While technically still in the ‘proposal phase’, it is imperative that all partnerships, LLPs and LLCs who are structuring deals, or have otherwise existing operating agreements, read this Alert carefully and bear in mind the possibility that these regulations could be in effect soon.
To the surprise of many investors, substantial changes are being proposed that will adversely influence the way Limited Liability Companies, Limited Liability Partnerships and other tax partnerships deal with and potentially settle Internal Revenue Service audit findings. If passed, starting with federal income tax returns filed for taxable years beginning after December 31, 2017, these changes could suppress your investor rights. However, with advance modification of the operating agreement such infringement can be mitigated.
What You Need to Do Before Year’s End
While the proposed regulations are not yet final or effective, investors must understand the guidance and begin making some very important business decisions in order to protect themselves from economic uncertainties.
- Elect to Opt-Out if Eligible
Certain partnerships will be eligible to elect out of the new centralized audit regime. Eligibility opting-out is three-fold: (i) the partnership must file an annual election, (ii) it must have 100 or fewer partners and (iii) all of the partners must be either an individual, a C corporation, any foreign entity that would be treated as a C corporation if it were domestic, an S corporation, or an estate of a deceased partner.
This annual opt-out is not applicable if one or more of the partners is (i) a partnership, (ii) a trust, (iii) a foreign entity that is not an eligible foreign entity described in paragraph above, (iv) a disregarded entity, (vi) a nominee or other similar person that holds an interest on behalf of another person, or (vii) an estate of an individual other than a deceased partner.
- Amend Your Partnership and Operating Agreements NOW
For those not eligible to opt-out, you should consider your options relative to your partnership and operating agreements in order to be consistent with the new law, if enacted. If you don’t, you, as an investor, will lose many of your due process rights. Amendments to existing partnership agreements will need to address, among other things, (i) the designation of a “Partnership Representative” (PR); (ii) the outlining of expectations and a definition of the fiduciary duties of the PR to all partners (including consent rights held by the partners to any decision taken by the PR); (iii) the establishment of rules governing the PR’s interactions with the IRS; and (iv) the allocation of responsibilities for tax liabilities among the partners.
The Impact of Failing to Act
Below are just a few of the ways you and your partners will be impacted if you fail to act.
- The IRS can self-appoint, at its sole discretion, a PR from among the partner group who will have sole authority to act on behalf of the partnership and all its partners.
- Partners will lose their individual rights to be informed of the partnership’s dealings with the IRS (all agreed upon findings will flow to the partners through the K-1).
- Partners will lose their individual appeal rights with the IRS.
- Partners will have no individual say in:
- extending the statute of limitations or deciding to settle the partnership’s IRS case
- deciding if the total tax liability will be paid at the entity level or “pushed-out” to each of the partners (and determining how to allocate the tax liability amongst the partners)
- Existing partners could find themselves liable for the unpaid tax of former partners.
When many dollars are at stake, we should all be aware of this impending matter, and take corrective actions to protect our individual rights before the IRS. For more information and to discuss what your partnership should be doing now to maintain your balance of power, contact MFA today.