 1, 2018. Complete my online Tax Audit Agreement Questionnaire.
If you have questions about the new tax audit rules or my Tax Audit Agreement, call me, partnership tax attorney Richard Keyt at 480-664-7478 or send an email to Richard at email@example.com.
McDonald Hopkins: “Section 6223 of the new partnership and LLC audit rules (the “Audit Rules”), . . . provides that ‘the partnership representative . . . shall have the sole authority to act on behalf of the [LLC taxed as a] partnership.’ Some of the more troubling aspects of this section include:
- The partnership representative has complete authority to act on behalf of the partnership . . . when dealing with the IRS. . . . [N]othing can change the partnership representative’s authority as far as the IRS is concerned. Of course, a partnership or operating agreement can require that the partnership representative receive the consent of the partners before agreeing with the IRS on a matter . . . .
- This authority includes the ability to bind the partnership and the partners in audits and other proceedings, including settlement authority and decisions on procedural issues, such as whether to proceed to litigation.
- Significantly, there is no legal obligation under the IRS rules for the partnership representative to keep the other partners updated on the status of an audit or even to notify the partners of the audit.
- The partnership representative does not need to be a partner in the partnership, raising the issue of naming a partnership representative permanently in a partnership or operating agreement, only to have that partner leave the partnership.
- Finally, if the partnership does not appoint a partnership representative, the IRS has the authority to appoint one for the partnership.”
McDonald Hopkins: This article is an excellent summary of issues that arise under the new partnership tax audit rules. “partners (which for purposes of this alert include members in a limited liability company) need to start discussing the implementation of the new rules now and amend their partnership/operating agreements appropriately before” the rules become effective on January 1, 2018. The article states:
“Key Changes to Prepare For
- In most cases the IRS will be able to assess any additional tax resulting from an audit against the partnership itself – eliminating the need to proceed against individual partners. . . .
- Every partnership will have to appoint a partnership representative who will have exclusive authority to represent the partnership before the IRS and to make every decision relating to certain elections, audits, and settlements with the IRS.
The implementation of these seemingly simple concepts is complex – evident by the nearly 280 pages of regulations and explanation the IRS . . . that only begin to address the issues raised by the new audit rules. This white paper describes . . . the practical impact the rules will have on partnership/operating agreements, and how these agreements will need to be amended.”
The IRS recently issued proposed regulations (REG-136118-15) that will, if implemented, govern the new partnership audit rules created by Section 1101 of the Bipartisan Budget Act of 2015, P.L. 114-74, and amended by the Protecting Americans From Tax Hikes Act of 2015, P.L. 114-113. These new rules apply to partnerships and limited liability companies that are taxed as a partnership for federal income tax purposes beginning January 1, 2018.
The new partnership audit rules allow the IRS to assess and collect income tax at the partnership level rather than from individual partners. The new audit rules replace the partnership audit procedures created under the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA). The new audit rules apply to tax years beginning January 1, 2018.
The Bipartisan Budget Act of 2015 replaced the TEFRA tax matters partner with a partnership representative that must be a person or entity that has a “substantial presence” in the United States. If the partnership or LLC taxed as a partnership fails to designate a partnership representative the IRS may name the partnership representative. This is one of the reasons LLCs taxed as partnerships must amend their Operating Agreement or adopt an Operating Agreement, i.e., to name a partnership representative in the Operating Agreement to prevent the IRS from doing so. The LLC taxed as a partnership cannot change its designated partnership representative without the IRS’s consent.
The partnership representative can be an entity or a person. The partnership representative does not have to be a member of the LLC. After being appointed by the partnership or LLC, the partnership representative must then be designated on the partnership’s or LLC’s tax return.
Take care when appointing a partnership representative because the partnership representative has the sole authority to deal with the IRS on behalf of the partnership or LLC and all of its partners or members with respect to the following matters: (i) settling a tax audit, (ii) agreeing to a final partnership tax adjustment, (iii) making an Internal Revenue Code Section 6226 election to pay a partnership liability at the partner level, and (iv) agreeing to a Section 6235 extension of the period for making partnership adjustments.
