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October 15 2020

Are Your Corporate Documents Prepared for an Audit?

By: Curtis L. Underwood

When was the last time your company updated your operating agreement, bylaws, or other governing document?  If it was before 2018, then it may be time for a quick tune-up if your organization is taxed as a partnership.  In 2015, Congress passed the Bipartisan Budget Act of 2015 (the “Act”) which became effective in 2018.  Title XI of the Act changes the tax code in several manners that are relevant to many businesses.  One of the purposes of the Act is designed to streamline the IRS audit processes for entities taxed as partnerships.  While this could be beneficial for all parties, some of the changes are fairly aggressive to businesses and are worthy of attention.

First, the Act replaces the old regime for entities taxed as a partnership, which required a “tax matters partners,” and replaces that regime with the requirement that such businesses select a “partnership representative.”  Under the old regime, a tax matters partner was a partner, member, or shareholder who was selected to negotiate with the IRS in tax matters.

Under the new regime, a partnership designates a “partnership representative” who does not need to be a partner (or a member or shareholder taxed as a partner).  In the event of an audit, the partnership representative will have full authority to negotiate with the IRS and bind the company.  It will be important for companies to update their governing documents to facilitate the selection of a partnership representative and provide any rules regarding how that partnership representative operates – such as requiring the partnership representative to provide notice or receive consent before binding the company.  Finally, the IRS is entitled to select a partnership’s representative if the company has not already designated one.

Second, the Act dictates that unpaid taxes by a single partner may be levied against the partnership as a whole.  Generally, for entities taxed as a partnership, each partner pays his or her own taxes based on the income and liabilities apportioned to that partner from the company.  Thus, prior to the Act, if one partner fails to pay his or her taxes on the partnership income, the company does not have a major need for concern since the IRS will have to seek recourse against that individual partner.  However, under the Act, any unpaid taxes by one owner can be levied against the company at the highest tax bracket (though there can be some options for relief from this).

Companies have several ways to mitigate the harsh results of this rule, namely elections for an opt-out or push-out.  Under the push-out election, a company whose ownership has changed between the taxable year in question and the year of the audit can seek to shift the obligation from the current owners to the owners during the taxable year at issue.  The Opt-Out election allows certain qualifying companies to opt-out of the new rules upon the completion of certain procedurals requirements.

While the Act may aid in streamlining the audit process, it can create several concerns for companies who are taxed as partnerships. Any company taxed as a partnership which has not updated its operating agreement or partnership agreement since 2018 should seek to do so.  If your company is in this position, the attorneys at Mika Meyers are up to date on these changes in the law and can aid in amending your corporate documents.