New Partnership Audit Rules Require Amending Partnership and LLC Agreements

Ulmer Client Alert
Practice Area: Tax

Authors: John C. Goheen, Douglas K. Sesnowitz, Frederick N. Widen

New Partnership Audit Rules Require Amending Partnership and LLC Agreements

On June 13, 2017, the IRS released its long-awaited proposed regulations on new audit rules that will apply to partnerships and multiple-member limited liability companies (LLCs) taxed as partnerships. Effective for taxable years beginning after December 31, 2017, the new audit rules provide for entity-level assessments and collections, in contrast to the partner/member-level focus of the old rules. In addition, the new audit rules require partnerships and LLCs to appoint a “Partnership Representative” who has much broader authority than the “Tax Matters Partner” had under the old rules.

The purpose of the new audit rules is to make it easier for the IRS to assess and collect taxes from partnerships and LLCs, with the increased collections estimated at $10 billion over the next ten years. This indicates that IRS audits of partnerships and LLCs will increase significantly once the new rules are in effect.

Action Step: Most partnerships and LLCs will need to amend their governing agreements to address these new audit rules.

A key issue to address is what controls (if any) should be placed on the broad authority of the Partnership Representative. For example, the Partnership Representative has no statutory duty to notify the partners or LLC members of an IRS audit or any related judicial proceedings. In addition, the Partnership Representative has no statutory duty to obtain the consent of the partnership/LLC or any partner/member to decisions of the Partnership Representative regarding IRS audit proceedings, agreeing to or contesting an IRS assessment, or making certain elections (see below). This broad authority of the Partnership Representative may be acceptable to some entities, while others may want to require notice to and approval of the managers and/or the members before the Partnership Representative can act.

Certain elections available under the new audit rules also raise issues regarding imposing controls on the broad authority of the Partnership Representative. For example, partnerships or LLCs with 100 or fewer partners/members (none of whom are themselves partnerships, LLCs, trusts or disregarded entities such as single-member LLCs) can elect to “opt-out” of the new audit rules. In addition, a partnership or LLC that receives an entity-level IRS assessment may be able to elect to “push-out” the assessment to the partners/members who owned the entity during the year being audited. Should the Partnership Representative alone decide whether to make these opt-out and push-out elections, or should the approval of the managers and/or members be required?

ImportantThere is no “one size fits all” amendment to address the new audit rules.

Ulmer’s tax and business attorneys have analyzed the new audit rules and have developed alternative governing document provisions to address the differing facts and circumstances of various partnership and LLCs. Please contact your primary contact here at the firm or one of the lawyers listed above to discuss what amendments are appropriate for your situation. Once you decide how to proceed in amending your partnership or LLC agreement, we can prepare the amendment document. We do not anticipate this to be a time-consuming or expensive process. Prompt action is necessary, however, since the new IRS audit rules first apply to partnership and LLC returns for the 2018 tax year.

We look forward to working with you.