The new audit rules take effect January 1, 2018. There are three important take a-ways to be learned from the new partnership audit rules:
- All existing partnerships and limited liability companies taxed as partnerships that have an Operating Agreement need to amend their Operating Agreements to add provisions dealing with the new partnership audit rules and to designate a partnership representative.
- All existing partnerships and limited liability companies taxed as partnerships that do not have an Operating Agreement need to adopt an Operating Agreement that contains provisions dealing with the new partnership audit rules and that designates a partnership representative.
- All new partnerships and limited liability companies taxed as partnerships should adopt an Operating Agreement with the new partnership audit provisions and should designate a partnership representative.
Hire Us to Amend or Prepare an Operating Agreement for Your LLC that Has Partnership Tax Audit Provisions & Names a Partnership Representative
We’ve made it very easy to hire us to amend an existing LLC Operating Agreement or prepare a new Operating Agreement. The first step to hire us is to go to our Buy an Operating Agreement page.
If you have questions about adopting or amending an LLC Operating Agreement, call LLC attorney Richard Keyt at 480-664-7478 or send an email to Richard at firstname.lastname@example.org. You may also call Richard’s son LLC attorney and former CPA Richard C. Keyt at 480-664-7472 and email at email@example.com.
The article concludes with this statement:
“A final warning: Anyone that is either (1) contemplating a new . . . business that will be classified as a partnership for federal tax purposes (including an LLC or joint venture) or (2) needing to amend an existing agreement should strongly consider incorporating these changes into the new or revised agreement immediately“
Paul Hastings LLP, Thomas S. Wisialowski, Erika Mayshar and Noah Metz: “Hedge funds, private equity firms, real estate companies, and other businesses structured as partnerships or limited liability companies are paying close attention to recent changes in IRS audit procedures. . . . This means that under the rules described above, if a partnership filed a tax return and paid its taxes in year 1 (the year 1 tax return), partner X sold its interest in the partnership to new partner Y in year 2, and the partnership was audited in year 3 in respect of its year 1 tax return, then partner Y would bear its share of any additional tax liability assessed on the partnership in year 3 in respect of the year 1 tax return, despite that partner X, and not partner Y, was a partner in the partnership in year 1.”
The article states one of the most important reason that operating agreement of all LLCs taxed as partnerships must be amended to deal with the new audit rules:
“Partnership and LLC agreements should generally be revised to provide for who will act as the ‘partnership representative’ because in the absence of an appointed person, the IRS has the discretion to pick a ‘partnership representative.’
Taft Stettinius & Hollister LLP, Todd C. Lady and Lourdes E. Perrino: “On Nov. 2, 2015, President Obama signed into law the Bipartisan Budget Act of 2015 (the “Act”). The Act dramatically changes the way the IRS will conduct partnership audits going forward and, in turn, likely will have far reaching implications on how partnerships, including funds, conduct operations in the future. . . . Although these rules have not yet taken effect, they should be taken into account when drafting new operating agreements or engaging in acquisitive transactions involving partnerships. Operating agreements should include procedures that address the option to elect to pass any adjustment on to the reviewed-year partners. Additionally, partners should clearly define their respective rights to notice and participation during an audit and carefully select the partnership representative that will have the authority to bind the partnership.”
Cozen O’Connor, Richard J. Silpe”If you are a partner of a partnership or a member of a limited liability company (LLC) taxed as a partnership, or are entering into a new partnership or LLC, you may have some important decisions to make in light of impending changes to the rules governing federal tax audits. . . . These new rules will lead to new provisions in partnership and LLC agreements and amendments of existing agreements to, among other things, designate a method for selecting a partnership representative and its rights and obligations of the partners, address whether certain tax elections will be made, and provide for indemnification and other contractual provisions (e.g., in the case of a withdrawing partner).
