AMC 2017 Session 8 Track C Partnership and Operating Agreements Must Change: The Impact of the New IRS Partnership Audit Rules

Transcription

1 ` AMC 2017 Session 8 Track C Partnership and Operating Agreements Must Change: The Impact of the New IRS Partnership Audit Rules Alison E. Helland, Murphy Desmond S.C., Madison Robert A. Mathers, von Briesen & Roper S.C., Oshkosh Thomas J. Phillips, Quarles & Brady LLP, Milwaukee Robert B. Teuber, von Briesen & Roper S.C., Milwaukee

2 About the Presenters... Alison E. Helland is an attorney at Murphy Desmond S.C. in Madison, Wisconsin. Alison received her J.D. from the University of Iowa College of Law in 2005, and her LLM in Taxation from Northwestern University School of Law in Alison s practice focuses on assisting clients with federal and state tax issues, business entity formation, contracts and negotiations, business sales and acquisitions, nonqualified deferred compensation plans, succession planning and estate planning. She is the past Chair of the Taxation Section, a member of the Taxation Section Board, and a member of the State Bar Legislative Oversight Committee. Alison speaks Spanish fluently, and volunteers her time with a number of community organizations teaching courses in English and Spanish on topics ranging from business tax reporting requirements to tax planning and basic bookkeeping. Alison was named an "Up and Coming Lawyer" by the Wisconsin Law Journal in Bob Mathers is a Shareholder with von Briesen & Roper, s.c. He provides legal and business advisory services to businesses and their owners with a focus on closely-held businesses, estate planning and private wealth services. He is a Certified Public Accountant and is AICPA Accredited in Business Valuation (ABV) and is an AICPA Personal Financial Specialist (PFS). He leverages his prior experience as one of the country s largest CPA firm s National Tax Director, and CEO of its Wealth Management subsidiary, to provide tax and transactional guidance to clients. He is recognized in The Best Lawyers in America in Trusts and Estates. Bob s professional memberships include American Institute of Certified Public Accountants (Tax Practice Responsibilities Committee), Wisconsin Institute of Certified Public Accountants, American Academy of Attorney-CPAs, Fox Valley Estate Planning Council, Winnebagoland Estate Planning Council, the Winnebago County Bar Association, the State Bar of Wisconsin (Director, Tax Section) and the American Bar Association (Tax Section). Bob serves on the Board of Trustees for Mercy Medical Foundation, Inc. He is a member of the Oshkosh Area Community Foundation Investment Board, Oshkosh Chamber of Commerce, Oshkosh Area Community Pantry, and FaB Wisconsin. Thomas J. Phillips, Retired Partner, Quarles & Brady LLP, Milwaukee. Robert B. Teuber is a tax attorney with von Briesen & Roper s.c., whose practice focuses on tax disputes and controversies. He works with clients across the United States to resolve IRS tax audits, Tax Court litigation, federal tax collection matters, and foreign account disclosures. He also serves clients in dealing with the Wisconsin Department of Revenue and local tax authorities to address sales, employment, income and property tax disputes. Rob regularly writes and speaks about the procedures available in addressing tax problems. He currently serves as chair of the State Bar CLE Committee, the chair-elect of the Taxation Section Board of Directors and on the State Bar Finance Committee. Rob has also sat on the board of directors and executive committees of various non-profit organizations in the Milwaukee area.

3 Partnership and Operating Agreements Must Change: The impact of the new IRS partnership audit rules Thomas J. Phillips, Phillips Tax Law Associates, LLC Robert A. Mathers, JD, CPA, von Briesen & Roper, s.c. Alison E. Helland, Murphy Desmond S.C. Robert B. Teuber, von Briesen & Roper, s.c. State Bar of Wisconsin Taxation Section 2017 Annual Meeting & Conference Why care about the new rules? The new audit rules govern how partnerships are audited and the related tax liabilities are paid. Yet, the framework of the new rules also impacts: All Partnership agreements Multi-member LLC operating agreements Who can/should be a partner or member Who will pay the tax when the audit is over THE CURRENT AUDIT REGIME 1

4 The Big Picture A multi-member LLC is taxed as a partnership unless a specific election is made to be taxed as a C or S Corporation. Partnerships are pass-through entities. Currently, when a partnership is audited, the tax impact of the audit adjustments passes through to the partners of the partnership in the year that is audited. There are currently 3 different procedures for auditing partnerships or their partners: Small Partnership Audits at the partner level (pursuant to IRC 6231(a)(1)(B)(i)) for partnerships with 10 or fewer partners, each of whom falls into one of the following categories: Individuals (excluding resident aliens) C corporations Estates of deceased partners The centralized partnership regime enacted as part of the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) (IRC ) The reporting and audit procedures for electing large partnerships (IRC , , and 6255) AUDITS OF SMALL PARTNERSHIPS Each partner is examined separately Partners sometimes take inconsistent positions IRS enters into separate settlement agreements with each partner, frequently for different amounts 2

