Tax Audit Risk Shifted from Partners to Partnership


A legislative change to partnership tax audit procedures enacted under the Obama administration is set to go into effect as of January 1, 2018. All tax partnerships need to be prepared to make certain amendments to their governance agreements, preferably prior to December 31, 2017.

All partnership agreements and operating agreements of LLCs taxed as partnerships will need amendment.

Present Law

Under present law, entities taxed as partnerships are required to appoint a tax matters partner to represent the partnership in connection with IRS audits. If the result of an audit is an alleged deficiency, the tax matters partner can agree on behalf of the partnership or dispute the deficiency, but cannot bind the partners. Once the deficiency becomes final, it is assessed to and collected from the partners in the year under audit.

New Law

Under the new law, there is a nomenclature difference and the tax matters partner is now known as the “partnership representative.” The partnership representative still represents the partnership in audits and still has the authority to agree to deficiencies or dispute them, but also can bind the partners. The new audit procedures also are significantly different in that once a final determination is made, the default rule is any deficiency is assessed and collected against the partnership. This creates the possibility that the partners in the year that the liability of the partnership for a prior years’ taxes arises (the “reviewed year”) will be different or own different percentages than the partners of the year of the audit (the “adjustment year”).

There are certain exceptions to this default rule:

Actions Required

All tax partnership operational agreements should be amended to either appoint a partnership representative or establish a procedure for the appointment of a representative by the partners/members.

Other Considerations

In view of the possibility that a tax partnership may be obligated for the taxes of its partners under the new audit provisions, care should be taken when purchasing an entity taxed as a partnership or joining an entity taxed as a partnership to secure indemnities to provide protections to the purchaser/new member for tax liabilities accruing prior to purchase or admission.

This possibility may also require revisions to private placement memoranda or offering statements relating to securities in entities taxed as partnerships.

For more information, please contact:
J. Grant Coleman
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