New Rules Demand a Review of Your Operating Agreement

February 8, 2017


While not one of those top news stories, an important change has taken place to rules regarding business partnerships that might prove costly to anyone who ignores the changes.

Congress recently enacted significant changes to their partnership audit and adjustment rules.  In effect, the change will dramatically increase the IRS’s audit rate for partnerships.  As a result, these changes may require partners to carefully review—and potentially change—their operating agreements.

It gets better. More IRS audits will most certainly mean more chance for penalties, and there are big changes on that front as well.

The IRS can now collect any additional tax, interest and penalty directly from the partnership rather than from the partners.  In addition, it is possible that the IRS may assess the tax at the highest individual tax rate.

Plus, in some instances, current partners may be responsible for tax liabilities of prior partners.

The new rules also include a number of new tax terms, concepts, potential election options and opt-outs available for you to consider in the terms of your operating agreement.  The rules also require your agreement to specify who in the partnership will be permitted to enact these optional changes.

For example, in the past, operating agreements have designated a “tax matters partner”.  The new rules require a “partnership representative” in place of the ‘tax matters partner’.  The “representative” of your partnership will act as the single point of contact between the IRS and your partnership.  This person will have full authority to bind the partnership—and the partners—during an audit.

It may be possible for some—but not all—partnerships to opt out of the new provisions.  Certain partnerships with fewer than 100 partners can make an annual “opt-out” election when filing their annual partnership tax return (Form 1065) but only if the filing is completed in a timely manner. On the other hand, some entities, such as tiered partnerships, will not be eligible for opting out.

Prior to filing your tax returns, we highly recommend that all those with partnership entities consult with a CPA (as well as their attorney) for a review of documents and a discussion of your options to ensure proper compliance and minimize any unexpected tax exposure.

The good news is that the changes do not go into effect until January 1, 2018, but it is important to do your planning now.  Lastly, do not forget the rules also apply to limited liability companies (LLCs) that are taxed as partnerships.

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