5 AUDITS UNDER TEFRA AUDITS UNDER TEFRA Bifurcated proceedings (partnership-level and partner-level) Certain Partnership Items are calculated at the partnership level and allocated to partners in accordance with their interest in the partnership: Income, gain, loss, deduction and credits Section 754 election adjustments Section 183 intent to engage in an activity for purposes of making a profit (as opposed to a hobby) AUDITS UNDER TEFRA (cont.) Step 1: Adjudication of Partnership Items Starts with a Notice of Beginning of Administrative Proceeding (NBAP) Ends with a Final Partnership Administrative Adjustment (FPAA) The Tax Matters Partner (TMP) for the partnership represents the partnership during this process, and has the authority to bind the partnership to any agreed upon FPAA 3

6 AUDITS UNDER TEFRA (cont.) Step 2: Adjudication of Partner-Level Items Partnership-level adjustments will result in changes to items on the returns of the individual partners ( Affected Items ) Because affected items are contingent on partnership items, any partner-level litigation involving them must wait until the resolution of the partnership proceeding Affected Items fall into two categories: Computational Affected Items, which can be determined mathematically (ex: a partner s deduction for medical expenses) Factual Affected Items, which require further determinations at the partner level (ex: a partner s basis or whether a partner is at-risk for purposes of IRC 465) Foundation for Comparison to New Rules Under the current (TEFRA) audit regime for partnerships: A partnership is treated as an aggregate of its partners rather than an entity of its own The partnership is audited, but the partners returns are also adjusted and the partners generally pay the tax The individual partners have rights to information and recourse to administrative and judicial challenges This is about to change... Robert A. Mathers, JD, CPA New Rules: The Basics for the Corporate Attorney 4

7 Basics of the 2015 New Rules that Influence Provisions of the Partnership Agreements and Operating Agreements Partnership/LLC audits conducted, adjusted, determined and assessed and collected at the entity level (IRC 6221). Partnership representative controls entire audit process, decision to settle, litigate, etc. Certain Entities are eligible to elect out of the new audit regime (IRC 6221(b)). Basics of the 2015 New Rules that Influence Provisions of the Partnership Agreements and Operating Agreements (Cont.) Imputed Underpayment can be adjusted for member tax attributes (IRC 6225(c)). Entity pays the deficiency (which is now know as the Imputed Underpayment ) (IRC 6225). Entity may opt to pass-through an adjustment to member (IRC 6226). Basics of the 2015 New Rules that Influence Provisions of the Partnership Agreements and Operating Agreements (Cont.) Proposed regulations were issued but required to be withdrawn (Executive Order). If Entity ceases to exist, former members are liable ( 708(b)(1)). Introduced technical corrections legislation 5

8 Alison Helland New Rules: Procedural Rules for the Corporate Attorney Procedural Implications of the Partnership Representative Role Partnership/multi-member LLC operating agreements should incorporate provisions regarding: Appointment and removal of the Partnership Representative Liability of the Partnership Representative to other partners for decisions he/she makes Possible indemnification of the Partnership Representative for certain decisions he/she makes Partnerships/multi-member LLCs should re-assess their liability insurance needs Is a director and officer insurance policy in place? If so, does it cover activities of the Partnership Representative Procedural Implications of the Partnership Representative Role Approval procedures should be put into place regarding adoption of tax positions (ex: the election to opt out of the rules, push out adjustment, or request an adjustment to an Imputed Underpayment) Will an internal procedure be established to approve any positions to be taken by the Partnership Representative? Will approval of a tax position require unanimous approval of the partners/members? If unanimous approval cannot be obtained, what will happen? Procedures should be put into place regarding liability for partners/members joining after the year(s) under audit Will the prior partner/member indemnify the new partner/member for any liability passed through to him or her as a result of an audit? 6

9 Procedural Implications of the Partnership Representative Role Offering/sale materials may need to contain additional disclosures, and alert purchasers to the provisions of the operating agreement addressing the adoption of tax positions, and potential tax liability related to prior tax years Robert A. Mathers, JD, CPA Drill Down #1: Push Out Election & Tax Rates IMPUTED UNDERPAYMENTS The partnership pays any imputed underpayment with respect to an adjustment of any partnership items in the adjustment year (IRC 6225(a)(1)) This differs from the current rules, where adjustments to partnership items flow through to the individual partners For purposes of this provision, the adjustment year means: In the case of an adjustment pursuant a court decision relating to a proceeding under IRC 6234, the year in which the decision becomes final In the case of an administrative adjustment request under IRC 6227, the year in which such request is made In any other case, the year in which the notice of final partnership adjustment is mailed 7

