The Tax Equity and Fiscal Responsibility Act (TEFRA) once governed the auditing process for LLCs that are taxed as partnerships. Previously, the IRS could not hold the LLC responsible for federal income tax deficiencies, only the members of the LLC were liable. TEFRA has since been repealed and effective January 1, 2018 the Bipartisan Budget Act of 2015 governs the auditing procedures. This adjustment allows the IRS to collect underpaid taxes directly from the LLC if the LLC is taxed as a partnership rather than a C-corp or S-corp. This important change will require companies to update their operating agreements.
Under TEFRA, most operating agreements and partnership agreements had a person designated as a “Tax Matters Member” or “Tax Matters Partner.” This person was responsible for representing the partnership or LLC before the IRS. The TMP had the authority to work with the IRS during the audit process and make decisions that will affect the LLC. They essentially acted as a liaison between the IRS and the entity. Partners and members were required to be informed of the audit and had the chance to participate in the audit and make appeals. This requirement has changed under the new rules.
The Tax Matters Member is replaced with the Partnership Representative under the BBA. The rights of a PR are far broader than those of a TMP. The PR has the power to bind the partnership or LLC to agreements, settle tax matters, and waive the statute of limitations. Further, under the new rules, the IRS does not have to give notice to all members of the partnership or LLC informing them of the audit. This places the members at risk of being liable for a bill that they were never made aware of and eliminating their ability to appeal. Although the PR does not have to be partner or member, they will have the authority to make major alterations related to tax issues to the organization. This reason alone is why it is important to choose the Partnership Representative carefully.
There is a way to opt out of this new auditing process. One requirement to be eligible to opt out is that all of the members or partners are either individuals, the estate of an individual, or a C-corporation. If a member is an LLC, LLP, or Partnership, opting out is not an option. Another requirement to be eligible is that there must be less than 100 members or partners within the organization. Opting out must occur on a yearly basis.
Consult with a local Nevada business lawyer today to discuss your operating agreement. Find out if your business needs a Partnership Representative Clause and how it can protect your business’ interest in the future.