Should Your LLC Change Its Operating Agreement to Address 2018 Tax Law Changes?
If your LLC has multiple members and is taxed as a partnership, you may want to amend your LLC’s Operating Agreement to respond to tax law changes in effect beginning with the 2018 tax year.
The Bipartisan Budget Act of 2015 (“BBA”) made significant changes to the rules governing IRS audits of all business entities taxed as partnerships, effective on January 1, 2018. The effect of these changes is to make it easier for the IRS to audit partnerships, which will allow the IRS to use its existing resources to audit more partnerships.
Certain small partnerships may elect to opt-out of the new regime and (in so doing) decrease the likelihood that they will be audited. To be eligible to opt-out, the partnership must have less than 100 partners and consist only of “eligible partners,” i.e., individuals, estates of deceased partners, S corporations, C corporations, and foreign entities that would be treated as C corporations under existing law. Certain types of partners will cause a partnership to become ineligible to opt-out, such as other partnerships, single-member LLCs, estates that are not estates of a deceased partner, trusts, and any other person that holds an interest on behalf of another person (each an “Ineligible Partner”).
We anticipate that most—if not all—of our existing LLC clients that are eligible to opt-out will want to do so, and will want to amend their Operating Agreements accordingly. They may also want to amend their Operating Agreements to bar Ineligible Partners from becoming members of their LLCs.
If a partnership does not opt-out (or is ineligible to do so), and the partnership is audited and is required to pay additional tax for a prior tax year (the “Adjusted Year”), some partners may find themselves paying more (or less) than their pro-rata share of the partnership’s tax for the Adjusted Year—particularly if (since the Adjusted Year) partners have left, been added, or had their percentage interests change. To address these inequities, under the new law, the partnership may elect to “push-out” the partnership’s tax liability for an Adjusted Year to the partners—including former partners who were partners during the Adjusted Year—who will pay their share of the tax based on their respective percentage interests for the Adjusted Year. LLCs that desire to “push-out” the partnership’s tax liability should amend their Operating Agreements to ensure that partners during an Adjusted Year are contractually bound to pay their share of the additional tax, whether or not those partners are currently partners, or whether their percentage interests have changed in the interim.
In addition, an audit adjustment in prior tax years can cause accounting distortions that are unfair to the current partners (e.g., such adjustments can distort the current partners’ capital accounts). It may be desirable for an LLC taxed as a partnership to amend its Operating Agreement to authorize the Manager to make equitable accounting changes to correct those distortions.
In addition, the new law requires that business entities taxed as partnerships appoint a “Partnership Representative” in place of the “Tax Matters Partner.” Under the new law, the Partnership Representative has more authority to take tax positions on behalf of the entity than the Tax Matters Partner did. To address this, LLCs taxed as partnerships should consider amending their Operating Agreements to describe the extent of the Partnership Representative’s authority and to provide direction to the Partnership Representative as to the tax positions he or she should take (e.g., whether to “opt-out” or “push-out” as described above).
If you are a member of an LLC taxed as a partnership and you have questions about how the BBA affects you and your LLC, please contact one of our business attorneys.
Author Kevin N. Tharp
Kevin Tharp’s diverse business and litigation practice focuses on the construction industry. Kevin counsels owners, general contractors and subcontractors, and represents them in disputes involving claims for payment, delay, and design and construction defects, as well as mechanic’s liens.
Kevin also counsels clients in the selection and formation of business entities, mergers and acquisitions, business selection planning, and general contractual matters.
Kevin previously served on the Firm’s Management Committee (2011-2013).
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Posted on Oct. 03 2018, by Kevin N. Tharp