Know the Law: Complying with Federal Partnership Audit Rules

Catherine H. Hines
Counsel, Tax Department
Published: Union Leader
December 31, 2018

Q: My business is an LLC taxable as a partnership and has only a few members. I understand that the new federal partnership audit rules may require me to name a “partnership representative.” Should I just name my current “tax matters partner” as my partnership representative?

A: As a company taxable as a partnership for federal income tax purposes, your LLC is required for tax years starting in 2018 or later to appoint a “partnership representative” to represent it in tax audits and in judicial proceedings, unless the company is eligible to opt out of this regime and makes an affirmative election to do so each year. However, the role of the partnership representative is far more powerful than that of the tax matters partner, so it is not always appropriate for the current tax matters partner to take on the role of partnership representative. Unlike your LLC’s tax matters partner, your LLC’s partnership representative will have the power to bind your LLC and all of its members in settlements with the IRS with respect to federal income tax liabilities and, in the absence of express provisions in your LLC’s operating agreement to the contrary, can do this without the consent of, or even notice to, the members. Also, depending on the elections made by your partnership representative, federal income tax liability may be payable by the LLC and borne by current members, even if they were not members during the year under review.

Your LLC may be able to opt out of these rules, but it is important to authorize the designation of a partnership representative in case your LLC is later deemed ineligible to opt out, or inadvertently fails to make a valid election to opt out. Your LLC is eligible to opt out if it has 100 or fewer members, each of which is an individual, estate of a former member, or a corporation. If, however, your LLC has members that are trusts (including grantor trusts), LLCs taxable as partnerships, partnerships, disregarded entities, foreign entities (that are not taxable as corporations), estates of individuals other than a deceased member, or nominees or similar persons that hold an interest on behalf of another person, it is not eligible to opt out. Furthermore, even if your LLC is currently eligible to opt out of the regime, it may become ineligible in the future if ineligible members are admitted. For instance, if a current member transfers his interest to a trust for estate planning purposes, your LLC would become ineligible to opt out.

Thus, even if you think your business is eligible to opt out, you should consider amending your LLC’s operating agreement to specify the terms of the opt out (such as the duties of members to provide required information), as well as to designate a partnership representative and to identify any desired restrictions on the actions of, or duties of, the partnership representative.