Final regulations issued on partnership audit regime representatives
TAX ALERT |
On Aug. 6, the IRS issued final regulations governing the designation and authority of the partnership representative under the newly effective centralized partnership audit regime (the “BBA”). The final regulations are effective Aug. 9, 2018.
The new audit rules, which were enacted in 2015 and became effective for tax years beginning after Dec. 31, 2017, require partnerships and all of their direct and indirect partners to deal with the IRS through a single representative of the audited partnership, eliminating any right of dissent or disagreement with proposed settlements or concessions. In the event of an adjustment, a partnership would have to choose between paying an entity-level tax, computed under complex rules designed to estimate the partner-level effects or ‘pushing-out’ its adjustments to its partners, who would then be required to re-compute their prior year tax liabilities in light of the adjustments. The partnership representative has full and unilateral authority to negotiate with the IRS on behalf of the partnership, and thus the rules regarding the representative should not be underemphasized.
The final regulations published yesterday adopt the proposed regulations regarding the partnership representative, with revisions. Below is a discussion of some of the more notable changes in the final regulations. While the rules themselves can be dry to most tax and non-tax experts, partnerships must consider taking additional steps in sync with implementing the final rules; arranging its internal partnership affairs to provide for the relationship between the partnership representative and the partnership (and the other partners). Because the representative has great authority, the other partners need to carefully consider how the representative will act on behalf of the partnership. Addressing this issue early on is important to provide comfort to all partners and direction to the representative on a number of matters, including whether and how the other partners have input into the administrative process, how and when the representative is to act in different situations, if adjustments will be pushed-out to the partners, and if and how information about the partnership will be provide to the IRS. Thus, the partners should incorporate into the partnership’s governing documents mechanisms for how the representative should perform its duty in coordination with the other partners and in the best interests of the partnership.
Relatedly, the partnership should also prepare for the role of the representative in the event of liquidation. The partnership should strongly consider setting out the continuing obligation of a partnership representative and its duty to represent the interests of the partnership during the winding-up of the partnership and also after the partnership has dissolved as IRS administrative proceedings can arise years after the business of the partnership has ended and the entity is no longer in existence.
For more background on the partnership audit regime and related regulations, see our prior alerts:
- Proposed IRS partnership audit regulations allow tiered push-out
- Proposed partnership audit regulations released by the IRS
- IRS issues proposed regulations for new partnership audit procedures
- IRS regulations address opting-out of new partnership audit rules
Eligibility to serve as the partnership representative
The proposed regulations require that, when an entity is the partnership representative, the partnership must also name a designated individual to act on behalf of the entity. The final regulations clarify that any entity, including a disregarded entity or the partnership itself, can be the partnership representative, as long as there is a designated individual. In reality, the designated individual is effectively the “real” partnership representative; they carry all the powers of the partnership representative and are subject to the same resignation or removal procedures. Relatedly, the IRS stressed in the preamble the importance of designating a representative (and if needed, a designated individual) before the IRS initiates an administrative action against the partnership in order to avoid confusion and delays.
The BBA also requires that a partnership representative must have a substantial presence in the United States. The proposed regulations stated that a person has substantial presence in the United States if the person is able to meet in person with the IRS in the United States at a reasonable time and place, has a United States street address and telephone number where the person can be reached during normal business hours, and has a United States taxpayer identification number. While some commentators argued that the “reasonable” aspect is too vague, the IRS largely adopted this provision with minor adjustments because the open language allows for more flexibility. However, the IRS did add a requirement that the partnership representative not only be able to meet at a reasonable time and place, but also be willing to do so.
One of the proposed requirements to serve as a partnership representative or designated was the so-called “capacity to act” for the partnership. Under the proposed rules, there were five specific events that would cause a person to lose the capacity to act, including a catch-all provision for any unforeseen circumstances. The result of loss of the capacity would be that the partnership representative designation would cease to be valid. Ultimately, the IRS removed the capacity to act requirement from the final regulations, reasoning that partnerships themselves are best positioned to determine if a partnership representative is fit for the job. As discussed further below, however, the final regulations retain the proposed rule that the IRS can make its own determination that a representative is not valid due to the other requirements in the code and regulations, including by not making themselves available (e.g. in prison).
Designating or changing a partnership representative or a designated individual
As proposed, a partnership can only change its representative at initiation of an audit or filing of an administrative adjustment request. However, the final rules do provide some flexibility when an audit is imminent. A partnership is allowed to change its representative when it is notified that the partnership return is selected for examination, in addition to when the notice of administrative proceeding is mailed. This notice is made to the partnership, not the representative, which we expect will be very helpful to partnerships who are no longer associated with their designated representative.
In addition, the final regulations remove the ability of a resigning partnership representative or designated individual to designate a successor. This is to prevent, for example, a resigning representative with a soured relationship with the partnership from nominating their successor.
The proposed regulations provided that a revocation must be signed by a person who was a general partner at the close of the taxable year for which the partnership representative designation is in effect, as shown on the partnership return for that taxable year. In the interest of providing maximum flexibility to partnerships, the final regulations allow any partner (or LLC member) to make a revocation. In addition, the final rules clarify that a revocation can be made for any reason or no reason at all, except if the designation is made by the IRS, where IRS consent must be obtained.
In addition, the proposed regulations stated that a resignation or revocation of the partnership representative (or designated individual, if applicable) is effective 30 days from the date on which the IRS receives written notification of the resignation or the revocation. The final regulations now provide that a revocation is effectively immediately upon receipt by the IRS (or upon acknowledgement by the IRS that the revocation was valid if the designation was made by the IRS), which eliminates a rather large window of time in which a “rogue” partnership representative could cause significant damage to the partnership. Note that revocation is effective upon IRS receipt, not mailing, so partnerships with a very urgent need to change their partnership representative should consider hand-delivery of their revocation to IRS personnel.
IRS designation of partnership representative
The proposed regulations state that the IRS has authority to determine that a partnership representative designation is not in effect under certain circumstances. As noted above, there are certain requirements for the representative, including satisfying the substantial presence test so that the IRS can easily get in contact with the representative. The proposed regulations list a number of reasons why the IRS could find a designation is not in effect, and the final rules adopts that list without change. However, the final regulations also added a new rule that permits the IRS to determine that a designation is not in effect for “any other reason described in published guidance.” Thus, there is perhaps a much wider range of reasons that the IRS could assert that no designation is in effect which allows the IRS to designative a new partnership representative.
We would also like to reiterate the brutality of the “multiple revocations” rule, by which the IRS can take control of partnership representative selection if they receive multiple partnership representative revocations within 90 days. There is no escape from this provision, aside from IRS grace. It is critical that partnerships ensure control over partnership representative revocations, especially now that any partner can sign a revocation.
Authority of the partnership representative
As noted above, the partnership representative wields an enormous amount of power on behalf of the partnership in that it is the sole party authorized to negotiate with the IRS. The final regulations reinforce that state law principles, or private contract, regarding partnership authority does not control in the context of the BBA, from the Federal government’s perspective. Therefore, partnerships wishing to control their representative must ensure adequate private remedies are available to dissuade the representative from rogue actions.
The final regulations make other changes as well, often providing additional clarification including:
- How the IRS will exercise its discretion to choose a partnership representative, including factors to be considered
- Revocation of a representative chosen by the IRS
- Authority of the partnership representative to execute powers of attorney
- Effects of withdrawal of notice of administrative proceeding
- Updating of contact information
Finally, the IRS noted that it did not receive any public comments regarding proposed regulations for early election into the BBA regime. Therefore, those proposed regulations, previously effective as temporary regulations, were finalized without any substantive changes.