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The Treasury department republished Proposed Treasury Regulations stating that as of January 1, 2018, partners may find themselves liable for unpaid tax of former partners. How can a foreign institutional investor conduct adequate due diligence to protect themselves?

We are interested in entering into a general partnership with a hospitality company concentrated on the U.S. east coast. I heard about the new partnership audit rules and want to make sure we protect ourselves from entering into a deal where we have to pay tax because of the fault of former partner(s).

  • Greenberg Traurig, LLP
    February 09, 2018

    This new regulation requires even more extensive due diligence and careful representation, warranties and indemnities from your partner regarding tax liabilities. However, this regulation mostly applies to circumstances of your buying into an existing partnership where the partners have not discharged their tax obligations, and the IRS would have the right to go after the partnership itself and, derivatively, the incoming partner. If you are forming a new venture, properly structured, I would expect that this potential liability can be greatly mitigated. You should get high-level tax advice on all of this from both a qualified CPA firm and law firm. Note that I am not a tax lawyer, but a real estate lawyer, and my knowledge of tax issues are more anecdotal and not based upon the kind of expertise you need in this area, so be sure to engage proper professionals in any transaction early on.

  • WenWinSolutions
    January 13, 2018

    This is not something that can be answered via a public forum. You should retain the services of an attorney who specializes in these legal matters or hire a consultant to handle the due diligence process for you. I’ll be happy to discuss my services with you if you’re interested to pursue further. All the best!

  • Triangle Accounting Group, Inc, USA
    January 14, 2018

    By having a strong solid purchase agreement and a complete partnership agreement, prior liability can be avoided.

  • Horizon Realty Group
    January 15, 2018

    Requesting an advance third-party external audit with representatives (possibly the chief audit executives) of both companies present can provide mutually verifiable confirmations of tax status as part of the due diligence process. Due to new laws, this audit procedure is becoming more commonly used in an audit of financial statements to verify. Additionally, partnerships that desire to comply with the economic uncertainties caused by the new audit regime should immediately modify their existing partnership and operating agreements, so that these documents are consistent with the new law.

  • Eric Zhang & Associates LLP
    January 16, 2018

    As a foreign partner in a general partnership, the partner should be withheld income tax by the partnership. The partnership will provide 8804 and 8805 forms to the foreign partner each year to show details of withholding taxes.

  • Beijing Dacheng (Guangzhou) Law Firm
    January 15, 2018

    In order to protect the foreign institutional investor from being liable for unpaid tax of former partners, we understand that the foreign institutional investor shall conduct detailed due diligence on the target enterprise covering the following aspects: (1) the duly registration as a taxpayer of the target enterprise; (2) the financial rules of the target enterprise; (3) the tax categories involved in the business of the target enterprise; (4) the tax payment by the target enterprise, especially the tax payment regarding the related-party transactions; and (5) the tax dispute or the tax punishment against the target enterprise (if any).

  • SPC Advisors, LLC
    January 18, 2018

    Your question is certainly timely. The starting point is that the general partner is responsible for taxes of other partners. If K-1's are filed properly for the partners, there is no liability. As you have most likely read, the tax law was approved hastily, with many parts left to be spelled out. In this instance, the process lacks specifics. By the end of the month, we will have a better handle on the background and nuances of the best way to have the partnership agreement protective of the general partner. Even if you are not the general partner, a partnership agreement may contain a provision for indemnification.

  • Chair, Real Estate and Financial Services Department, Polsinelli
    January 20, 2018

    The following is for general information only and should not be considered legal or tax advice. For more than the general information imparted below you should consult an expert who can ascertain the complete relevant facts. You are correct that under the new rules a partner could end up paying for the taxes of a former partner if an adjustment to the partnership’s income occurred. The new rules took effect as of Jan. 1, 2018, so if an investor bought into a partnership in 2018, he would not have liability for another partner’s allocable share of taxes in, say, 2017 because the new audit rules don’t apply to adjustments in years prior to 2018. Under the new audit regime, IRS makes adjustments to the partnership’s income rather than at the partner level. It also takes collection actions at the partnership level. Further, adjustments take place in the year of the audit rather than the year to which the audit relates. There is a "small partnership" exception that applies if the partnership has less than 100 partners. This election, if made, apparently pushes the adjustments out to the partner level and the adjustment would be allocable to the partners that held equity in the year to which the adjustment relates. However, this exception does not apply to any partnership that has a partnership as a partner. In addition, the election must be made on an annual basis. Unless the small partnership election applies, an investor is stuck with the new rules and would need to try to protect himself contractually against the former partner through purchase agreement or partnership agreement provisions or otherwise. The partner would also be well advised to form a holding entity for his partnership interest to potentially limit the assets IRS could attach.