10 CALCULATING IMPUTED UNDERPAYMENTS Imputed underpayments for a given year are determined by netting all adjustments of items of income, gain, loss or deduction, and multiplying the net amount by the highest rate of tax in effect under IRC 1 and 11 for the reviewed year under IRC 6225(b)(1)(A)) Any net increase or decrease in loss is treated as a decrease or increase in income, respectively (IRC 6225(b)(1)(B)) Any adjustments to items of credit are taken into account as an increase or decrease in the amount of imputed underpayment (IRC 6225(b)(1)(C)) This process can be modified under certain circumstances (IRC 6225(c)(1)) CALCULATING OTHER ADJUSTMENTS Any adjustment that does not result in an imputed underpayment, and is not a credit, is taken into account by the partnership in the adjustment year as a reduction in non-separately stated income, or as an increase in non-separately stated loss item Any adjustment that is a credit is taken into account as a separately stated item (IRC 6225(a)(2)) THE PUSH OUT ELECTION ALTERNATIVE If, within 45 days of the notice of final partnership adjustment, the partnership elects to furnish amended Schedules K-1 to each of its partners showing that partner s share of any adjustment to income, gain, loss, deduction or credit, the partners will be responsible for taking these adjustments into account in calculating their taxable income (IRC 6226(a)) Each partner s tax for the adjustment year will be increased by the increase in tax that would result if the adjustments included in the amended Schedule K-1 were taken into account for the reviewed year (IRC 6226(b)(1)) 8

11 CALCULATING TAX AT THE PARTNER LEVEL Increases in tax from adjustments to tax attributes in other taxable years before the taxable year including the amended Schedule K-1 are taken into account in calculating the partner s tax liability (IRC 6226(b)(1)) Penalties, additions to tax and any additional amounts shall be determined at the partnership level, and the partners of the partnership of the reviewed year shall be liable for them (IRC 6221(a) and 6226(c)(1)) Interest is determined at the partner level from the due date of the return for the taxable year in which the increase is attributable (IRC 6226(c)(2)(A)-(B)) Interest is assessed at the underpayment rate under IRC 6221(a)(2), but by substituting 5 percentage points for 3 percentage points (IRC 6226(c)(2)(C)) Thomas Phillips Drill Down #2: Partnership Representative and Indemnification FUNCTION OF THE PARTNERSHIP REPRESENTATIVE Who can be a Partnership Representative? Anyone with substantial presence in the US (see IRC 6223(a)) it DOES NOT need to be a partner Remember: if you do not choose a Partnership Representative, the IRS will choose one for you What does the Partnership Representative need to do? Make sure the partnership takes all required actions under the partnership audit rules Take any actions that are permissible (but not required) under the new rules Serve as the main contact for receipt of (i) notices of any administrative proceedings initiated at the partnership level, (ii) notices of any proposed partnership adjustments resulting from those proceeding and (iii) notices of any final adjustments resulting from those proceedings 9

12 FUNCTION OF THE PARTNERSHIP REPRESENTATIVE (cont.) What else should a Partnership Representative do? Keep all of the partners updated on the status of any ongoing examination Facilitate discussions with legal counsel/the partnership s tax advisor regarding the status and validity of any proposed adjustments If it is not spelled out in the partnership/operating agreement, facilitate discussions amongst the partners regarding recoupment of any imputed underpayment amounts attributed to partners from prior years who are no longer members of the partnership FUNCTION OF THE PARTNERSHIP REPRESENTATIVE (cont.) What things can ONLY be done by the Partnership Representative? Elect out of the new partnership rules (if the partnership is eligible to do so) Inform IRS of the partnership s selected method for satisfying any imputed underpayments Represent the partnership in IRS proceedings/examinations File an AAR with the IRS Seek judicial review of examination adjustments Agree to extensions of limitations for IRS FUNCTION OF THE PARTNERSHIP REPRESENTATIVE (cont.) Issues to address in the partnership/operating agreement regarding the Partnership Representative: Who will be the initial Partnership Representative? How will the partners select successor Partnership Representatives? How can the partners get rid of a bad/negligent Partnership Representative? What does the Partnership Representative have unilateral authority to do? When must the Partnership Representative get the majority/unanimous approval of the partners prior to acting? How will the personal representative be held liable for failure to perform their duties? 10

