Last week, the U.S. Department of the Treasury and the Internal Revenue Service issued final regulations concerning the designation and authority of a partnership representative under the centralized partnership audit regime that went into effect for tax years beginning after Dec. 31, 2017. Partnerships should review their partnership agreements to determine what changes are necessary to comply with the final regulations.
The Treasury Department and the IRS issued the regulations after receiving more than 30 written comments and additional comments during a public hearing on the previously released proposed regulations. The proposed regulations addressed (i) the eligibility of a person who could serve as the partnership representative, (ii) designating and changing a partnership representative, and (iii) the binding effect and the authority of a partnership representative. The Treasury Department and the IRS, in a few key areas, modified the proposed regulations under Internal Revenue Code Section 6223 in an effort to clarify and/or address concerns raised by the commentators.
Significant Authority Rests With the Partnership Representative
Similar to the tax matters partner under the old partnership audit regime (known as TEFRA), the partnership representative is the spokesperson for the partnership and has the ability to bind the partnership with respect to an IRS examination. Partnerships should be aware that the new rules do not obligate the partnership representative to inform partners about the audit proceedings or to obtain permission from the partners to extend the statute of limitations, settle a tax dispute or pursue litigation in Tax Court. Under the new rules, the partnership representative has been designated as the sole authority to bind the partnership in tax audits. Because the rules give the partnership significant flexibility to select its partnership representative, the Treasury Department believes the new rules should not place restrictions or limits on such partnership representative’s powers in the regulations.
However, the Treasury Department and the IRS did note that a partnership is freely permitted to enter into a contractual arrangement with its partnership representative that places obligations and restrictions on the representative’s powers. For example, the partnership could, through its partnership agreement or a side agreement, require the partnership representative to (i) keep the partners informed of significant developments during an IRS audit; (ii) obtain consent or permission before taking certain actions, like extending a statute of limitation for assessment or filing an election to “push out” a tax liability to the partners; and (iii) obtain the prior written consent of the partners to have authority to settle a dispute with the IRS.
It should also be noted that under the final regulations, the IRS gave up, except in very rare circumstances, its authority to determine whether the partnership’s designee for its representative has the “capacity to act” as a representative for the partnership. The partnership now must make this determination on a case-by-case basis. To facilitate this, the partnership should consider adding a definition of “capacity to act” in its partnership agreement or any side agreement with its designated partnership representative.
The concern for partnerships is that such an agreement is not binding on the IRS and a partnership representative’s failure to abide by the terms of an agreement does not invalidate any action the partnership representative takes with respect to the IRS. The only remedy for the partners would be under state law. Partnerships should consult their tax advisers to determine how to properly address these concerns.
Limited Opportunities to Change Partnership Representatives After Filing Return
Starting with tax years beginning after Dec. 31, 2017, the partnership must designate a partnership representative with respect to each tax year when filing its annual return (Form 1065). The final regulations clarify that a partnership may designate as its partnership representative an individual or an entity, including the partnership or an entity that is disregarded for federal tax purposes. However, if the partnership designates an entity as the partnership representative, the partnership must also designate an individual to act on behalf of the partnership representative entity. The Treasury Department noted that the designated individual does not necessarily have to be an employee, officer or director of the entity designated as the partnership representative.
The regulations clarify that, to be eligible to serve as a partnership representative or the designated individual, the designee must have a substantial presence in the United States. The final regulations also clarify that a substantial presence means that the person is able to make himself or herself available to meet in person with the IRS, has a street address in the United States, has a telephone number with a United States area code and possesses a United States taxpayer identification number.
Once an initial designation is made, the partnership cannot revoke or change its choice of partnership representative until it files an administrative adjustment request or it has been notified that the IRS intends to audit a tax return filed by the partnership. The IRS stated that it will provide a notification to the partnership that it has been selected for examination before sending the official notice of administrative proceeding to the partnership representative. Once the partnership has received a notification, the partnership will have the ability to revoke its designation of a partnership representative and choose a successor, provided such successor meets the qualifications to serve. Commentators on the proposed regulations had requested that the IRS create a system that allows a partnership to change its designated partnership representative at any time; however, the Treasury Department and the IRS did not adopt the comments, citing administrative burden.
Furthermore, a partnership representative cannot resign until he or she receives the notice of administrative proceeding. The final regulations clarify that a resignation is the final act of a partnership representative and is effective upon receipt by the IRS; the resigning person has no ability to designate a successor. Therefore, it is very important for the partnership to be conscientious when making the initial selection of a partnership representative.