Kilpatrick Townsend & Stockton LLP, James E. Brown, Heather L. Preston, Lynn E. Fowler and Charles E. Hodges II “Congress has recently scrapped the existing procedures for IRS audits of partnerships. The new rules (the “BBA Audit Rules”1) are effective for partnership taxable years beginning on or after January 1, 2018. A partnership that fails to address key concepts of the BBA Audit Rules could make a partner indirectly liable for federal income tax of the partners assessed for a year prior to becoming a partner. Almost all partnership (and LLC operating) agreements will need to be amended at a minimum to clarify which partners will be liable with respect to audit adjustments asserted by the IRS.”
Holland & Knight LLP, William B. Sherman and Daniel L. Janovitz: “The Bipartisan Budget Act of 2015 (P.L. 114-74) includes a complete overhaul of the procedures that apply to Internal Revenue Service (IRS) audits of partnerships, including limited liability companies (LLCs) taxed as partnerships and their partners. . . . . Issues that Partnerships Need to Address . . . . 1. Existing partnership and LLC operating agreements should be reviewed, and amendments will need to be drafted to address aspects of the new rules, including:
- designating the partnership representative in place of the TMP
- determining the partner(s) that will control the decision to opt out of the new regime
- preventing assignments of partner interests to persons that would preclude the ability to opt-out
- addressing the payment of entity-level tax
- committing to making certain elections in the event of an audit adjustment
- addressing circumstances where partners agree to “adjusted information returns” in lieu of entity-level tax
2. Negotiations will be necessary to determine the appropriate partnership representative and the contractual limitations on the authority of such representative.
Dykema Gossett PLLC, Jeffrey A. Goldman, Steven E. Grob, Anthony Ilardi, Jr., William C. Lentine and Robert W. Nelson: “On November 2, President Obama signed the Bipartisan Budget Act of 2015 (the “Act”), which significantly changes the procedures for tax audits of partnerships. . . . The sweeping changes in the realm of partnership tax audits will likely require revisions to most partnership agreements and new considerations when entering or leaving a partnership.”
See the end of the article for a list of changes to make to operating agreements and partnership agreements.
Venable LLP, Brian J. O’Connor, Norman Lencz, Michael A. Bloom and Christopher S. Davidson: “On November 2, 2015, President Obama signed into law the Bipartisan Budget Act of 2015 (the Act). The Act significantly changes how partnerships (including LLCs taxed as partnerships) are audited by the IRS. . . . As a result of changes made to the Internal Revenue Code by the Act, partnerships may now be directly liable for any tax deficiency resulting from an adjustment to partnership items (e.g., income, gain, loss deduction and/or credit). Thus, the current partners in a partnership could bear economic responsibility for improper tax reporting in prior years, even if one or more of such partners was not a partner in the year in which the improper reporting occurred.”
This article includes the following statement:
“existing partnership agreements should be reviewed to account for these new audit procedures”
I agree. I recommend without exception that all existing LLCs taxed as partnerships amend their Operating Agreements to cover the issues created by the Bipartisan Budget Act of 2015. LLCs that are taxed as partnerships that do not have an Operating Agreement should adopt an Operating Agreement that contains language that deals with the issues created by the BBA.
Akerman LLP, Donald K. Duffy: “Effective for partnership tax years beginning after 2017, the Bipartisan Budget Act of 2015 repealed the current partnership audit rules and replaced them with rules described in general terms below. Partnerships can also elect to apply the new rules sooner to partnership tax years beginning after the date of the Act’s enactment. In brief, the major change is that the partnership itself can be liable for federal income tax in the tax year the audit adjustments become final. The partners in that year bear the economic burden of the tax and not the partners in the earlier tax year under audit and with respect to which the adjustments are made. Since partnerships can elect to apply these new rules earlier than 2018, some extra diligence is needed now in the acquisition of partnership and LLC interests.”
