Partnerships and LLCs Should Review (and Likely Update) Partnership and Operating Agreements in Light of New IRS Audit Rules
On January 1, 2018, new IRS audit rules took effect in an effort to streamline the audit process for any entity taxed as a partnership for income tax purposes (i.e., partnerships and some LLCs). In general, any partnership audit adjustment will now be made in the current year, not the year subject to audit, and will be made at the partnership level, meaning the IRS will collect the assessed amount, plus penalties and interest from the partnership, not the individual partners. This change particularly impacts partnerships (or LLCs taxed as partnerships) where partners or members have withdrawn or been added in the intervening years. Under the new default rules, the economic adjustments will be imposed on current partners or members, not those who were partners or members during the year being audited.
In addition, the new rules also eliminate the former “tax matters partner” and replace this person with a “partnership representative”. The partnership representative has sole authority to act on behalf of the partnership in IRS audits and other proceedings. Additionally, the partnership representative no longer needs to be an owner of the business. Given the incredible amount of authority vested in the partnership representative, partnerships (and LLCs taxed as partnerships) should give considerable thought in naming the partnership representative. At a minimum, partnership and operating agreements should be modified to specify this change from a tax matters partner to a partnership representative.
Finally, the new rules do allow certain small and simple partnerships to opt-out of the new default rules, but timely action is required to opt out. Partnerships may also elect to push out imputed underpayments, penalties and interest to affected partners by timely electing to do so and issuing revised Schedule K-1 statements to affected partners. Several factors must be considered by the partnership (or LLC taxed as partnership) when deciding whether to opt-out entirely or make a push-out election, and partnership and operating agreements may need to be modified to require the partnership representative to analyze specified factors in given cases.