entity

DOES YOUR PARTNERSHIP OR LLC AGREEMENT NEED TO BE AMENDED BY DECEMBER 31, 2017?

by Harold F. Ingersoll, CPA/ABV/CFF, CVA, CM&AA

Partner at Atchley & Associates, LLP

 

Partnerships and many LLCs file partnership income tax returns.  As a result of the Bipartisan Budget Act of 2015 (“BBA”), the IRS has new audit rules for entities that file partnership income tax returns beginning January 1, 2018.  These audit rules significantly change the regime that currently governs partnership tax audits, assessments and collections.

The condensed version of the changes is, in the past when a partnership was audited, the IRS pushed the adjustments through to the partners of the partnership who were partners in the year under audit.  The new rules allow the IRS to charge the tax, due to audit adjustments, directly to the partnership and the current partners.

Your first thought may be, why could this be a problem?  Well, let’s assume you bought into a partnership in 2017, and shortly thereafter the partnership is audited by the IRS for 2015 and there is an adjustment that causes there to be more taxes paid.  Under the new rules you would likely be paying the tax for the partners that were owners in 2015.

To solve this problem, you can make changes to your partnership or LLC member agreement.  Partnerships with 100 or fewer partners that meet certain other requirements may be eligible to elect to opt out of these rules.  For partnerships or LLCs that qualify for this “opt out”, the partnership agreements could be modified to make the “opt out” mandatory.

Another change with the BBA is the term of “Tax Matters Partner” is eliminated.  The new term is “Partnership Representative”.  The partnership or LLC agreement could be changed to reflect how the Partnership Representative will be selected, removed or replaced.  You may also consider limiting the Partnership Representative’s authority over certain tax matters, such as extending a statute of limitations or settling the dispute.

There is also a new election labeled the “Push Out Election”.  As it sounds this allows the partnership or LLC to push out any audit adjustments to prior year partners.  This election is not automatic and must be elected within 45 days of receiving the final notice of partnership adjustment.  The requirement to make this election can be documented in the partnership or LLC agreement.

The IRS has put us on notice that we can expect to see more partnership and LLC audits than in the past.  Consulting your advisors about the issues raised in the BBA will leave you prepared for any audit in which your partnership may be involved.

 

 

 

How entity type affects tax planning for owner-employees

Come tax time, owner-employees face a variety of distinctive tax planning challenges, depending on whether their business is structured as a partnership, limited liability company (LLC) or corporation. Whether you’re thinking about your 2016 filing or planning for 2017, it’s important to be aware of the challenges that apply to your particular situation.

Partnerships and LLCs

If you’re a partner in a partnership or a member of an LLC that has elected to be disregarded or treated as a partnership, the entity’s income flows through to you (as does its deductions). And this income likely will be subject to self-employment taxes — even if the income isn’t actually distributed to you. This means your employment tax liability typically doubles, because you must pay both the employee and employer portions of these taxes.

The employer portion of self-employment taxes paid (6.2% for Social Security tax and 1.45% for Medicare tax) is deductible above the line. Above-the-line deductions are particularly valuable because they reduce your adjusted gross income and modified adjusted gross income, which are the triggers for certain additional taxes and phaseouts of many tax breaks.

But flow-through income may not be subject to self-employment taxes if you’re a limited partner or the LLC member equivalent. And be aware that flow-through income might be subject to the additional 0.9% Medicare tax on earned income or the 3.8% net investment income tax (NIIT), depending on the situation.

S and C corporations

For S corporations, even though the entity’s income flows through to you for income tax purposes, only income you receive as salary is subject to employment taxes and, if applicable, the 0.9% Medicare tax. Keeping your salary relatively — but not unreasonably — low and increasing your distributions of company income (which generally isn’t taxed at the corporate level or subject to employment taxes) can reduce these taxes. The 3.8% NIIT may also apply.

In the case of C corporations, the entity’s income is taxed at the corporate level and only income you receive as salary is subject to employment taxes, and, if applicable, the 0.9% Medicare tax. Nevertheless, if the overall tax paid by both the corporation and you would be less, you may prefer to take more income as salary (which is deductible at the corporate level) as opposed to dividends (which aren’t deductible at the corporate level, are taxed at the shareholder level and could be subject to the 3.8% NIIT).

Whether your entity is an S or a C corporation, tread carefully, however. The IRS remains on the lookout for misclassification of corporate payments to shareholder-employees. The penalties and additional tax liability can be costly.

As you can see, tax planning is extra important for owner-employees. Plus, tax law changes proposed by the President-elect and the Republican majority in Congress could affect tax treatment of your income in 2017. Please contact us for help identifying the ideal strategies for your situation.

© 2016