New BBA audit rules may affect choice of tax treatment for LLCs
You will remember that difficult discussion with your small business attorney about how you wanted your limited liability company to be treated for purposes of taxation. If you do nothing, then your multi-member LLC is taxed as a partnership. And in this article, when we refer to a “partner” or a “partnership,” we are generally referring to a member in a LLC that is taxed as a partnership.
If you want to be taxed as a corporation, you need to file an election. This article highlights the new audit rules and whether you may want to consider making changes to your multi-member LLC.
Related article: Choice of Entity Considerations
In November 2015, congress enacted new rules for IRS audits of entities taxable as partnerships, including your multi-member LLC. These new rules are part of the Bipartisan Budget Act of 2015 and the new rules are often referred to as the BBA rules.
The BBA rules not only apply to large investment partnerships at which they were targeted, but also your multi-member LLC taxed as a partnership. The BBA rules are extremely technical and all members of multi-member LLCs should be in contact with their tax advisers to navigate the new rules.
We don’t provide tax guidance, but we can highlight some of those parts of the audit rules that may be the most difficult to navigate.
Related article: Starting a LLC: Tax as a Corporation or Partnership
If you can’t opt out of the new rules, then the LLC itself is subject to audit, not the individual partners. Imputed underpayments of federal income taxes resulting from BBA audits are assessed at the partnership level.
The LLC must designate the member or manager of the LLC responsible to handle a BBA audit. And if you are a member, but not designated, then you can’t participate in the audit. Nevertheless, you are bound by the audit.
Pull-ins and push-outs
At this point, you probably have figured out that tax guidance is probably a good thing. If the audit shows an underpayment, the members may pay their shares by filing amended tax returns, and the operating agreement may require partners to make these payments. Under the push-out provisions, which apparently are not very clear, in general a partnership agreement may push out audit liabilities on a pro rata basis to the person who were partners in the reviewed year.
BBA audit rules
If you are subject to BBA audit rules and cannot escape these rules as discussed below, then you will have to find a suitable LLC representative and to incorporate in your operating agreement rules that are appropriate for those LLC subject to BBA audit rules. It is not possible to gauge the audit risk for a small multi-member limited liability company, but it is nevertheless important to take into account.
Electing partnerships may opt out
So the idea is that you generally want to avoid a BBA audit. If you qualify as an “electing partnership” you don’t have to subject yourself to a BBA audit. You can opt out if you don’t have more than 100 members and are in a category of eligible partners, such as corporations or individuals.
But if one of your members is a revocable trust, then you can’t opt out. And probably the most important exclusion is single member LLCs classified as disregarded entities. Consequently, if one of your members is a single member LLC, then your LLC cannot be an “electing partnership.”
Options to consider to avoid a BBA audit
If you can qualify as an electing partnership, then you can opt out. If you do not currently qualify and still want to opt out, you may have some options:
- • You may want to think about s corp tax treatment for the LLC. A LLC taxed as a s corporation is not subject to the BBA rules
- • If other members of the LLC are disregarded entities, those members may want to assign their interests to the individuals owning the LLCs.