Finance Tips,Legal Tips

FAQ: Easing confusion on how the new tax law affects LLCs

Taxes can be downright frightening. Unless you’re an accounting whiz or tax lawyer, things can be extremely confusing. And when tax law changes, it gets even murkier. So how do we keep the IRS from knocking on our doors?

We tried to get to the bottom of that during our webinar with Erica Opitz, a senior associate at Chamberlain Hrdlicka in Atlanta. You can watch the full webinar, where Opitz delves into the Xs and Os of the new tax law and how it affects LLCs, here.

For now, let’s try to answer the most common questions you likely have. We might even debunk a few myths that have been floating around:

What’s the simplest way to explain the new tax law?

According to Opitz, it’s not too complicated: At the end of the day, the new tax law doesn’t actually affect *how* LLCs or partnerships are taxed. It just changes how they are audited (or what happens if one of their members is audited).

Is this the case for all LLCs?

No! Here’s the good news: The new law only applies to LLCs that have 100 or more partners, or LLCs that have multiple levels of partnerships. For example, if you have an investor that is an LLC, S-Corp, C-Corp, etc. , that would qualify as “multiple levels of partnership.”

Just make sure that if you *are* excluded from this law – if your LLC has fewer than 100 members – make sure that all partners are selecting the “opt-out” box on their tax returns. If you’re working with a CPA, make sure he or she checks this “opt-out” box when it comes time to file your tax returns.

So what happens if an LLC is audited under this new law?

This is where things could get sticky. The new tax law has a provision that allows the IRS to assess any individual partner’s underpayment of taxes against the LLC itself.

Let’s look at an example scenario from Opitz:

“If you’ve got an LLC that Ann, Bob and Carl started three years ago, and they’ve been filing tax returns for the past three years,” Opitz said, “Bob leaves the partnership in Year 4. In year 5, the partnership or Bob himself ends up getting audited, and it turns out Bob underpaid his taxes from his partnership income in Year 2. Well, Bob’s not part of the partnership anymore, so Ann and Carl are having to deal with the audit that’s all related to Bob’s underpayment of tax.”

Yikes. So an LLC could conceivably pay for a former partner’s mess-up on his or her taxes?

Yep. The LLC would be responsible for any penalties or fees the IRS charges in relation to the audit of the former employee.

So how does one protect their LLC from employees who don’t pay their share of taxes?

It all comes down to the operating agreement. Thanks to this new law, it’s crucial that there are provisions in the LLC’s operating agreement that assign the responsibility of tax underpayment to the individual partners – not the entire entity.

According to Opitz, there can even be a provision for this kind of situation, where the LLC would actually pay what is owed to the IRS, but the individual partner who underpaid in the first place must pay the partnership back within a certain time period. If they don’t, an interest fee can be applied.

Let’s look back at the example of the LLC Opitz mentioned before:

“There’s usually a provision that says, ‘If the partnership ends up paying for this, we’re going to allocate the deficiency of what we’re going to pay the IRS among the people who caused this basically,’” Opitz said. “If Ann and Carl did everything perfectly, but Bob didn’t pay his, the whole deficiency would be allocated to Bob, and he would have the responsibility to pay that.”

What about single-member LLCs?

Lucky for you: This part of the new tax law doesn’t affect you. But again: Make sure to opt out on your tax return.

If you’re looking for some help on setting up your LLC’s operating agreement, or want to learn more about Erica, check out her WMN/WRK profile here. If you’re looking to learn more about operating agreements specifically, click here.