On January 1, 2018, the rules and procedures relating to IRS audits of partnerships, including those limited liability companies taxed as partnerships, (for purposes here, collectively, the “Partnerships”) will change. The Bipartisan Budget Act of 2015 (“BBA”)(26 U.S.C.A. §§6221-6241), which was signed by President Obama on November 2, 2015, is generally intended to make it easier for the IRS to audit Partnerships and to assess and collect underpayments of taxes. It allows the IRS to assess and collect taxes directly from the Partnerships rather than from the partners or members (for purposes here, collectively, the “Partners”) as was the case under the old rules. (Apparently, the IRS’s collection efforts directly against the Partners were unsatisfactory.) This change is significant – it not only assesses the Partnership for the underpayment of taxes by the Partners, but it also shifts from the IRS to the Partnerships themselves the task of collecting those taxes from the Partners who benefitted from the underpayment. It also introduces complications, e.g., when there are changes in the Partners from the audited year in the past (the "reviewed year") to the year in which the Partnership is assessed and has to pays the taxes (the "adjustment year"). At that point, the Partners in the adjustment year suffer the consequences by having to pay the tax and not the former Partners who directly benefitted from the underpayment in the reviewed year.

In order to simplify or stream line audits, the IRS is not obligated under the BBA to give notice of an audit to any of the Partners and the individual Partners are not permitted to participate in the audit or challenge the results. Instead, the BBA requires that each Partnership designate a ‘partnership representative’ (a “PR”) who does not need to be a Partner but has the sole authority to act on behalf of the Partnership and to bind the Partnership and its Partners. This designation must be made annually on the Partnership’s tax return and, if it is not made, the IRS may select a person to serve as the PR. The PR replaces the ‘tax matters partner’ under the old rules but without the attendant protections for Partners.  

Many of the changes and ramifications created by the BBA and issues relating to any audits need to be addressed by a Partnership’s accountants. Examples include whether or not to opt out of the new rules, which is permitted assuming the Partnership qualifies. Other issues, however, should be reviewed and addressed by a Partnership’s legal counsel, and revisions will likely need to be made to the partnership or the operating agreement (the “Agreement”) of Partnerships formed prior to January 1, 2018.

Among the issues that counsel will need to address in the revisions to the Agreement include:

• Whether or not the Partnership should seek to opt out of the new rules (§ 6221 Opt-Out) and, if so, should the Agreement obligate the Partnership to conduct its affairs so that it qualifies for the election? Who decides if the Partnership should opt out?
• The selection of a PR; the criteria for the selection and replacement of the PR; and the PR’s qualifications.
• The level of duty owed by the PR to the Partners and Partnership.
• The rules for the PR, such as mandatory notice to the Partners, obtaining consent from the Partners before binding the Partnership, etc.
• Requiring Partners and former Partners to cooperate in good faith, file amended returns as reasonably requested by the PR and Partnership’s accountant, etc.
• In the event of an assessment after an audit, requiring (i) the Partners and former Partners to contribute to the underpayment considering the Partners’ allocable share of the underpayment and the benefit received by the Partners; or (ii) the Partnership to make a ‘push out’ election (§ 6226 Push-Out) which would push out the tax liability resulting from the audit to the Partners in the reviewed year.

We strongly recommend that each Partnership contact its counsel and discuss the BBA and the changes that should be considered for its Agreement.