Q. My business is organized as a limited liability company and I am named as its “tax matters partner.” What does that mean for me and my co-owners?
A. Because an LLC is often treated as a flow-through entity for tax purposes, its owners must each report and pay tax on their respective shares of LLC income. When an LLC is audited, the IRS is faced with the challenging task of chasing down each of the LLC’s members. Congress addressed this issue in 1982 with a law (“TEFRA”) that requires each flow-through entity to designate a “tax matters partner” (the “TMP”). The idea of a TMP is that the LLC selects a single person that the IRS can work with, rather than having to deal with each LLC member individually. An LLC with ten or fewer members may be not be subject to the TEFRA rules, but LLCs with more complex structures fall within the TEFRA regime.
The members of an LLC covered by TEFRA should choose the TMP carefully as the TMP has significant powers and responsibilities in the audit process. Although all members are entitled to participate in the process, the TMP determines the time and place of proceedings and makes certain decisions that will bind the LLC and its members. The TMP must provide identifying information regarding the members to the IRS and notify members of certain milestones in the audit process. The TMP is empowered to extend the statute of limitations for the tax items under audit, and, if the LLC desires to challenge an IRS decision, the TMP has the right to select the court to which to bring the contest. In a Tax Court proceeding, a TMP’s settlement of the case has the potential to bind all members without their prior consent.
The role of the TMP is important now, but it is headed for obsolescence. As of 2018, a new federal law will go into effect and significantly reform the audit process. The new law streamlines audits by imposing liability for any tax adjustment resulting from the audit on the LLC itself (rather than on members of the LLC for the year under review). Responsibility for conducting the audit is shifted from the TMP to a single member in a newly created role, the “partnership representative,” who will have the right to bind all members to a settlement with the IRS in an audit or a judicial proceeding. To address the changes mandated by the new law, owners and managers of LLCs should be thinking about amending operating agreements in the upcoming year and a half to address the new audit regime.