The IRS has issued its final regulations for the designation, authority and replacement of a partnership representative (PR) under the new default audit regime for partnerships (including limited liability companies taxed as partnerships). The PR replaces the previous role of the tax matters partner and possesses a broader authority to bind the partnership and all partners in dealings with the IRS. The final regulations are effective for tax years beginning after 2017.
Under the default audit regime, the IRS will assess tax on an adjustment that increases a partnership’s income against the partnership itself, rather than against individual partners from that tax year. However, a partnership can elect to “push out” the adjusted items to partners from the relevant tax year. Those partners would take their shares of the adjustments into account on their individual tax returns.
When the IRS audits a partnership, the PR has sole authority to act on the partnership’s behalf. The PR can extend the statute of limitations, proceed to litigation and make the push-out election—all without any duty to communicate with the firm’s partners.
Who can serve as PR
The proposed regulations allowed a partnership to designate any person with a substantial presence in the United States (meaning, essentially, that the person is available to meet in person with the IRS) and the “capacity to act” as PR. If an entity was designated as PR, the partnership also was required to appoint a designated individual to act on the entity’s behalf.
The final regulations make clear that disregarded entities (those that are disregarded as separate from their owners for income tax purposes, such as single-member LLCs) can serve as PRs. Because a disregarded entity would be an entity PR, the partnership must appoint a designated individual to act on the PR’s behalf. Both the disregarded entity and the designated individual must satisfy the substantial presence requirement. Additionally, a partnership can serve as its own PR if it has a substantial presence in the United States and appoints a designated individual with such a presence to act on its behalf.
The final regulations also eliminated the capacity-to-act requirement altogether in order to give partnerships as much flexibility as possible in picking their PRs. However, the IRS may determine that a designation of a PR is not in effect due to circumstances that would have resulted in the PR not having capacity to act under the proposed regulations. That is because some of the proposed capacity-to-act requirements overlapped with substantial-presence requirements.
How to replace the PR
The final regulations maintain the proposed rule that a partnership can change its PR only in the context of an administrative proceeding or in conjunction with the filing of a valid administrative adjustment request (AAR). They also revise the proposed regulations to permit a partnership to change the PR when notified that its return has been selected for exam, in addition to when a notice of administrative proceeding (NAP) is mailed.
What about when a PR resigns? The final regulations do not allow that PR to designate a successor. They also prohibit a PR from resigning when the partnership files an AAR. Resignation is allowed only when an NAP has issued.
In contrast, a partnership can revoke a PR’s designation (including a designation made by the IRS, provided the agency grants permission) for any or no reason. Anyone who was a partner during the partnership taxable year to which the revocation relates can sign a revocation. Notice of revocation (and of resignation) becomes effective on IRS receipt.
Help is available
Notably, the regulations establish that a PR can engage someone, such as a CPA, to act on the PR’s behalf under a power of attorney during the administrative proceeding. So, your professional advisor can participate in meetings or receive copies of correspondence.
Sidebar: Ways to limit the PR’s authority
The final regulations for PRs clarify a proposed regulation that provided that no state law, partnership agreement or other document could limit the PR’s authority. According to the IRS, it often expended significant resources under the previous law to determine which state law restrictions might affect who could act for the partnership and under what circumstances. The new partnership audit regime removes this burden.
The IRS emphasizes that this rule applies only with respect to the audit. In other words, the failure to adhere to state law requirements will have no effect on a PR’s actions taken within the audit process.
But, the IRS notes that the regulations allow a partnership and its PR to enter contractual agreements to define the scope and limits of their relationship. The IRS will not be bound by such an agreement, but a partnership could obtain a remedy under state law if the PR fails to act in accordance with it.