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How Do New Partnership Audit Rules and the New Role of a “Partnership Representative” Affect my LLC or Partnership?

April 24, 2018

In case you missed it, January 1 of this year (2018) ushered in a significant change in the world of limited liability companies and partnerships.  Under the Bipartisan Budget Act of 2015 (“BBA”) the existing rules for auditing partnerships were replaced with an entirely new set of rules.  In addition, the role of the “tax matters partner” was replaced with that of a “partnership representative”.  Both of these changes are significant and impact the operating and partnership agreements of a lot of existing limited liability companies and partnerships.

PARTNERSHIP REPRESENTATIVE

Before the BBA, partners in a partnership and members in a limited liability company rarely gave much thought to who would serve as the “tax matters partner” for the partnership (for ease of reference I will refer only to partnerships going forward but this article will apply to all limited liability companies taxed as partnerships, which is the majority of multi-member limited liability companies).  In most cases, the tax matters partner’s authority was fairly limited and the partners, for the most part, had the right to participate in audit proceedings.  Under the BBA, the tax matters partner is replaced with a “partnership representative” who has much more authority when compared to the prior tax matters partner status.  The partnership representative generally has full authority to act on behalf of the partnership and all partners with the IRS during an audit as well as certain other matters (e.g. settlement authority and decisions to litigate).  If a partnership fails to designate a partnership representative, the IRS can appoint any person with a substantial presence in the United States.    Under the new rules, the partnership representative does not even need to notify the partners of the audit!  Given the extensive powers and authority of the partnership representative, special care should be taken in selecting a partnership representative, including grounds to terminate a partnership representative’s status, reporting requirements and limits on authority. 

NEW AUDIT RULES

Under the BBA, if a partnership is audited, the partnership itself will be liable for any adjustments.  This is a major shift from the prior law where adjustments were made at the partner level as opposed to the partnership level.  How might this be an issue?  Well, if a partnership is audited for a tax year closing three years ago, when the partnership had four partners, but in the year of the audit only has three partners, then any adjustments are born by only the three partners who remain.  Similarly, if a partnership adds a member and is then audited for a prior year, the new partner would, absent corrective action, bear part of the adjustment burden for the prior partner’s actions.  Recognizing that the new partnership level audit rules may result in harsh individual results, the BBA allows for various ways to opt out of the new rules.

The first is known as a Section 6221 Opt Out and results in a complete removal of the partnership from the new audit rules.  However, this option is limited to partnerships that:

  • elect out for each and every tax year that they want to opt out for;
  • provide 100 or fewer K-1s to its partners;
  • have only individuals, C corporations, foreign entities that would be a C corporation under U.S. law, S corporations, or the estate of a deceased partner as partners in the partnership; and
  • make the election with the partnership’s timely filed return with proper disclosure and the partners are notified of the election

For those partnerships that fail to opt out or cannot opt out, there are other options available to allow a partnership to avoid imposition of any adjustments at the partnership level.  A Section 6226 Push-out election allows for a partnership to issue adjusted returns to its partners with their share of the adjustment resulting from the audit.  Another option is for all partners to agree to file amended returns pursuant to Section 6225.  When and how these options apply varies depending on the particular circumstances of the partnership. 

The BBA effected a major change in the role of the “partnership representative” and in the audit process for partnerships.  New partnerships would do well to make sure that they have accounted for the new audit regime in their documents and existing partnerships should make sure that their existing documents are current and do not leave them exposed in an unexpected way. 

Brent Haden is a corporate attorney at Pender & Coward and focuses his practice on corporate and transactional work.

Filed Under: Blog Category 1