Partnership Agreement Issues

We deal with agreements on a daily basis — from the terms and conditions on a website to municipal regulations that guide public actions. These agreements are often forgotten, if not entirely ignored, which may only become apparent when an issue arises. Similarly, partnership agreements may be drafted and then ignored. Partnership agreements guide many aspects of the partnership, including important tax consequences. Unless you have a legal background, you may have retained an attorney’s help when your partnership drafted its partnership agreement. What you may not have considered at the time was having a CPA review the agreement.

If a lawyer prepared your partnership agreement, what’s the benefit of having a CPA spend time reviewing the document? While the attorney may be an expert in drafting contracts, he or she may not have a business background and may not fully understand the tax implications of decisions outlined in the partnership agreement. The best time for this review is when the agreement is initially drafted, as this can save you money in the long-run. By properly drafting the document from the start, you can avoid incurring legal fees at a later date if revision is required. Greg Freyman can work with your attorney to ensure that the partnership agreement is properly worded so that tax issues are avoided. Greg will rely on your partnership agreement during tax preparation, so it’s important that the information that he pulls from the return reflects what was actually intended when the agreement was drafted.

Hundred dollar billsPartnership agreements are sometimes drafted in ways that cannot be followed for tax purposes. For example, an agreement may state that Partners X and Y will split distributions of profits evenly, but that Partner X will be allocated all of the income while Partner Y will be allocated any losses. While partnerships do allow more flexibility than S-corporations, the allocations must reflect the actual economic effect. In essence this means that a partner who enjoys the economic benefit (i.e., cash) is allocated the corresponding income. When Greg reviews your partnership agreement he can run various scenarios to ensure that the resulting outcomes are aligned with what you anticipated when you drafted the agreement. If the outcome is different from what you expected, Greg can work with you or your lawyer to update the agreement so that the outcomes are in line with your expectations.

Perhaps your partnership agreement was extremely well drafted for the situation that existed at the time of its creation. Unlike agreements that cover a single instance in time, such as a purchase agreement for a house, partnership agreements cover the entire life of the partnership. As such, they should be crafted to cover changes that may occur in the partnership. If you started a partnership with a friend or business associate, did you consider what might happen if one of you passed away? What happens to all of the allocations if one partner contributes cash or property to the partnership and the other partner or partners don’t? Having extensive experience with partnerships gives Greg a unique insight into the life cycle of a partnership, and he can point out factors that may need to be considered. Although CPAs do not actually draft the partnership agreements, the knowledge and experience of partnerships allows them to help lawyers understand the tax and financial implications of the terms and conditions of the partnership agreement.

Person working at a deskEven if you already have a partnership agreement in place, it may be helpful to have Greg review it. IRS rules and regulations change over time, and new legislation may require updates to your agreement. There is legislation currently set to go into effect in 2018 that completely overhauls the way in which partnerships are audited. These rules would have serious implications on any partnership that is audited. While the new administration may change or delay the rules, if they are enacted as planned, it might behoove your partnership to update the agreement to address these elements. A CPA review of your agreement can highlight any missing elements or sections that relate to outdated tax regulations.

The partnership agreement governs tax treatment as well as many other legal aspects, so it’s important that you understand the agreement. By working with a CPA and attorney you can ensure that you understand the partnership agreement and that it properly reflects your intentions.

Do you need advice about a partnership agreement?  We are here to help you.  Please feel free to get in contact with us, so we can help you navigate through these issues with confidence.

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