Chances are you haven’t looked at it in a while, which is a good thing because you are likely busy running your business. But, if you haven’t looked at your operating agreement since before January 1, 2018, it’s probably a good time to dust it off.
How do changes to audits and tax collection impact your business?
The Bipartisan Budget Act of 2015 (BBA) changed how partnerships are audited and the way the Internal Revenue Service (IRS) collects and assesses taxes from partnerships. These new BBA rules apply to taxable years beginning on or after January 1, 2018. Your company’s accountant has likely inquired about your “partnership representative” or discussed certain elections on the company’s tax returns, but your company’s operating agreement should also be updated to reflect the new BBA rules.
Prior to 2018, under US federal income tax audit rules that applied to partnerships and LLCs (taxed as partnerships), a company appointed a tax matters member to represent the company in tax proceedings affecting the company and its members. Generally, the tax matters member had to be a member-manager or a member/partner of the company, and the other members or partners still had the right to participate in audit proceedings. The IRS conducted its audit at the partnership or LLC level, but any audit adjustments were passed through to and collected from the partners or members.
For taxable years beginning January 1, 2018, the new BBA rules apply. Under these rules, the company appoints a partnership representative who will have the sole authority to represent the company in audits and tax proceedings, and this representative does not need to be a member or a partner. Additionally, the IRS is now authorized to assess and collect taxes, interest and penalties relating any audit adjustments directly from the company rather than the members or partners. This means that current members or partners will bear the financial burden of a prior year’s tax liability unless certain steps or elections are taken.
A partnership or LLC can opt-out of the new BBA rules if it meets certain criteria (e.g., if the partnership has 100 or fewer partners or members and each member or partner is not a trust, partnership, LLC taxed as a partnership, or disregarded entity), and if such election is made on a timely filed tax return every tax year.
What updates should you make to your operating agreement?
Your company’s operating agreement should be updated to name your partnership representative, set forth the authority of the partnership representative, and the authority required to decide how elections are made (or not made) relating to the BBA rules.
When you dust off your operating agreement to make the BBA-related changes, it will also be a good time to review it to ensure it still meets the goals and plans for your company. Your business and corporate lawyers at McCarty Law LLP can help and are just a call away!