Have You Amended Your LLC’s Operating Agreement? Here’s Why You Should.
The auditing requirements for partnerships and limited liability companies taxed as partnerships have changed. If your LLC is taxed as a partnership, not updating your LLC’s Operating Agreement could end up costing you power over the actions of your LLC and money.
In 2015, Congress enacted the Bipartisan Budget Agreement of 2015, or the BBA. Bipartisan Budget Act of 2015, Pub. L. No. 114-74, 129 Stat. 584 (2015). Beginning January 1 of this year, the BBA caused the Internal Revenue Service’s audit rules for partnerships and businesses taxed as partnerships to change. Pub. L. No. 114-74, § 1101.
In the past, the IRS did not audit partnerships, it only audited members of partnerships. Gregory H. Taggart, LLCs: New Rules and Regulations, 4-5 (Jan. 2018). Under the BBA, not only may the IRS audit a partnership, but it also may collect underpayment and penalties from previous years from the partnership. Id. at 5, 6. A current member of an LLC taxed as a partnership could be responsible for this underpayment and penalties for previous years, even if that current member was not a member during those previous years. Betty J. Boyd, Dig into the New Partnership Tax Rules, Business Law Today at 9 (Feb. 2016).
Further, under the new audit rules, a member has no right to participate in audits by the IRS or even have notice of an audit. Id. Those rights are vested in a newly created role, the “partnership representative.” 26 U.S.C. § 6223. The partnership representative, who does not need to be a member of the LLC, has the sole authority to act on behalf of the partnership. Id. If a partnership or an LLC taxed as a partnership does not choose its own partnership representative, the Secretary of the Treasury can choose for it. Id.
By updating your Operating Agreement, you can ensure you choose your LLC’s partnership representative, you decide what the partnership representative is required to convey to other members, and members and former members are ultimately responsible for their tax penalties.
It is possible to opt out of the new audit rules. If your LLC has one hundred members or less and each partner is either an individual, an estate, a C corporation, or a foreign corporation, your LLC can opt out of the new audit requirements. 26 U.S.C. § 66221(b). Your LLC can make this election by updating its Operating Agreement.
Bottom Line: With the new partnership audit rules adopted as part of the BBA, it is important—if your LLC is taxed as a partnership—to update your LLC’s Operating Agreement.