Back in February we discussed the impact of tax-related matters as a result of President Trump’s executive order to halt implementation of tax changes. See article here. As a result of that regulatory freeze, Proposed Centralized Partnership Audit Regulations, that were drafted at that time in response to the enactment of Section 1101 of the Bipartisan Budget Act of 2015 (BBA), were withdrawn. However, on June 13, 2017, the Internal Revenue Service released new proposed regulations that are largely the same as the rules withdrawn in January; they provide insight to both taxpayers and tax professionals into how the new tax examination process will be implemented. Absent future congressional action, the rules go into effect beginning January 1, 2018
While an intended purpose of these new regulations is to decrease the administrative burden on the IRS during tax audits of complex partnership structures, the rules create new issues for partnerships and partners. From the perspective of the IRS, the adjustment, assessment and collection process will become more efficient, since all communication regarding the tax examination will be made through a designated “partnership representative” (PR), as opposed to the current Tax Matters Partner. The PR will have sole authority to act on behalf of the partnership. Another important feature of the new rules is that they allow the agency to collect unpaid tax at the partnership level (rather than from each partner); this will be discussed in more detail in our Part II follow-up article.
The PR can be an individual or an entity, but either must have a substantial U.S. presence. However, the representative does not need to be an owner (partner/member) of the partnership or limited liability company. The selection of the PR should not be taken lightly. The BBA basically grants the PR unconditional autonomy to act on behalf of the partnership; once an audit begins, the fortune of the partners regarding an adverse audit outcome rests in the hands of the PR. The Joint Committee on Taxation explanation of the unified audit rules indicates that the PR was intentionally endowed by Congress with sweeping authority to act on the partnership’s behalf and to bind the partnership and its partners without the partners’ direct involvement.
The PR will be responsible for:
Managing all phases of a partnership tax dispute;
Choose whether to extend the statute of limitations;
Bind the partnership, and the partners, to an adjustment or settlement in an IRS audit or court proceeding;
Decide whether, and in what court, to seek judicial review and to be the sole representative of the partnership in those court proceedings;
Choose whether to push out an underpayment liability to the partners or have the partnership pay the underpayment.
The new regulations also provide an option to elect out of the new partnership level audit regime if the partnership has 100 or fewer “eligible partners.” An eligible partner is defined as an individual, C corporation, S corporation, eligible foreign entities, and estates of deceased partners. In addition, a formal election out of the new audit regime is required to be made on a timely filed return. Additional detail on this topic will also be discussed further in our Part II follow-up article.
Unfortunately, with the authority granted a PR from the BBA arises the opportunity for misuse. If the PR is a partner in the partnership, there exists the potential for conflicts of interest between the PR’s interest in the audit outcome and the interest of the other partners in resolving partnership audit matters. Therefore, partnerships, partners, and their advisors need to begin considering how to deal with the new requirements and to determine who the designated partnership representative will be.
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Material discussed is meant for informational purposes only, and it is not to be construed as investment, tax, or legal advice. Please note that individual situations can vary. Therefore, this information should be relied upon when coordinated with individual professional advice.