New IRS Rules Regarding Partnership Audits (including LLCs), Part II
This blog is part two of three regarding the new IRS BBA Rules that went into effect on January 1, 2018.
Background: The new IRS “BBA Rules” reduce the partnership audit burden on the IRS by placing an increased burden on the current partners to both: (1) satisfy tax deficiencies for prior tax years and then (2) decide whether to (a) take no action to recoup that expense from reviewed year partners for the audited year, or (b) attempt to collect the deficiency from those reviewed year partners if the partnership has a mechanism in place to do so. Because LLCs are classified as partnerships by the IRS, I generally refer to partners and partnerships rather than members and LLCs.
What entity-level operating agreement changes should be addressed for an entity that may become bound by the BBA Rules? Generally, operating agreements should address contingency situations, including default language to address when an entity fails to take explicit action regarding opting out of the BBA Rules.
1. Determine how to select a Partnership Representative (the “PR”) and require the PR to resign as PR and (if desired by partnership) designate the new PR to the IRS
2. Determine whether the PR will be a partner or a third party; whether to compensate and indemnify the PR; and whether fiduciary duties will apply to the PR
3. Determine how much discretion the PR will have to make decisions without a partner vote (keeping in mind that the PR will have sole authority to bind the partnership and all partners in IRS and judicial proceedings)
4. Determine how the partnership and the PR will keep partners informed of IRS matters and include partner enforcement mechanisms against non-complying PR and the partnership
5. Require current and former partners to fully and timely cooperate with the PR, including providing requested information and supporting documents
6. Determine whether to push-out tax liabilities to reviewed year partners
7. Determine how to recover tax liabilities from reviewed year partners
8. Ensure partnership agreements require partners’ tax returns to be consistent with partnership’s treatment of partnership items
9. Require former partners to provide updated contact information to the partnership
10. Address the statute of limitations (3-6 years) for IRS tax adjustments
What entity-level operating agreement changes should be addressed for an entity that intends to successfully “elect out” of the BBA Rules? Provisions should address contingencies, including default language to address when an entity fails to take explicit action (especially by failing to elect-out, which must be done each year).
1. Provisions should describe the hierarchy of partner priorities (e.g. elect out of BBA Rules; push-out tax liability to reviewed year partners; and how to recoup deficiencies from prior partners)
2. Provide indemnity language addressing situations where a partner transfers its ownership interest to an ineligible transferee, voiding the partnership’s election-out of the BBA Rules
3. Include requirements for the partnership and the tax matters partner/PR (if the PR needs to be selected) to notify each partner within 30 days after electing-out of the BBA Rules
4. Consider whether to designate a tax matters partner to avoid IRS default selection rules
5. Require the partnership to timely provide K-1s to partners
6. Require each partner’s tax returns to be filed consistent with the partnership’s treatment of partnership items
7. Require former partners to provide updated contact information to the partnership
8. Address statute of limitations (3-6 years) for IRS tax adjustments
The final blog in this series will discuss changes that should be made at the partnership agreement (or LLC agreement) level so that each partnership/LLC has adequate provisions in place to address issues such as M&A activities, death of a partner, dissolution, securities offerings and bankruptcy. For more information, see Proposed IRS Rules Published June 14, 2017 (https://www.federalregister.gov/documents/2017/06/14/2017-12308/centralized-partnership-audit-regime) , and Internal Revenue Bulletin 2017-28 (click here).
This information is provided for general educational purposes only. For more detailed analysis regarding specific partnership or LLC circumstances, contact one of our attorneys.