This article lists eight partnership tax issues that should be addressed in partnership agreements and operating agreements of LLCs taxed as partnerships. Bottom line: If your existing or new LLC is or will be taxed as a partnership it must have an operating agreement that includes language that addresses the issues created by the Bipartisan Budget Act of 2015.
Drinker Biddle & Reath LLP, Stephen D.D. Hamilton, David Shechtman and Jonathan D. Grossberg: “Although the new rules under the Budget Act will first apply to returns filed during 2019 ( i.e., for a partnership’s 2018 taxable year), partnerships and their advisors need to plan now for these eventual changes. Anyone entering into a new partnership agreement or acquiring an interest in an existing partnership should focus on what tax audit rights, and what tax representations and covenants, to seek. Partners of “small partnerships” should consider whether to bind themselves to the election-out procedures and whether to adopt transfer restrictions that will insure that the election-out remains available. Existing partnerships should begin consideration of the procedures for designating the PR and whether to utilize the alternative regime for allocation of assessed tax liability back to the partners in the Audit Year.”
Kaye Scholer LLP, David A. Sausen, Willys H. Schneider and Zeno Houston: “The Bipartisan Budget Act of 2015 (the Budget Act), which was signed into law on November 2, 2015, has dramatically reformed how the U.S. Internal Revenue Service (IRS) will assess and collect taxes from partnerships, including limited liability companies (LLCs) treated as partnerships for tax purposes. . . . Accordingly, absent the exercise of an election as described below, the New Audit Rules can result in the imposition of an entity-level tax on the partnership as a result of audit adjustments. This heralds a significant change from the existing partnership audit procedures”
The authors state:
“All partnerships will need to consider appropriate revisions to existing partnership agreements—preferably, long in advance of the Effective Date
Ropes & Gray LLP: “On Monday, November 2, President Obama signed the Bipartisan Budget Act of 2015 (the “BBA”) into law, effecting sweeping changes to the rules governing audits of entities treated as partnerships for U.S. federal income tax purposes. The new rules can be expected to increase partnership audit rates by making audits and related tax assessments more efficient for the IRS, including by imposing an entity-level tax on the partnership on audit adjustments, absent an election (described below) to shift tax liability to partners. The new rules constitute a stark change from existing law“
The authors said the partners of a partnership and the members of an LLC taxed as a partnership should take the following action:
“Revision of partnership agreement provisions addressing the sharing among the partners of any partnership-level tax and related items.”
The authors described six other issues that partnerships and LLCs taxed as partnerships must consider.
Shearman & Sterling LLP, David S. Raab, Julie M. Marion and Thomas H. Halpern: “Existing partnerships should review operating agreements before new rules take effect. The Bipartisan Budget Act of 2015 (the Act), which President Obama signed on November 2, upends the way the Internal Revenue Service (IRS) conducts partnership audits, with potentially far-reaching effects. . . . Small partnerships will have to decide whether they want to elect out of the new regime, thereby weakening the ability to control consistent partner reporting. Partnerships that do not elect out or that are ineligible to elect out will need to ensure their operating agreements address the new procedural requirements, such as addressing whether the partnership is required to elect to pass-through audit adjustments to the partners or who will have the authority to make that decision.
Sutherland Asbill & Brennan LLP, Thomas A. Cullinan, Sheldon M. Kay , Daniel R. McKeithen, David A. Roby, Jr., Amish M. Shah and H. Karl Zeswitz: “On November 2, 2015, President Obama signed the Budget Act of 2015 (the “2015 Budget Act”), which makes significant amendments to the procedural rules governing federal income tax audits and judicial proceedings that apply to partnerships and other entities (such as limited liability companies or statutory trusts) classified as partnerships for federal income tax purposes. . . . existing partnerships and their partners will also need to consider the extent to which the new rules will necessitate amendments to their partnership agreements to preserve their existing arrangements.”