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operating agreement compliance

Is Your Operating Agreement Compliant With IRS Streamlined Audit Rules for Partnerships?

The Bipartisan Budget Act of 2015 (BBA) introduced new rules for auditing partnerships. In many ways, the law makes it more efficient for the IRS to conduct audits but poses an additional administrative and possibly financial burden on partnerships. Small partnerships can exempt themselves from the new law, but should take care to assess the pros and cons of doing so. Continue reading to find out what you need to know about your operating agreement compliance.

Underpayment Burden

Perhaps one of the most important changes is who is liable to pay for any underpayments at the time of an audit. Under the old law, underpayments, as well as any fees and penalties, were paid by those who were partners in the years the underpayments occurred.
Now, those underpayments are the responsibilities of the current partnership, even if the relevant partners are long gone. While this saves the IRS from the burden of tracking down old partners, it can cause current financial partners to take a financial hit.

Partnership Representative

Under the BBA, one person, the partnership representative, is the voice of the entire partnership during an audit. This person has the authority to finalize any agreements with the IRS. He or she does not have to tell anyone an audit is happening.
Because of the importance of the representative, partnerships should carefully assess who should take on this role. According to the BBA, he or she does not have to be a partner. The IRS will conduct business with whomever the operating agreement identifies as the partnership representative. If no one is named in the agreement, the IRS can pick whomever they want to act on the partnership’s behalf.

Amended K-1s and Consistency Requirement

The partnership can pass the cost of any adjustments down to the partners by issuing amended K-1s. This applies to the year under audit review. With this election, each partner takes responsibility for a share of the adjustment.
Like with the current law, individual partner adjustments must be consistent with those of the partnership as a whole. In the case of inconsistency, the IRS has the power to issue a summary assessment. This can often be avoided by declaring the inconsistency to the agency.

Opting Out of BBA

The new rules are mandatory for partnerships with more than 100 partners. The regime is optional for smaller partnerships. By opting into the BBA, smaller partnerships should anticipate a shorter lead time for potential audits, as it is easier for the IRS to begin the process. At the time of review, the partnership can elect to pay any monies owing or undertake the K-1 amendment process. The most important factor to weigh may be understanding how the burden shifts for partnerships who are now following the updated rules.

As with any changes to business taxation law, it is important to assess the long- and short-term effects both financially and in the nature of how your operations may be constrained. In the world of partnerships, in particular with the new BBA rules, it may be wise to assess how the new taxation regime affects relationships with past partners. The operating agreement is your means to outline the rules of how you work together with respective rights and responsibilities. A business lawyer can help you draft the right agreement to meet your objectives given the new laws.

Additional Help 

Unsure if your operating agreement is up to par? Johnstun Law can help you make needed amendments to your operating agreement to ensure your compliance with IRS audit rules for partnership.

Sources

https://www.bakermckenzie.com/en/insight/publications/2017/10/updating-partnership-agreements-audit-rules/

https://www.thetaxadviser.com/issues/2017/sep/irs-reissues-centralized-partnership-audit-rules.html

https://www.cpajournal.com/2017/11/01/irss-new-streamlined-audit-rules-partnerships/