Two recent acts of Congress (including the rather interestingly named Protection of Americans from Tax Hikes Act) created new audit rules for partnerships.  Normally one would not think that a change to "audit rules" would impact estate planning.  However, many estates have LLCs taxed as partnerships, or even limited partnerships or limited liability partnerships, which are used as family limited partnerships in order to obtain valuation discounts through lack of control and lack of marketability (provided that all of the proper procedures and documentation is followed).  Moreover, many estates have revocable trusts that own limited liability companies, which is a common way to avoid the often lengthy process of probate for business assets.  Again, these techniques are quite common.

So what are the new audit rules, and how do they impact estate planning?  Briefly, starting in 2018 the new audit rules allow for a partnership level determination of deficiencies if the partnership is audited as the default regime.  The problem with this determination is that if there are different partners currently than the year under audit, then the current partners could end up being liable for the past deficiency.  There also can be issues with allocation, since the IRS won't undo erroneous allocation and will simply assess the net increase against the partnership.  Another problem is that this deficiency will be assessed at the highest tax rates.  The tax matters partner is no longer, and instead there is a partnership representative who does not even need to be a partner.  It will be important to select a partnership representative since the IRS gets to choose the representative if one is not selected.  Due to the possible negative consequences of the new laws, many partnerships will want to opt out (which will keep determinations at the partner level).  The issue is whether trustees that own partnership interests on behalf of trusts will be able to opt out.

The new audit rules allow opting out if there are less than 100 K-1s, and the "each of the partners of such partnership is an individual, a C corporation, any foreign entity that would be treated as a C corporation were it domestic, an S corporation[note that there are some additional rules for S Corps], or an estate of a deceased partner."  Unfortunately the new code section does not mention trusts or trustees at all, so it is currently unclear as to whether partnership that have trusts as owners will be able to opt out.  I recently attended a tax conference, and the IRS representative on a panel there informally stated that there would likely be regulations regarding grantor trusts and the ability to opt out (the new audit rules do allow the IRS to prescribe similar rules for other partners not listed in the new code section).

What to do now?  For partnerships, family limited partnerships, limited partnerships, limited liability partnerships (and limited liability limited partnerships), as well as LLCs taxed as partnerships, that are currently being formed, it would be prudent to include some of the language from the new code in partnership and operating agreements in order to insure later that the entity is in compliance, in case the partners do not return to amend the agreements.  For existing partnerships, it makes more sense to wait to amend as more regulations are promulgated by the IRS.  Extra caution should be taken regarding trusts (particularly non-grantor trusts) as owners, since it is unclear how or if partnerships with trustee owners will be able to opt out.

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