Decisions, Decisions: Partnership Audit Considerations Resulting from the Bipartisan Budget Act of 2015
As if there weren’t enough decisions to be made when filing a partnership tax return (Form 1065 U.S. Return of Partnership Income), for tax years beginning after December 31, 2017, partnerships will now need to make a critical decision when filing their return. Due to the passing of the Bipartisan Budget Act of 2015 (BBA), P.L. 114-74, partnerships will now need to annually select a Partnership Representative (PR) in place of the former Tax Matters Partner (TMP) adhering to the new centralized partnership audit procedures under the BBA. Unlike the TMP, a PR can make decisions that will ultimately bind the partners of the partnership to any decision made as a result of an audit. The individual partners no longer have the right to appeal any adjustments agreed to by the PR. This in turn, may lead to more Internal Revenue Service (IRS) audits of partnerships as it will be easier for the IRS to collect any proposed adjustments agreed upon by a single PR as opposed to going after each individual partner.
New Partnership Audit Rules under the BBA
Under the new partnership audit regime, unless an election is made to opt out of the centralized partnership audit regime under IRC Sec. 6221(b), a partnership will now owe an entity level income tax liability should an adjustment be determined as the result of an audit. If the Partnership elects to opt-out (assuming it meets the requirements of IRC Sec. 6221(b)(1) as discussed below), the partnership under audit will follow the rules under the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), P.L. 97-248 and the partners will be subject to any adjustments on a partner-by-partner basis. As it is more difficult to go after each individual partner, eligible partnerships may elect out of the new BBA rules by checking “No” for question 25 on page 3 of Form 1065. However, many partnerships will be unable to elect out of the new BBA rules due to eligibility limitations. Partnerships eligible for opting out must have no more than 100 partners and all partners must be either an individual, a C corporation, a foreign entity that would be taxed as a C corporation were it domestic, an S corporation, or an estate of a deceased partner.
The Partnership Representative replaces the Tax Matters Partner previously designated by the partnership for tax years beginning prior to January 1, 2018 (unless a valid election is in effect for any partnership tax years beginning after November 2, 2015 and before January 1, 2018). The PR and TMP are representatives of the partnership who act as the liaison between the partnership and the Internal Revenue Service if the partnership is selected for an audit. Under the old rules, the TMP had to be a General Partner of the partnership and did not have the authority to bind the partners within the partnership. Section 6223 of the Internal Revenue Code has been amended due to the BBA and now sets the rules for the PR. The PR does not need to be a partner in the partnership or have any affiliation to the partnership. For example, the PR could be designated to be a partner from an accounting firm or a law firm.
Under Section 6223(a), the PR can be anyone with a substantial presence in the United States and will have the sole authority to act on the behalf of the partnership. Substantial presence is defined in the regulations as a person who meets the following three criteria. First, the person must be able to meet within the United States at a reasonable time and place. Second, the person must have a United States address and telephone number and be reachable during normal business hours. Third, the person must have a Taxpayer Identification Number (TIN). However, the PR’s TIN does not need to be listed on Form 1065 although there is a space to enter the TIN. While the PR can be an entity, a designated individual (DI) must be selected and satisfy the substantial presence requirement as well. If the PR is not selected by the partnership, the IRS may designate one. Should the PR need to be changed, a new PR can be designated on Form 8979 “Partnership Representative Revocation, Designation, and Resignation Form” following the procedures set out in the regulations. However, the partnership is not to notify the IRS of the change in PR until the partnership has been notified of an audit or files an administrative adjustment request (AAR) as part of an amended partnership tax return.
Section 6223(b) states that the PR has the authority to bind the partnership AS WELL AS all partners within the partnership. In other words, the partnership and all partners are bound by any decisions made by the PR in all matters involving any audit, protest to the Appeals Office, legal representation in court to dispute a tax adjustment, and whether or not the partnership elects to opt out of the centralized partnership audit regime. Therefore, partnerships and their income tax advisors should discuss the impact of these new rules, based upon their circumstances, to ensure the suitable PR has been decided upon prior to filing their future Forms 1065.
As these rules are already in effect for the 2018 tax year, partnership agreements should be updated to include a section related to the Partnership Representative. If a decision has not been made on who will be chosen to be the PR, a decision will need to be made by 9/15/19 (assuming a 12/31/18 year-end return has been properly extended). As the PR has an enormous amount of authority and responsibility, no choice should be made without consulting your tax advisor and counsel (internal or external). If an external PR is chosen, it is imperative to make sure that they understand the intentions of the partnership and a have well-written contract that spells out there requirements and/or restrictions related to any decisions made.