13 PROVIDING FOR PAYMENT OF PARTNERSHIP EXAMINATION ADJUSTMENTS There are three methods of satisfying adjustments made at the partnership level: Having the partnership satisfy the adjustments (default rule) Having the partners to whom the adjustments relate amend their returns to decrease the partnership s imputed underpayment Pushing out all of the examination adjustments to the partners HAVING THE PARTNERSHIP SATISFY THE ADJUSTMENTS (DEFAULT RULE) Can be combined with the second method (having some partners amend their returns for adjustments attributable to them) If this method is used, the partnership/operating agreement should very specifically state what things are calculated at the partner level: Partnership income, gain, loss, deduction and credit Partners distributive shares of items adjusted at the partnership level Tax attributable to adjustments made at the partnership level (and adjustments related to any partner s distributive share) Applicability of penalties, additions to tax or additional adjustments at the partnership level HAVING THE PARTNERSHIP SATISFY THE ADJUSTMENTS (DEFAULT RULE) (cont.) Adjustments to items other than a credit that does not result in an imputed underpayment (treated as reductions in non-separately stated income or an increase in non-separately stated loss) Adjustments to items of credit that do not result in an imputed underpayment (treated as a separately stated item) 11

14 HAVING SOME OF THE PARTNERS AMEND THEIR RETURNS Under this method, not all partners are required to file amended returns for the reviewed year This method of satisfying any imputed underpayment does not take the form of an election by the partnership rather, the partnership/operating agreement must set forth the procedure for pursuing this alternative Since this method is set forth in the partnership/ operating agreement, is must be drafted carefully HAVING SOME OF THE PARTNERS AMEND THEIR RETURNS (cont.) The partnership/operating agreement for a partnership using this method should require one or more partners to do the following: File amended returns for the taxable year of the partners that includes the end of the reviewed year of the partnership, which include (i) all adjustments per the examination that are allocable to them, and (ii) all adjustments properly allocable to them for any other taxable year with respect to which any tax attribute is affected by reason of the adjustments) Pay any tax due as a result of these adjustments at the time they file their amended returns PUSHING OUT ALL OF THE EXAMINATION ADJUSTMENTS TO THE PARTNERS The partnership/operating agreement should set forth the matter and timing for pushing out examination adjustments to the partners Any adjustments must be pushed out to partners no later an 45 days after the date of the notice of final partnership adjustment (see IRC 6226(a)(1)) The partnership must provide to the IRS, and each partner in the partnership, a statement showing each partner s adjustments to income, gain, loss, deduction or credit If this option is selected by the partnership, ALL partners who were partners during the reviewed year will compute the change in tax to the reviewed year and will pay any additional tax due for the reviewed year in his/her return for the adjustment year 12

15 PUSHING OUT ALL OF THE EXAMINATION ADJUSTMENTS TO THE PARTNERS (cont.) The partnership/operating agreement should also set forth when this method is used, and how it will be selected Does the Partnership Representative have authority to select this method without first consulting the partners? Is this always going to be the method used to address imputed underpayments? If not, and if the Partnership Representative must get approval from the partners before selecting it, what is the process for getting that approval? What if the partners in the adjustment year are not the partners in the reviewed year? IDENTIFYING OPPORTUNITIES TO REDUCE PARTNER LEVEL TAX There are things that can be done at the partner level to reduce the amount of tax recognized on a partner s return, such as: Proving that a specific partnership adjustment pertains solely to a tax-exempt corporation or a C corporation Proving that a specific adjustment relates to an item that should be taxed a the capital gains rate Remind clients that, in order to request an adjustment to their partner-level liability, they must provide proof to the IRS within 270 days ELIGIBILITY TO ELECT INTO THE NEW RULES EARLY Partnerships may elect into the new regime for tax years beginning after November 2, 2015 (NOTE: If you elect into these rules for a certain year, you CANNOT later elect out of them/claim an exemption from them for that same year). There are two situations where a partnership is eligible to elect into the new regime early: The partnership has received a notice from the IRS that it is being selected for examination for an eligible taxable year; or The partnership has not received a notice of selection or examination, but wants to file an administrative adjustment request (AAR) 13

