Section 6223 of the new partnership and LLC audit rules (the “Audit Rules”), which addresses the responsibilities of the partnership representative, seems clear enough. This Section provides that “the partnership representative . . . shall have the sole authority to act on behalf of the partnership.” Some of the more troubling aspects of this section include:
- The partnership representative has complete authority to act on behalf of the partnership (and, therefore, effectively the partners) when dealing with the IRS. This authority CANNOT be modified by state law or by contract. Therefore, nothing can change the partnership representative’s authority as far as the IRS is concerned. Of course, a partnership or operating agreement can require that the partnership representative receive the consent of the partners before agreeing with the IRS on a matter, but nothing can change the fact that the IRS will look solely to the partnership representative for these decisions.
- This authority includes the ability to bind the partnership and the partners in audits and other proceedings, including settlement authority and decisions on procedural issues, such as whether to proceed to litigation.
- Significantly, there is no legal obligation under the IRS rules for the partnership representative to keep the other partners updated on the status of an audit or even to notify the partners of the audit.
- The partnership representative does not need to be a partner in the partnership, raising the issue of naming a partnership representative permanently in a partnership or operating agreement, only to have that partner leave the partnership.
- Finally, if the partnership does not appoint a partnership representative, the IRS has the authority to appoint one for the partnership. This IRS appointment cannot be revoked by the partnership without the consent of the IRS.
Proposed regulations (“Regulations”) issued in February shed a great deal of light on the role of the partnership representative. Significantly, the Regulations confirm the very straightforward mandate of the statute that the partnership representative has complete control over IRS matters, and no participation by other partners is permitted. Yes, these are the same Regulations that were “frozen” by the White House and then withdrawn by the IRS. As we have noted previously, however, it is hard to imagine these Regulations not ultimately being issued. The Audit Rules will become effective in 2018; this could only be changed by Congress. The Regulations are critical to the implementation of the Audit Rules and, therefore, provide more than just a glimpse into what the IRS is thinking with respect to the partnership representative. Some of the highlights of the Regulations in this area include:
- The Regulations make it clear that the concept of the “Tax Matters Partner” is completely eliminated.
- This authority of the partnership representative includes the ability to make certain elections under the Audit Rules. For instance, a common election is the Section 6226 “push-out” election, where the partnership elects not to pay the assessment but instead to issue information returns to the partners who were partners during the year under audit. The Regulations provide that the partnership representative has the authority to make this election.
- The Regulations specifically provide that the other partners have no right to participate in, or contest the results of, IRS audits and related proceedings.
- The partnership representative must be designated each year on the partnership’s tax return; once designated, the partnership representative cannot resign, and the partnership cannot terminate the partnership representative for a particular year, prior to the issuance of a notice of administrative hearing (with a limited exception).
- The resigning partnership representative can appoint a successor partnership representative.
- If the IRS appoints a partnership representative (because the partnership has not done so) the partnership cannot revoke this appointment without the consent of the IRS.
It was clear prior to issuance of the Regulations that the partnership representative concept was one that would require most, if not all, partnerships and LLCs to amend their governing documents. Some of the clarifications provided by the Regulations, in particular those relating to the ability of the partnership representative to make elections under the Audit Rules, and the apparent difficulty in replacing the partnership representative once a designation has been made, make these amendments even more critical. Partners and members of LLCs should, therefore, start discussing these changes with their advisors and determine how to amend their agreement to address (i) the fact that the concept of the Tax Matters Partner is no longer valid; and (ii) the issues relating to the authority of the partnership representative noted above.
Soon we will discuss some more specific issues relating to the partnership representative and some potential governing document amendments that partners and LLC members will need to consider.