Time to Amend Old Operating Agreements: January 1, 2018 Audit Rules in Effect

Partnership audits might sound like a rather boring topic, but new rules now in effect make auditing partnerships much easier for the IRS and as such should be an area of concern for businesses.  We have previously published a couple of articles regarding the audit rules: "Do We Really Have to Change Every Operating Agreemen? The New Partnership Audit Rules" and "Estate Planning With Partnerships: Important New Considerations."  The Bipartisan Budget Act of 2015 and the Protection of Americans for Tax Hikes Act of 2015 created new audit rules replacing the current TEFRA regime beginning January 1, 2018.  The new default rule is that if a partnership (or an LLC, LP, etc. taxed as a partnership) is audited, there will be a partnership level determination, assessment and collection.  As we also indicated, the problem with this default regime is what happens if you currently have different partners than who you had during the audited year.  Also problematic is if certain allocations are challenged, the IRS will still assess the tax difference against the partnership (rather than simply undoing the allocations), which can create distortions.  Notice comes solely to the partnership, and a partner individually cannot appeal.  Since publishing the previous articles, the IRS has issued regulations, and due to the fact that the new rules are now coming into effect, now is the time to amend old agreements.

Specifically, there will need to be changes to operating agreements of limited liability companies taxed as partnerships in order to make sure that a partnership representative is chosen, and that issues with the representative regarding notice to the other partners is properly dealt with in the agreement.  However, the IRS is not bound by these provisions.  Also needed will be new provisions so that current year partners are not liable for prior year partner’s liability.  Even if the company plans to opt out of the new regime because it has less than 100 partners, the IRS has interpreted the cases for opt out quite narrowly, so many simple and small partnerships may not be able to opt out.  There will also need to be provisions regarding how and perhaps even what elections will be made under the new rules and also how that will be determined under the agreement. Again, it is important to note that these are largely issues between the partners, and the IRS will instead be looking to the partnership representative to make the various elections, and the IRS itself is generally not bound by the language in the agreement, so it’s important to make sure the partnership representative is chosen wisely. If there is an audit and a deficiency assessed, the various choices available can have significant effects on the amount of tax owed.  As such, it is imperative that any agreements specifically set forth the indemnification obligations and tax return amendment obligations of the current and prior partners.

Our tax attorneys here at Stites & Harbison, PLLC have worked on amending numerous agreements to properly take into account these new rules, and we are happy to help businesses navigate the various issues.