By Nicholas M. Tokar
The Rule Changes Explained
Beginning January 1, 2018, the IRS will begin implementing new tax rules directed at partnerships and LLC’s taxed as partnerships (which is most LLCs) as part of the Bipartisan Budget Act of 2015. One of the main purposes of the new rules are for the IRS to have a more streamlined process to analyze complex partnership and LLC structures, and for the IRS to more effectively be able to collect tax deficiencies from these entities.
Essentially, the new rules being implemented in 2018 provide for the assessment and collection of tax deficiencies at the partnership/LLC level, meaning that the IRS can now target the entity itself to collect a tax deficiency. This is a significant change from the current rules, which require the IRS to track down individual partners/members of the entity to pay the deficiency. This change makes the process of collecting tax deficiencies much simpler for the IRS, but can lead to significant difficulties and challenges for partnerships and LLCs.
While at first glance this rule change may not seem too significant, its impact can be far reaching. First, the entity will need to elect a representative from the partners/members to be the direct liaison to the IRS should the entity be audited. This elected representative has the exclusive authority to deal with the IRS. Further, if the IRS conducts an audit and finds a deficiency, the imputed underpayment is computed based on the highest income tax rate applicable to an individual.
As noted, the IRS now has the ability to collect that deficiency from the entity. Therefore, if an IRS audit does reveal a deficiency, any partner/member who left the entity and/or sold their interest in the entity, are no longer on the hook for the deficiency. On the other side, if a new partner/member purchases an ownership interest in an entity after such an audit and deficiency, that new partner/member will be on the hook for that deficiency. This means that any individual thinking of buying an ownership interest in a partnership/LLC will need to be especially vigilant in asking about the company’s tax status and whether they have been, or are currently being audited.
This new audit regime may present some major complications and conflicts for partnerships/LLCs, but there are options available to deal with the changes. First, partnerships/LLCs may elect to “push-out” the tax deficiency. This means that the partners/members may decide to shift the assessment to the partners/members who had an ownership interest in the entity during the year of the audit. This would essentially retain the IRS’s status quo by agreement, and make the partners/members liable for the deficiency. Second, an entity may be allowed to opt-out of the new audit rules. In order to do this, the partnership/LLC must have 100 or fewer partners/members, and all partners/members must be eligible. In order to be “eligible,” it means that the partners must be an individual, and not a C corporation, an estate of a deceased partner, etc.
Action Items for Partnerships and LLCs
LLCs and partnerships should take several steps in light of the new tax rules. First, LLC’s and partnerships should elect a tax representative. This should be memorialized in writing. We suggest that a LLC consider amending its Operating Agreements, and a partnership consider amending its Partnership Agreements to appoint a tax representative. Secondly, we recommend that LLCs and partnerships consult with tax and legal advisors regarding taking advantage of the push-out and opt-out options described above.
The new rules affecting partnerships/LLCs might seem daunting and confusing, and indeed even the IRS has not ironed out all of the mechanics of the new rules. The attorneys at DeFur Voran are staying on top of this issue, and are available for anyone who needs to seek guidance on these rules.