New Audit Rules May Require Action by Partnerships and Multi Member Limited Liability Companies
Last year, new partnership audit rules enacted by Congress went into effect. Starting with tax returns for the 2018 calendar year, partnerships and limited liability companies (“LLCs”) taxed as partnerships will need to provide specific information regarding these new rules on IRS Form 1065. In addition, these new rules are expected to increase audits of partnerships and LLCs taxed as partnerships.
Prior partnership audit rules prohibited the IRS from assessing any tax on a partnership. As a result, partnership audits became a rare event due to the time and difficulty the IRS encountered in pursuing tax collection from members of partnerships and LLCs.
The new rules allow the IRS to assess a tax deficiency against a partnership or LLC without having to pursue collection from its members. Audits of partnerships and LLCs are therefore expected to significantly increase.
There is good news. Eligible partnerships and LLCs (i.e. those with 100 members/partners or fewer and all of which are individuals, C or S corporations, estates of deceased members and certain foreign eligible entities) may opt out of the new audit rules. An opt-out election needs to be made annually on an entity’s federal income tax return, and all partners or LLC members need to be notified of the opt-out election. If a partnership or LLC fails to opt out, the new audit rules will apply.
The new rules also amended provisions regarding who can legally bind the partnership or LLC in audit proceedings. Partnerships and LLCs will no longer appoint a “tax matters member”, but instead will designate a “partnership representative”. The partnership representative can be an individual or an entity and does not have to be a member of the partnership or LLC. If a partnership representative is not chosen and also disclosed on the entity’s federal income tax return, the IRS could choose the partnership representative.
Partnerships and multi-member LLCs should consider taking the following actions before filing their 2018 tax returns:
- Amend partnership and LLC agreements to opt-out of the new audit rules if eligible to do so – and then annually make the necessary election on federal income tax returns and notify all partnership and LLC members of the election;
- Amend partnership and LLC agreements to name a partnership representative and remove outdated references to tax matters members – and then identify the partnership representative on federal income tax returns; and
- Review and update partnership and LLC agreements for compliance in light of the expected increase in audits.
Our office can assist you in determining if beneficial changes should be made to your partnership or LLC agreements. Please contact us if you would like to discuss these new rules and the opportunities they present with respect to your business.