LLC OPERATING AGREEMENTS AND PARTNERSHIP AGREEMENTS SHOULD BE AMENDED TO ADDRESS NEW LAW
If you signed an LLC operating or partnership agreement prior to January 1, 2018, it may need to be amended to accommodate a significant new rule regarding taxation of partnerships. Effective for tax years beginning after December 31, 2017, the federal income tax rules applicable to audits of tax partnerships have been substantially revised. These new rules apply to any general partnership, limited partnership, limited liability partnership, or limited liability company (“LLC”) that is taxed as a partnership. Most LLCs that have more than one member are treated as partnerships for tax purposes. These rules do not apply to single member LLCs, nor to LLCs that have elected to be taxed as a corporation.
Historically, all taxes attributable to the income of a partnership have been paid by its partners and not the partnership. Under the new rules, the liability for tax adjustments resulting from IRS audits will shift to the partnership unless the partners elect otherwise. This is problematic for partners in a partnership where some partners have left the firm since the continuing partners will pay the tax on income earned by the exiting partners.
A partnership can elect out of these new rules if it has no partners other than individuals, estates, or corporations. Ownership of an interest by a trust, partnership or limited liability company will preclude this election. In that case, it may be appropriate to restructure a partnership in order to avoid these rules.
Even if a partnership is not eligible to elect out of the new rules and there is a tax liability resulting from an audit, . it can elect to have that liability allocated to the partners who received the income that generated the liability. To take advantage of this option, the applicable partnership agreement or operating agreement must be amended to designate a tax representative who has the authority to make this election with the IRS.
Many existing partnership agreements and LLC operating agreements provide for a tax matters partner who has some limited authority with respect to partnership tax audits. The tax representative under the new law will supersede the tax matters partner and have far greater authority. Accordingly, partnership agreements and LLC operating agreements should be amended to specify who will act as the tax representative and who has the authority to direct and remove the tax representative.
Reviewing and revising your LLC Operating and Partnership Agreements should be done as soon as possible to address these new audit taxation rules and to protect your organization and its partners.
Robert W. Malone is a business attorney with Buckingham, Doolittle & Burroughs, LLC. He is the Chair of the Business practice group and a member of Mergers & Acquisition and Taxation. He focuses his practices on helping clients create, restructure, purchase and sell their businesses, including negotiating and documenting their relationship with other entities. He can be reach at 330.258.6545 or [email protected].
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