In the Crowdfunding world, almost every equity investment involves a limited limited liability company. Because (1) limited liability companies are treated as partnerships for tax purposes, and (2) Congress has just turned the law governing tax audits of partnerships on its head, all those LLCs will need to revise their Operating Agreements. And all new LLCs will have to follow suit.
Until now, tax disputes involving partnership were conducted at the partner level. That means the IRS had to pursue partners individually, based on each partner’s personal tax situation. With its budget cut and manpower reduced, the IRS was unable to pursue everybody.
Seeking to streamline partnership audits and ultimately collect more taxes, the (bipartisan) law just passed reverses that rule. Now, the IRS conducts audits at the partnership level and no longer has to argue with all those partners and their accountants. In fact, even though partnerships are not normally subject to tax, under the new law the partnership itself must pay any tax deficiency arising from the audit, unless it makes a special election.
EXAMPLE: NewCo, LLC owns an apartment building. The IRS decides NewCo used the wrong method of depreciation, and adds $1 million to NewCo’s taxable income. Under the new law, NewCo itself is liable for tax on $1 million, calculated at the highest possible tax rate. However, NewCo may elect to make its members personally liable instead.
Under old law, every partnership had a “tax matters partner” with broad administrative responsibilities. The new law creates a much more powerful position, the “partnership representative,” with the power to bind the partnership and all of its partners on tax matters. The partnership representative doesn’t even have to be a partner, just a person or entity with a substantial U.S. presence: an accounting firm, for example.
The law becomes effective in 2018. Between now and then, all existing limited liability companies should revise their Operating Agreements to:
- Provide whether taxes due as a result of tax return audit will be paid at the partnership or partner level
- If the tax is paid at the partnership level, how the economic cost will be shared by the partners
- Designate a partnership representative
- Describe the duties and powers of the taxpayer representative, within the statutory limits
- Describe the obligations of the partnership and partners to share tax-related information
Obviously, all new limited liability companies should deal with those issues at the outset.
Questions? Let me know.