There is a change in the federal partnership audit rules that take effect for tax years on or after January 1, 2018, that may impact you.
Who is Affected?
All entities classified as partnerships for federal tax purposes. This includes, for example, multi-member LLC’s that have not elected to be taxed as corporations (C or S). If the entity files IRS Form 1065, it is a partnership. Certain partnerships may opt out of the new audit rules, but they must meet the eligibility requirements, including identity and number of partners (no more than 100 partners, all must be individuals, estates, C corporations and S corporations).
The Changes
The new law and regulations proposed by the IRS will replace the current audit regime. The details of the changes to the audit regime are beyond the scope of this letter, but in general, under the new partnership audit rules, any adjustments to tax items for a partnership are generally determined, and the tax attributable to such adjustments is assessed and collected, at the partnership level, with the tax assessed at the highest tax rate then in effect. The adjustments relate to a prior year (the “reviewed year”), but the assessment and collection of the tax will affect the partners in the year of the assessment (the “adjustment year”). The partnership may be able to elect to “push out” the adjustments to the partners who were partners in the reviewed year, rather than assessing it at the partnership level.
In addition, the partnership is now required to designate a “partnership representative” on an annual basis. This designation replaces the appointment of a “tax matters partner” under the prior regime. Comparing the two, the requirements for who may serve as a partnership representative are broader (e.g., not required to be a partner) and the partnership representative has significantly more authority in dealing with the IRS on behalf of the partnership (i.e., sole authority to act and the other partners have no right to receive notice from the IRS or participate in the audit).
What Does This Mean For You?
All partnership agreements (or operating agreements, in the case of an LLC taxed as a partnership) should be reviewed and amended to adopt appropriate changes to reflect the application of the new IRS rules effective January 1, 2018. The nature of these amendments will differ among partnerships/companies depending on the specific situation. Changes may include:
- appointing the partnership representative, with a mechanism for appointing replacements and any contractual limitations on his authority;
- ensuring the partnership is eligible to opt out of the rules by restricting who can be a partner;
- providing for a method of allocating the adjustments in the event of changes in partners between the reviewed year and the adjustment year; and/or
- providing for an election to “push out” the adjustments to the reviewed year partners.
Please feel free to reach out to any of our tax attorneys to update your partnership’s and/or company’s agreements to remian compliant with these federal tax law changes:
- Guy E. Whitesman, 239-344-1180
- Erin Houck-Toll, 239-344-1296
- Robert Forman, 239-344-1239
- Paul Shuman, 239-344-1183