Partnership and LLC Agreements Should Be Amended in Light
of the New Partnership Audit Rules

The Bipartisan Budget Act of 2015 became effective January 1, 2018. Partners in general or limited partnerships, family limited partnerships, and LLCs will want to address the issues raised by this new law by amending their partnership agreements sooner than later.

The key changes are two-fold:

1. Unlike prior law, the IRS can now assess the partnership itself, rather than the partners, for additional tax resulting from audit of the Partnership.

2. Every partnership (including LLCs taxed as partnership) must appoint a partnership representative (“PR”) who will have exclusive authority to represent and bind the partnership and the partners (even prior-year partners) before the IRS.

Because of this power of the PR to present and bind the partners, it is imperative that the partnership agreement address the duties, responsibilities, and limitations on the powers of the PR.


Under the new rules, the IRS will examine the partnership return, and if an assessment results, the partnership itself will be responsible for any adjustments, which may be in the current year (adjustment year) or a prior year (reviewed year). Under prior law, partnerships were not required to pay tax at the partnership level. This is a huge difference, because if a partner took an aggressive deduction in a reviewed year, but then leaves the partnership before the adjustment year, he will not have to pay his share of the assessment because it will be paid from the partnership, and therefore the current partners will pay. That is one reason why the Partnership Agreement should be amended, to allow a recovery from the reviewed year Partner.

With some exceptions, the tax rate imposed on the additional income (“imputed underpayment”) is the highest individual tax rate (currently 37%).

The law provides three ways to avoid the application of the new rules.

1. The “Opt Out” (Section 6221). This is a true opt out to have audits performed at the individual partner level, but is limited to partnerships with 100 or fewer partners who are individuals, corporations (including Sub Chapter “S” Corporations) and estates of deceased partners. This leaves out trusts, even grantor trusts. The opt out election is made annually on the partnership tax return for the year it wishes to opt out, and the name and taxpayer ID number of each partner must be provided to the IRS. Each partner must be given notice of the election. If an S Corporation is a partner, the names and taxpayer ID numbers of each shareholder must also be provided. Be aware that even partnerships opting out must still appoint a PR.

2. The “Push Out” (Section 6226). If the partnership does not meet the requirements to opt out it can elect to “push” the assessment liability out to the partners. In this case, the partnership sends each partner an adjusted information return showing his share of the audit adjustment, and the partnership does not pay.

The election must be made within 45 days of receipt of the final audit adjustment from the IRS. If the election is made, the partner will report the income and pay the adjustment through a simplified, amended return. The Regulations permit the partner to elect to calculate the tax as though the adjustment had been made in the reviewed year. There is a “safe harbor” calculation rule, but it does not permit this election.

The adjusted income information is sent to the partners in the reviewed year, even though they may not still be partners in the adjustment year. This prevents new partners from being liable for an adjustment related to a year in which they were not a partner. If the push-out election is made, interest on the underpayment will be calculated at a rate that is 2% higher than if the partnership paid the tax. The rules can get very complicated if there are tiered partnership structures.

3. Section 6225 Reporting. If all the partners agree to file amended returns for the audit year, §6225 will relieve the partnership from having to pay the assessment. If the tax rates of some partners are lower than others, the lower-rate partners will benefit from this election. There must be a provision in the partnership agreement whereby the partners agree to make this election.


The PR replaces the Tax Matters Partner (TMP). Under prior law, the TMP was only relevant in certain types of partnership audit proceedings, and individual partners had the right to participate in those proceedings. The authority of the TMP was quite limited, and not much attention was paid to naming the TMP when drafting partnership or LLC agreements.

The new rules represent a complete change. Section 6223 provides that the PR has complete authority to act on behalf of and bind the partnership (and effectively, the partners) in dealing with the IRS, including audits and other proceedings, which includes settlement authority and procedural matters, such as whether or not to litigate with the IRS or agree to extend the statute of limitations.

The PR has authority to make the “Push Out” election on behalf of the partnership. There is no legal requirement in the tax law that the PR involve the partners in the proceedings or even give them status reports. If the partners do not designate a PR, the IRS will designate one for the partnership.

For these reasons it is important that these issues be addressed in the partnership agreement. The Agreement should appoint the PR and address his duties to the partners. It should address whether to elect “opt out” or “push out” and who will make the decisions. It should require the PR to consult with the partners, or at least with management, before taking action or making agreements with the IRS. It should address contribution from former partners to partners where the partnership pays the assessment.

Generally, the partnership will want to require the Opt Out, or if that is not available, the Push-Out, unless a majority or more of the partners decides not to.

The election should not be left to the PR if he is a partner because he may have conflicting interests. For example, if he had a greater ownership percentage in the reviewed year than the adjustment year, he might prefer not to make the election so the new partners will bear some of the liability. A partnership that elects opt out may also want to prevent transfer to non-eligible partners to avoid losing the opt out option.


Since adjustment year partners may effectively be assessed with tax resulting to a prior year
under audit, purchasers of partnership interests will need to review the partnership agreement carefully and include appropriate language in the partnership agreement or purchase agreement. Remedies could include indemnification for breach of tax warranties, an agreement that the Section 6226 elective will be made, or that there will be recourse against reviewed-year partners who have since left the partnership.

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As you can see, the new audit rules create a lot of problems for partnerships and partners, but makes auditing partnerships much easier for the IRS. Therefore, one might expect to see more partnership audits in the future.

In the meantime, partnership and LLC owners should review and revise their partnership and LLC operating agreements right away to address these issues.

By R. David Marchetti

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