Thursday, August 15, 2019
Edward H. Klees (Hirschler Law) and Mark E. Berg (Feingold & Alpert) have published a short commentary title Are Tax-Exempt Investors Really Tax-Exempt? on the Pensions & Investments website (photo from that website). Here is the introduction:
Call us old-fashioned, but we think of tax-exempt institutions as exempt from taxes.
Under a federal law that took effect in 2018, however, the IRS may audit investment funds structured as limited partnerships, limited liability companies or other pass-through vehicles and collect any resulting underpayments of the investors' income taxes from the fund itself. Unless its governing documents say otherwise, the fund may pass along the bill to its investors, including tax-exempts, however it sees fit, even though none of the tax is attributable to the tax-exempt investors. Plus, if the fund is unable to obtain reimbursement from a taxable investor for its share of the tax, the other investors, including tax-exempts, could be required to pony up. Unfortunately, the contracts we have seen so far leave the door open for these outcomes.
We note some possible fixes below. If left unaddressed, the potential tax liability in investment funds is a ticking time bomb for tax-exempt investors. Until such time as fund documents evolve toward provisions more favorable to tax-exempt investors, it is essential that tax-exempts and their advisers be aware of the implications of the new tax audit rules and the possible solutions to the significant problems they raise.