Does Your LLC Need a Partnership Representative?
Beginning January 1, 2018, LLCs taxed as a partnership must designate a partnership representative, which must be a member of the LLC, or other person, “with a substantial presence is the United States”. This new designation is part of a comprehensive change to the laws governing how the IRS audits partnerships and LLCs taxed as a partnership.
Under the current laws, the IRS must notify each LLC member of an audit of the LLC, and each member generally has the right to participate in the audit and to appeal the findings. Under the new laws, the IRS will be required to notify only the partnership representative of the audit, and only the partnership representative will have the right to act on behalf of the LLC during the audit and to appeal the findings of the audit. All decisions and actions of the partnership representative will be binding on the LLC and on each member. If the LLC has not designated a partnership representative, the IRS has the authority under the new laws to appoint one. Additionally, the new laws assess a tax rate of 39.6% on any tax underpayment imputed to the LLC, and it allows the IRS to seize LLC assets to satisfy such underpayment.
Opting Out
The good news, if there can be such a thing when it comes to taxation, is that certain LLCs can opt out of these new laws. The bad news is that many small LLCs, including those with just two members, will not qualify to opt out.
Under amended section 6221(b) of the tax code, an LLC can opt out of the new laws if it has 100 or fewer members, and if each member is either (i) an individual, (ii) a C corporation, (iii) an S corporation, (iv) or an estate of a deceased member. This means that an LLC is stuck with the new law if any member is another LLC or a trust, which are pretty common types of members. Additionally, the LLC must make the election to opt out each year with its timely filed tax return and it must include with the election the name and taxpayer identification number of each member. The LLC must also notify each member of the election to opt out of the change.
Two portions of the new laws provide some relief to LLCs that cannot opt out of the new law. Section 6225(c) allows a member to pay the member’s portion of any tax underpayment, which will thereby reduce the amount of the underpayment for which the LLC is liable. Section 6226 allows the LLC to elect to “push out” to its members, who were members during the year audited, the liability of paying the underpayment owed by the LLC.
Operating Agreement
Regardless of whether an LLC intends to opt out of the new laws, members of LLCs taxed as a partnership should amend their operating agreements in 2017 to address how the members intend for the new laws to apply to the LLC. For example, if the members intend for the LLC to elect to opt out of the new law pursuant to section 6221(b), assuming the LLC meets the above criteria to opt out, then the operating agreement should reflect that preference and direct the managing members or managers to do all things necessary to make the election. However, even with that preference stated in the operating agreement, the election to opt out might be invalid due to a failure to properly follow the procedures required to make the election. As such, the operating agreement should designate a member or other person to act as the partnership representative in the event the LLC fails to properly opt out of the new laws, or in the event the LLC is ineligible to opt out.
The operating agreement should also address whether to permit elections under 6225 and 6226; the extent to which the partnership representative must keep the members informed of proceedings conducted under the new laws; the extent to which the partnership representative must seek the consent of the members when making decisions on behalf of the LLC; and whether to require members to make additional capital contributions to cover a tax underpayment assessed against the LLC.
Sewell Law is located in St. Louis, Missouri and offers legal services in the areas of litigation and asset protection strategies, including LLCs and trusts. Please contact Michael Sewell at (314) 942-3232 or at michael@sewelllaw.net to discuss amending your operating agreement.
This article is for general informational purposes only. It does not include all of the laws and regulations related to the topics discussed in this article, and it is not intended as legal, tax, or investment advice. As such, you should not rely in this article alone in making decisions regarding the subject matter discussed in this article.
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