If you have partnership (including LLC) clients, you probably know the Partnership Agreement or Operating Agreement contains a provision appointing one of the partners (either partners or members) the “Tax Matters Partner” – typically without much thought to its significance. You knew the Tax Matters Partner made certain tax elections. But what else? No matter. The Tax Matters Partner is gone and a totally new concept of “Partnership Representative” (“PR”) has replaced it. If you don’t act, the IRS will fill that position for you (not necessarily with a partner) and it could be very costly.
This is part of the impact of the Bipartisan Budget Act of 2015 (“BBA”) with the addition of 26 U.S.C §6221 which took effect January 1, 2018. It has been overlooked by many who advise entities subject to partnership tax rules. For this and other critical reasons, Partnership and Operating Agreements must be amended now to account for the extensive impact of the new BBA rules.
The BBA provides two sets of rules which automatically subject partnerships and LLCs to entity-level tax audit. The default rule under IRC §6221(a) is that a tax audit and any resulting adjustments to items of income, gain, loss, deduction, or credit for a tax year will apply to the entity, not to each of the partners, for the tax years beginning in 2018, and for each subsequent tax year unless a timely election is made for each year to apply an alternate rule under which either (a) the entity’s PR may “opt-out” of the default rule or (b) a majority of the partners of the entity may elect to have the audit “pushed-out” and conducted at the entity level.
The Partnership Agreement or Operating Agreement should contain clear and definite provisions addressing the powers, obligations and limitations of the PR, not only in making elections and conducting audit matters with the IRS, but in establishing provisions that deal with fiduciary responsibility (which is limited by statutes in many states) and conflicts of interest (which a partner serving as PR inherently has). Language should provide for, among other things, a process for appointment and replacement of the PR, for effective transparency and communications with the PR, partner voting rules for elections to be made by the PR, allocation of entity level taxes among partners and capital contributions from partners to reimburse the audit adjustment burden suffered by the entity.
Remember, change your agreements now to appoint the person you want to be the “Partnership Representative”, or the IRS may name someone you do not want.
If you have questions regarding Tax Matter Partners, or the new tax audit rules,
please contact me at firstname.lastname@example.org or 703.745.1846.
ABOUT TOM HICKS, III
C. Thomas (“Tom”) Hicks III has more than 35 years business law practice experience in Northern Virginia. Mr. Hicks represents business clients in all their legal needs, working with the management team as outside general counsel, and otherwise coordinating the company’s general legal needs. Mr. Hicks assists the organizers with choice of business entity and organization, initial and private equity financing and debt financing. He advises the management team regarding corporate governance, executive employment and compensation matters, contract matters, business acquisitions, equity, and asset sales and merger, and business breakups and dissolutions of business entities, among other legal areas.
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