Bipartisan Budget Act of 2015 Requiring Critical Changes to Partnership and Operating Agreements

November of last year, the Bipartisan Budget Act of 2015 was signed into law, repealing the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) audit rules and changing the procedures for partnership audits. The new legislation renders many partnership and operating agreements obsolete, necessitating immediate revisions to ensure compliance and avoid exposure. Additionally, since many LLCs are taxed as partnerships, these new rules could affect a majority of small businesses.

The Bipartisan Budget Act (BBA) will now allow the IRS to collect taxes through audit procedures from the partnerships themselves, whereas under TEFRA the IRS had to pursue past due taxes from individual partners. This essentially places the burden on collection to the separate partners since the IRS collects from the partnership, leaving the partners to figure out each partners’ contribution to the past due amounts among themselves.

Obviously, if current partnerships and multimember LLCs taxed as partnerships are not proactive in reviewing past financial decisions and revising their partnership and operating agreements to account for the changes brought about by BBA, significant infighting and potential litigation may ensue for partners in disagreement as to appropriate contributions by individual partners as a result of a partnership audit.

The BBA also requires that partnerships must make audit adjustments in the year that the audit or judicial review is completed and not in the year in which the adjustment relates. The consequence to new partners is that they are now responsible for tax adjustments that relate to a review year when they were not partners. In other words, incoming partners should carefully negotiate partnership and operating agreements when joining partnership entities and LLCs taxed as partnerships so as to seek indemnification and avoid undue audit exposure.

Not only should new agreements be carefully scrutinized by incoming partners, but existing partnerships and LLCs taxed as partnerships need to revise current agreements to account for the changes made by the BBA that may have rendered provisions in current agreements obsolete. For instance, does the partnership or operating agreement contractually limit the authority of the partnership representative when the BBA provides the partnership representative broad powers?

Several other provisions of the BBA create such significant changes to tax elections and other decisions by company representatives that partnerships and LLCs taxed as partnerships will need current agreements reviewed and likely redrafted to ensure compliance and to protect the partners or members from any undue exposure or litigation. Not only should the partnership representative have an expanded role contractually to align with the broad powers granted under the BBA, but considerations should be made regarding opting out of partnership-level taxation, allocation of tax liability to prior-year partners and flexible effective date.

If you are involved in a partnership or an LLC taxed as a partnership, feel free to contact our offices to set up an appointment to discuss the impact of the BBA in greater detail and the need to revise your current agreement.

Are you looking for legal advice regarding your business?  Feel free to call us 816-561-5000 or send us a message through the form below.

*This post was originally published on March 31, 2016