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In an article published on Pensions & Investments on August 12, 2019, Ed Klees and Mark Berg, a partner with Feingold & Alpert LLP in New York, discuss a federal law that took effect in 2018 permitting the Internal Revenue Service to audit investment funds structured as limited partnerships, limited liability companies or other pass-through vehicles, and collect any subsequent underpayments of the investors’ income taxes from the fund itself.

As a result, the fund may pass along the bill to its investors, including tax-exempt investors who are not responsible for the tax. Additionally, if the fund is unable to secure reimbursement from a taxable investor for its share of the tax, tax-exempt investors could be required to pay instead.

“Why is this change significant for tax-exempt investors? Because once even a dollar of tax is collected from the fund itself as opposed to its investors, the economic burden of that tax, like that of any other expense of the fund, will be borne by all of those who are partners in the fund (including tax-exempt investors) in the year the audit is completed and the tax is paid, unless the fund's governing documents say otherwise.”

Ed and Mark offer some potential solutions in response to this change for tax-exempt investors to avoid bearing the tax liability of other investors in their fund. This includes the fund electing out of the new audit rules; the fund/partnership representative “pushing out” the liability to the prior-year’s partners; the fund/partnership representative asking the IRS to reduce the amount of tax to be paid by the fund; or establishing a side-by-side fund for tax-exempt investors. 

To read the full article, please click here.

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Kristen M. Chatterton

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