The Bipartisan Budget Act of 2015 (the “BBA”) enacted a new partnership uniform audit regime that applies to all partnership audits (including audits of most LLCs) for tax years commencing January 1, 2018 or later.
One big change under the new law is that the role of “Tax Matters Partner” is eliminated and the role of “Partnership Representative” is substituted in place thereof. The law gives the Partnership Representative vast powers to handle matters on behalf of (and bind) the partnership and its partners. Because the Partnership Representative is provided extensive powers to negotiate and settle tax issues on behalf of the partnership, it is imperative that partnership agreements (including LLC Agreements) be drafted to include parameters and restrictions around the Partnership Representative’s powers. Additionally, Partnership Representatives should be required to provide prior notice of their actions and plans to the partnership and/or the partners in order to provide the parties opportunity to provide input.
As noted in my prior blog post (linked here), certain eligible partnerships may be able to opt out of the new rules. It is widely believed that the ability to opt out will provide a major benefit to these eligible partnerships. Therefore, when drafting a partnership agreement, the draftsman should include transfer restrictions precluding partners from impacting the partnership’s eligibility to opt out.
Partnership Liability for Underpayments
If the IRS makes an adjustment to partnership income or loss, they will have the power to impose any resulting tax directly upon the partnership rather than the partners. When the IRS imposes such tax, the general rule is that the additional tax will be imposed at the highest rate of income tax applicable to individuals or corporations under the Internal Revenue Code for the tax year under audit. However, there are methods by which the partnership can reduce the rate of taxation or “push out” the tax to the partners. The partnership agreement must be drafted properly to permit these actions. Furthermore, in the event that the partnership is required to pay additional tax, there must be a methodology for allocating said tax to the respective partners. Finally, one or more partners who were partners in the year under audit may no longer be partners at the time of the audit. Therefore, it is important the partnership agreement provide the partnership with a mechanism to recoup tax underpayments from a former partner.
If you need assistance with the matters discussed herein please reach out to Aman Badyal by email at firstname.lastname@example.org or by phone at 415-994-2459.