New IRS RULES for LLC’s & LP’s Taxed As Partnerships
What has changed?
The new rules change how the IRS can audit an LLC or LP. In the past, an IRS audit of an LLC or LP taxed as a partnership involved auditing, settling and collecting tax shortfalls from each individual partner. In a master limited partnership (think oil and gas or real estate) with thousands of partners, this was very difficult.
The IRS decided (and Congress approved) that it was best to conduct audits at the entity (LLC or LP) level. They now can just audit the entity and not the individual partners. In many situations, the entity – and not the partners – will pay any tax shortfall. The new program is called the Centralized Partnership Audit Regime.
What if my LLC is taxed as an S Corporation or C Corporation?
The new rules only apply to LLCs taxed as partnerships. However, in the event of a change of taxation, it will be important to amend your LLC Operating Agreement.
How does the IRS benefit from the change?
The new rules allow the IRS to deal with only one point of contact – the Partnership Representative. This individual, who does not haveto be a member or partner, has the power to obligate the entire group.
The IRS will benefit from LLCs and LPs not being able to give them the run around on who has authority for the entity (which did occur under the old rules.)
They will also benefit from being able to asses any tax shortfalls against the entity itself and not the individual partners.
Why is the Partnership Representative so important?
The Partnership Representative has broad powers to obligate the LLC or LP. Any resolution they arrive at with the IRS binds all of the partners. You want to have the right person in place for this.
If you don’t appoint such a person, the IRS can appoint someone for you. You don’t want the IRS to have such a power over your entity. This is a key reason why LLC Operating Agreements and LP Limited Partnership Agreements must be amended to pre-appoint a Partnership Representative.
Who can be the Partnership Representative?
The Partnership Representative must be an individual with a substantial presence in the United States. Initially, we typically appoint a General Partner of an LP or a Manager/Member of an LLC to fill this role.
If the IRS later conducts an audit, a CPA or tax lawyer, who does not have to be a Partner or Member, can be appointed if desired. A professional firm can serve in this role but an individual with a substantial U.S. presence must also be identified.
Again, if you don’t appoint one, the IRS can do it for you, which is not in your best interest.
Can I opt out of these new rules?
Yes – but we don’t suggest it. Partnerships with no more than 100 eligible partners (and not one ineligible partner) can opt out and be governed by the old rules. However, ineligible partners include single member LLCs and living trusts.
Virtually all of our clients currently or in the future will use a single member Wyoming LLC and/or a revocable living trust for their asset protection and estate planning goals. These strategies involve ineligible partners.
If you opt out and a single member LLC or a living trust becomes a partner then you are back into the new rules. But because you didn’t amend your documents and appoint a Partnership Representative, the IRS now gets to pick one for you. You don’t want to give them such power.
Will there be greater IRS scrutiny of those who opt out?
Yes, as the IRS has posted on their website:
“To ensure that the election out rules are not used solely to frustrate IRS compliance efforts, the IRS intends to carefully review a partnership’s decision to elect out of the Centralized Partnership Audit Regime. This review will include analyzing whether the partnership has correctly identified all of its partners for federal income tax purposes notwithstanding who the partnership reports as its partners. For instance, the IRS will be reviewing the partnership’s partners to confirm that the partners are not nominees or agents for the beneficial owner.”
To stay compliant on the opt out, every year your CPA must provide the IRS with the name and tax ID of each partner. If they forget to do so you are under the new rules (without an appointed Partnership Representative). The IRS scrutiny and consequences of a simple error are not worth the supposed benefits of opting out.
What if a Partner owes money for year 2020 but is no longer a partner after an audit in year 2022?
A very good question. In many cases, the LLC or LP will pay the tax and assess the partners. What if a year 2020 partner is long gone? We have included language in the amended documents which allows a general partner/manager to go after former partners.
We have also included language to identify who will be responsible for prior year tax obligations upon a transfer of interest. But under the new rules there is a risk that current owners could be responsible for the taxes of former owners.
When do the new rules take effect?
The new rules apply for tax years beginning January 1, 2018. LLC Operating Agreements and LP Limited Partnership Agreements should be amended before that date.
What should I do now?
You should work with your attorney to amend your documents. You should discuss with your CPA that you are accepting the new audit rules. Once your documents are amended all Members/Partners should sign them in order for the transaction to be valid.
What does Corporate Direct charge to do this work?
As a service to our clients, we are charging just $295 for an amended and restated document. We will also include meeting minutes in which all partners approve of the new rules. It is your responsibility to make sure everyone signs the new agreement.
This is a minimum price and may be higher due to complexity and number of owners. For your friends and family members who are not our clients, the minimum amendment price is $670, which included one year of registered agent service in the domestic state.
Corporate Direct has also created a new service to better protect Wyoming LLCs. An explanation of our Armor8™ service is found on our website. Because the Armor8™ service also requires an amendment to your Wyoming LLC Operating Agreement, we will include such amendments to our existing clients at no extra charge through March 1st, 2018.
Please take the time to call your Incorporating Specialist at 1-800-600-1760 to arrange for the amendment of your documents before the end of the year.
