Tax Matters Partner is No More - Partnership Level Liability is the New Rule
Through enactment of recent legislation, the IRS has streamlined the partnership audit and collection process. The new rules apply to an entity electing to be treated as a partnership for income tax purposes (i.e., LLC). Partnership Representative (PR) replaces Tax Matters Partner (TMP).
The new rules shift the burden of tax collection from the IRS to the partners. The IRS will not have to pursue or “chase” the partners (individually) to collect each partner’s share of taxes. Rather, the IRS will look to the partnership, which likely will have some value (assets for example) associated with a business or investment activity. This would leave the partners to determine who must contribute funds to the partnership to make the business whole.
The general concept of both a TMP and a PR is to ensure that the partnership designates a person to act as the contact person between the partnership and the IRS in the event of an audit. The IRS will only communicate with the identified PR. If the partnership fails to identify the PR, the IRS will select the PR for the partnership.
While a TMP had the general authority to bind the partnership, it could not bind other partners. Therefore, under the prior system, a partner other than the TMP had rights during an audit, such as notification, participation and in some instances the ability to challenge the actions taken by the TMP.
However, under the new audit system, the PR can be any person (such as a non-partner), provided they have a substantial presence in the U.S. Additionally, the PR has sole authority to bind the partnership, and all partners are bound by the PR’s decision and any final decision in an audit proceeding. Therefore, other partners no longer have a statutory right to notice of, or to participate in, the partnership-level audit proceeding.
Starting January 1, 2018, each partnership must either (i) designate a PR annually for each partnership taxable year or (ii) elect to opt out of the new rules under one of the IRS’s opt out provisions.
Any person is eligible to serve as a PR provided they have a “substantial presence in the U.S.,” defined as: (i) being available to meet in person with the IRS in the U.S. at a reasonable time and place; (ii) having a street address in the U.S. and a telephone number where they can be reached during normal business hours; and (iii) having a U.S. taxpayer identification number.
These new partnership audit rules permit the partnership to opt out by exercising the opt-out election on an annual basis. To be eligible to opt-out of the new rules under the “small partnership” election, a partnership must have 100 or fewer eligible partners. The determination of whether a partnership has 100 or fewer eligible partners is generally based on the number of K-1s issued. Under the “small partnership” election, the partnership is required to notify each partner. The IRS will be required to audit and assess tax to each partner rather than at the partnership level if the opt-out election is selected.
Therefore, if the partnership is subject to the new rules (does not opt out), the partners must make sure that the governing documents of the partnership (the operating agreement or partnership agreement) name the PR (or at least identify a procedure and requirement to annually appoint a PR), as well as to define the PR’s authority, responsibilities and limitations to the partnership and the other partners.