By Phil Jelsma
The IRS's proposed regulations on the new centralized partnership audit regime are far reaching, impacting every partnership and limited liability company (“LLC”).
Under the new regime which is effective January 1, 2018, adjustments and underpayments are calculated at the partnership or LLC level instead of the partner or member level.
As previously discussed, the push out election allows IRS adjustments to be moved from the partnership or LLC to the partners or members, which requires appointing a partnership representative. Throughout the new centralized partnership audit rules, the role of the partnership representative is clearly an important position. There may only be one partnership representative for any partnership or LLC tax year and generally a decision of the partnership representative is binding on the partnership or LLC.
Eligibility to be
The person designated partnership representative must have a substantial presence in the United States and the capacity to act. The partnership or LLC may appoint either a partner or member -- or non-partner or non-member, including a management company -- to the be the partnership representative.
A person has a substantial presence in the United States if (1) the person is able to meet with the IRS in the U.S. at any reasonable time and place as necessary; (2) the partnership representative has a street address and phone number in the United States; and (3) the representative has a U.S. taxpayer identification number. An individual can serve as a partnership representative. Generally, only the partnership or LLC can replace or appoint a new representative or the IRS may take an affirmative action to terminate the designation. The partnership representative can resign, the partnership or LLC can revoke their designation or the IRS can determine that the designation is not proper.
How to designate
the partnership representative
A partnership or LLC is required to designate the representative on its tax return for the year under examination. The partnership or LLC may change a representative each year and the designation remains in effect until terminated, however representative can only be changed when the partnership or LLC files a valid Administrative Adjustment Request (“AAR”).
The representative may resign by notifying the partnership or LLC and the IRS in writing. The representative generally cannot resign prior to the issuance of an AAR but may resign any time after the issuance of a notice of administrative proceeding. A resignation is generally effective 30 days after sent to the IRS.
The partnership or LLC may revoke a designation and designate a successor to revoke, but the partnership or LLC has to notify the IRS in writing and the representative of the revocation. Generally, it cannot be done prior to the issuance of a notice to administrative proceeding unless in conjunction with the filing of a valid AAR. The revocation is effective 30 days after sent to the IRS. The revocation generally would need to be signed by a general partner of a general partnership or limited partnership. For an LLC, a member or manager would generally need to sign the revocation and, if there is none, then a member of the LLC. If there is not an appropriate designation of a representative, the IRS has the ability to do the designation itself. There are specific procedures that the IRS will follow if it has received multiple revocations from different partners.
Binding affect of the actions
of the representative
Generally, the partnership or LLC and all the partners or members are bound by the actions of the representative. The representative has the ability to bind the partnership or LLC and its partners or members to things such as settlements, agreeing to a notice of final partnership adjustment, making elections and extending the statute of limitations. All persons whose liability is determined by the centralized audit regime are generally bound by the representative's decisions. The broad authority of the representative is not limited by state law, the partnership agreement or any other document or agreement.
The selection of a partnership representative is critical to the application of the new centralized partnership audit provisions. The representative can bind the partnership or LLC and its partners or members — even if the proposed adjustments benefit the partnership representative and harm the other partners or members. This form of self-dealing is permissible under the new proposed regulations but can give rise to fiduciary duty issues under state law.
With this in mind, it is critical to carefully select the appropriate representative -- automatically appointing the manager of an LLC or the general partner of a partnership may not be the right decision.
Phil Jelsma is a partner and chair of the tax practice team at Crosbie Gliner Schiffman Southard & Swanson LLC (CGS3), a San Diego-based commercial real estate law firm with offices in Los Angeles. Jelsma is recognized as a leading joint venture and tax attorney. He has a 30-year background in real estate exchange transactions, syndications, nonprofit corporations and international tax planning.