How the New Audit Rules Will Impact Estate Planning
Future changes to partnership audit rules will impact estate planning. Typically, one would not assume these changes would impact estate planning but they do, considering many estates have LLCs taxed as partnerships to obtain valuation discounts. Entities taxed as partnerships will need to update their operating agreements so they:
- reflect the new rules,
- appoint a partnership representative and define their authority, and
- determine whether to elect out of the unified audit rules.
Effective January 1, 2018 both existing and new partnerships will be subject to new partnership audit rules. The new rules allow for partnership level determination of deficiencies if the partnership is audited as the default regime. There are several potential problems to consider:
- Current partners could be liable for past deficiencies if there were different partners during the year under audit.
- Allocation issues may arise since the IRS will not undo errors; rather, they will assess the net increase against the partnership.
- The deficiency will be assessed at the highest tax rate.
In addition, under the new rule, the tax matters partner (the partner that represents the partnership before the IRS in all tax matters) no longer exists. Under the new rule, the partnership representative does not even need to be a partner. A potential problem to consider:
- Electing a representative should be a high priority as the IRS can select one if one is not appointed.
These potential problems may motivate partnerships to opt out, keeping determinations at the partner level. If so, the question will be whether trustees that own partnership interests on behalf of trusts will have the capability to opt out. Under the new audit rules, opting out is allowed only if:
- there are less than 100 K-1s and
- the partner of the pass-through entity reveals the identity of its members. This is so that the master partnership can confirm that the pass-through entity has 100 or fewer direct and indirect partners who are US individuals, C corporations or foreign entities that would be treated as C corporations if they were US entities.
At this time, it is uncertain whether partnerships that have trusts as owners will be able to opt out as
the new code section does not address trusts or trustees.
Entities taxed as partnerships should ensure compliance by including portions of the new code in partnership and operating agreements. This will be especially important should a scenario arise where the partners do not return to amend the agreements.
Regarding existing partnerships, waiting to make modifications is best as the IRS will likely issue more regulations. For now, remain cautious regarding trusts as owners since it is uncertain whether they can opt out.
The professionals in our office can answer any questions you may have about the new audit rules. Call us today.