16 ELECTING EARLY: NOTICE OF SELECTION FOR EXAMINATION RECEIVED The Election must be filed with the IRS within 30 days of the date of the notice of selection (NOT the date it was received) Must be signed by the Tax Matters Partner or the individual having the authority to sign a partnership return for the taxable year under examination Must contain the following information regarding the Taxpayer Representative: Name Taxpayer Identification Number Address Daytime Phone Number Other information as required by IRS ELECTING EARLY: NOTICE OF SELECTION FOR EXAMINATION RECEIVED (cont.) The election is only good for the taxable year noted (a separate election should be filed for each year under examination) The partnership must make representations that: It is not insolvent/does not anticipate becoming insolvent before resolution of an adjustment for the partnership taxable year It has not filed/does not reasonably anticipate filing a petition for bankruptcy relief under Title 11 It is not subject to/does not reasonably anticipate becoming subject to an involuntary petition for bankruptcy relief under Title 11 It has sufficient assets/reasonably expects having sufficient assets, to pay potential imputed underpayment for the partnership taxable year at issue ELECTING EARLY: REQUEST FOR AAR Must be filed on or after January 1, 2018 for an eligible taxable year ( eligible taxable year typically means any partnership taxable year beginning after November 2, 2015 and before January 1, 2018 A partnership taxable year is NOT an eligible taxable year if any of the following occurred: The Tax Matters Partner has filed an AAR under TEFRA The partnership files an AAR request prior to January 1, 2018 An amended return of partnership income of a partnership not subject to TEFRA has been filed or deemed to be filed before January 1,

17 ELECTING EARLY: OTHER THINGS TO REMEMBER Once made, an early election into the rules is binding and may only be revoked with the consent of the IRS IRS will deny an election it believes was made to frustrate the purpose of the new partnership audit rules If you want the partnership to elect into the rules early, make sure to include language in the partnership/ operating agreement that sets forth: Whether the partnership will elect in early How the partnership will decide the years for which to make the election Who will sign the election Who will serve as the Partnership Representative Alison Helland Drill Down #3: Electing Out (a/k/a Opt Out ) of the New Rules and Types of Partners that Make Election Out impossible OPTING OUT OF THE NEW REGIME If a partnership opts out of the regime, any audit will be conducted at the partner level Under IRC 6221(b), a partnership may opt out of the new regime if: 1. The partnership elects to have IRC 6221(b) apply for the taxable year in which it opts out 2. The partnership is required to furnish 100 or fewer Schedules K-1 NOTE: The number of Schedules K-1 that an S corporation partner distributes to its shareholders is included in making this determination 15

18 OPTING OUT OF THE NEW REGIME (cont.) 3. Each of the partners falls into one of the following categories: Individuals C corporations Foreign entities that would be treated as a C corporation if they were domestic S corporations Estates of deceased partners NOTE: An S corporation may only be an eligible partner if it provides the IRS with the name and TIN of each of its shareholders for the taxable year 4. The election is made with a timely filed return, and includes the name and TIN of each partner 5. The partnership notifies each partner of the election ELECTING OUT OF THE NEW RULES Qualify for the small partnership exception (election must be made separately for each taxable year) Make sure that the partners in the partnership consist of the following: individuals, C corporations, foreign entities that would be treated as domestic C corporations, S corporations and estates of deceased partners Make sure that the number of Forms K-1 issued during the taxable year is 100 or less, counted by doing the following: Looking through each S corporation, and including each of the shareholders in the S corporation in the total Observing any rules issues with respect to ownership of foreign partners when including members of those foreign partners in the total To be cautious, if a partner in the partnership is a single member LLC owned by an individual, count both the LLC and the individual in the total ELECTING OUT OF THE NEW RULES (cont.) Manage the number of partners in the partnership to make sure the total number of Forms K-1 issued never exceeds 100 during any taxable year (NOTE: this can be a trap for the unwary in M&A situations) Include provisions in the partnership/operating agreement that discusses how a partnership will elect out of the new rules Automatically electing out of the new rules upon signing of the partnership/operating agreement Putting a procedure in place whereby the partners, by majority vote, can authorize the Partnership Representative to make the election Putting a procedure in place giving the Partnership Representative complete discretion over when to make the election 16

19 ELECTING OUT OF THE NEW RULES (cont.) Include provisions in the partnership/operating agreement that provide a roadmap to the Partnership Representative for electing out of the rules The election must be made each taxable year on a timely-filed return for that year The election must disclose the name and taxpayer identification number of each partner The Partnership Representative MUST make sure that ALL partners receive notice of this election Include provisions dictating when the Partnership Representative will be liable to the partners for failure to make an election, or making an election that was not in the best interests of the partnership Rob Teuber Wrap Up Contact Information Thomas J. Phillips Robert A. Mathers, JD, CPA Phillips Tax Law Associates, LLC von Briesen & Roper, s.c Tphillips368a@att.net Rmathers@vonbriesen.com Alison E. Helland Robert B. Teuber Murphy Desmond S.C. von Briesen & Roper s.c ahelland@murphydesmond.com rteuber@vonbriesen.com 17

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