By: Dan M. Smolnik

As part of a budget compromise, the Bipartisan Budget Act was enacted on November 2, 2015, and became effective on January 1, 2018. Title XI of the BBA is a revenue device and works to raise tax revenue without raising taxes by substantially streamlining IRS partnership audit procedures, including audit procedures for LLCs which are treated as partnerships for tax purposes.

Opt-Out for Small Partnerships

Small partnership can elect out of the new rules if:

  • The partnership is required to issue no more than 100 Schedules K-1
  • Each partner is an individual an estate of a deceased partner, and S corporation, a C corporation, or a foreign entity that would be treated as a C corporation if it were domestic
  • An election is timely filed with a timely filed return providing the names and identification numbers of the partners and
  • The partnership notifies each partner of the election

Hence, a partnership that includes among its partners another partnership or trust, including a grantor trust, may not opt out. Also, a partnership with a tax-exempt entity as a partner will need to determine if the entity is a C corporation. When an S corporation is a partner, the names and taxpayer identification numbers of the S corporation’s shareholders, together with the S corporation itself, must be included in the election statement, and the Schedules K-1 of the S corporation count toward the 100 shareholder limit for the opt-out qualification. Observe that IRS is authorized to issue rules allowing partnership to elect to opt-out regardless of the type of entities owning a partnership interest, so long as the total number of Schedules K-1 required to be issued by the partnership and its partners do not exceed 100 and the partnership discloses the identities of indirect partners.

The apparent counting problem created by issuance of multiple Forms K-1 to the same partner who holds different classes of interests in the partnership will likely need to be addressed by regulation.

In the same way, regulations will be needed to clarify whether a disregarded entity or nominee holding an interest will be disregarded in determining who owns the interest. Related to this issue will be the need for regulations for guidance as to whether a partnership interest held by an IRA, SEP, or other closely held retirement entity will be treated as owned by the individual beneficiary.

New Partnership Representative

The old rules called for appointment of a tax maters partner in many cases involving partnerships. Beginning with 2018, any audits will be managed at the partnership level by a Partnership Representative (PR). We are seeing many LLCs and other partnership entities attempting to comply with this change by merely changing nomenclature within their operating agreements. This, however, disregards the dramatically different authority the PR has from the old TMP.

Under the BBA, unless a partnership can and does opt-out (recall the opt-out election must be made annually) the IRS will deal only with the PR. The partners have no rights to appeal a tax assessment. The PR also has the authority to:

  • Waive the statute of limitations and other defenses
  • Communicate with the IRS and agree to settle the total tax liability of all the partners
  • After the total tax assessment is agreed, the PR can elect either to
    • Allocate the total amount among the partners enabling IRS to collect a specific amount from each partner or
    • Pay, at the partnership lever, the tax on behalf of each partner

The BBA eliminates the notion of Notice Partners who were formerly entitled to receive notice directly from the IRS. Under the new regime, an audit might commence and be completed, and the partners might never hear about it until they receive a non-appealable tax bill from the IRS.

So, in addition to accommodating the tax liability allocation scheme the BBA now imposes on partnerships,* partnership agreements should be amended to include:

A dispute resolution mechanism (e.g. mediation, arbitration) to manage disputes by partners who don’t agree with the acts of the PR

  • A collection mechanism for circumstances in which the partnership pays a tax assessment at the entity level but one or more partners does not voluntarily pay his share of the assessment
  • A reconciliation mechanism for cases where the PR makes a good faith error
  • Notice obligations as between the PR and the partners
  • Liquidity provisions, such as insurance, for the PR’s acts and omissions
  • Selection of the PR and successor PR

Operating agreements should also address the following issues:

  • Does a decision to extend the statute of limitations or a decision to settle an audit case require a simple majority vote of the partners, a majority of each class or a unanimous vote?
  • How should the PR settle the case if there is no agreement among the partners?
  • How and when should the PR notify the partners of correspondence and other communications with the IRS?
  • How should the partnership’s tax liability be allocated among the partners and the classes of partners? How should exiting and entering partners be obliged to manage tax liability of which they are nit yet aware?
  • Should any additional tax simply be paid by the partnership and charged against each partner’s account as a distribution? Or should the tax-payment responsibility be “pushed-out” to each partner so the IRS handles the collection? This election must be made within a very short 45 day window.
  • The new law presumes that all partners are taxed at the highest possible bracket, unless the PR proves otherwise within 270 days of making a settlement. How and when should the partners supply information to the PR that will enable him to protect their right to use the lower tax brackets?

This note does not include review of the entire effect on the BBA on partnerships. It is intended only as an illustration of selected general principles.


* The BBA now imposes imputed tax underpayments and all related penalties and interest directly on the partnership at the highest individual marginal tax rate. One of the several effects of this approach is that even partners who were not members of the partnership at the time the tax liability was incurred will be charged with the associated tax liability.

Tags: Tax