Owners of limited liability companies (“LLCs”), general partnerships, limited partnerships, and limited liability partnerships taxed as a partnership for federal income tax purposes should be aware of a recent change in federal income tax rules regarding audits of tax partnerships.
The new rule creates an exception to the general requirement that all taxes attributable to the income of an LLC or partnership are the responsibility of the individual (or members, in the case of a limited liability company). Going forward, the liability for tax adjustments due to IRS audits will shift to the entity, creating a liability where none previously existed.
However, for entities where all members/partners are individuals, estates, or corporations, members/partners may elect to allocate that liability to the individual members/partners. LLCs or partnerships that have a trust, partnership, or LLC as an owner are not eligible to make such an election, but in this case, the entity may elect to allocate the tax liability for an audit to the member/partner who was allocated the income that created the tax liability.
Many partnership agreements and operating agreements drafted prior to this rule change include provisions about a “tax matters partner,” and these provisions may grant certain rights and responsibilities to the tax matters partner with respect to IRS audits. But in most cases, this tax matters partner will not have the requisite authority granted to him/her under the agreement sufficient to make the election necessary to respond to the new rule. As such, an amendment to the company’s operating agreement or partnership agreement to supply the company’s tax representative with the necessary authority may be in order.