New IRS Audit Regime in Effect: Reviewing Your Partnership/LLC Agreement
Effective January 1, 2018, new guidelines went into effect with respect to partnership audits by the Internal Revenue Service. See Forbes article here. While no partnership or LLC that has chosen to be taxed as a partnership wants to be audited and while audits are rare, the changes to the audit regime are significant. Of particular importance is the new power of the Partner Representative to bind the entire partnership and that fact that the audit is now done at the partnership level. A review of your partnership or LLC agreement is in order. Here is a quick rundown.
San Diego Partnerships: Tax Matters Partner vs. Partner Representative
Under the previous audit procedures set forth in the Tax Equity and Responsibility Act of 1982 (“TEFRA”), partnerships and LLCs-taxed-as-partnerships (“LTAP”) appointed a tax matters partner (“TMP”). Previously, the TMP was required to be a general partner or managing member and, under the rules, the TMP was limited in his or her power to bind the partnership.
Under the new procedures, enacted as part of the 2015 budget appropriations, partnerships and LTAPs appoint what is called a “Partner Representative” (“PR”). The PR does NOT have to be a general partner. This is advantageous since the partnership can hire an audit expert and the PR can be an entity like an accounting firm. This can be disadvantageous, too. If the PR is not a partner, he or she or the entity might not have the requisite financial incentives to fight as vigorously as possible. Further, unlike the TMP, the PR now has the ability to bind the partnership. Once a PR is named for a taxing year, the PR cannot be changed until/unless an inquiry is begun by the IRS. Furthermore, under the new rules, partners and LLC members have no right to notice of audits or audit proceedings and do not have the right to participate or intervene in the audit or in court proceedings.
Because of these new rules, partnership agreements should be reviewed for provisions related to tax audits. If none exist, such provisions should be added. Among the issues that should be considered are:
- Provisions for deciding who should be the PR
- If the PR is expected to be an entity, provisions with respect to the what are the necessary qualifications, indemnifications, and related matters concerning the entity
- Powers, authority, and limitations given to the PR
- Provisions requiring forwarding of copies of all IRS notices and updates on any proceedings
- Provisions allowing a contractual right to intervene in court proceedings
- What issues will require partnership consent?
- Provisions for removal and replacement of PR
- How will tax, interest, and penalty liabilities be allocated — see below
- And more
San Diego Partnerships: Audit and Tax at the Partnership Level
Generally speaking, under the old TERFA, audits were done at the individual partnership level and tax liability (if any) was also assessed at that level. For many reasons, that procedure was cumbersome and inefficient.
Under the new rules, the audit is done at the level of the whole partnership and tax liability (if any) is assessed against the partnership as a whole. That is the “default” provision. However, the partners can choose to have the liability allocated to the individual partners (with an increased interest penalty imposed). Indeed, if a partnership meets certain criteria, a partnership can opt out of the partnership-level audit entirely.
Thus, as noted, the partners should review their existing partnership agreement and consider whether an amendment is in order. The partners can decide to opt in or opt out for all years, or make the decision each year. Here again, the partnership should take into account the new powers of the PM. Partners should consider a provision whereby partner consent is needed for any election to opt out of the default rule. Also, allocation issues should be discussed and considered. If the audit is triggered by decisions made or actions taken only by certain partners, should they be allocated the tax liability (if any)?
In a similar vein, if the partnership does not have cash on hand to pay any extra tax liability, how and from where are capital contributions to be obtained?
As can be seen, the new IRS audit provisions raise a host of questions with respect to potential tax audits. As always, it is best to attempt agreement on issues like this in advance.
San Diego Partnerships: Contact San Diego Corporate Law Today
If you would like more information about reviewing or amending your partnership agreement, contact attorney Michael Leonard, Esq., of San Diego Corporate Law. Mr. Leonard has extensive experience in drafting partnership agreements and the other contracts and agreements necessary for running your San Diego partnership. Mr. Leonard can be reached at (858) 483-9200 or by email.