Partnerships Must Take Immediate Action to Review Operating Agreements, Name Partnership Representatives on 2018 Tax Returns by Dustin Grizzle
Posted on February 01, 2019 by Dustin Grizzle
Most of the buzz surrounding the 2018 tax year centered on the overhaul of the U.S. tax code and how individuals and businesses can comply with the provisions of the Tax Cut and Jobs Act (TCJA). Consequently, taxpayers may have forgotten the new centralized partnership audit regime, established by the Bipartisan Budget Act of 2015 (BBA), which went into effect for tax years after Dec. 31, 2017.
The new law shifts the responsibility for correcting a partnership’s tax underpayments away from its individual partners/members to the partnership entity (at the highest individual rate of 37 percent, rather than 29 percent). Moreover, it requires each partnership and LLC treated as a partnership for tax purposes to designate on its 2018 tax returns one person or entity to serve as its partnership representatives (PR) who has the sole authority to act on the partnership’s behalf before the IRS. One challenge faced by many entities has been understanding who or what qualifies as a PR.
In August 2018, the IRS issued the following regulations regarding the designation and authority of a PR under the new federal partnership audit rules:
- A partnership must designate a partnership representative on its federal partnership income tax returns (Form 1063) for each applicable tax year. The designation must be made prior to the start of any IRS administrative proceedings. If the partnership does not appoint a PR, the IRS may appoint one for the partnership.
- A PR must have a substantial presence in the U.S., which the law defines as someone who has a U.S. street address, telephone number and taxpayer identification number, and who is able to meet with the IRS at a “reasonable” time and place.
- A PR may be a person or an entity, including the partnership itself and/or a disregarded entity.
- A partnership named as a PR must have a substantial presence in the U.S., and it must appoint a designated individual (DI) to act on the entity’s behalf in the partnership’s role as a PR.
- An individual named as a PR or DI need not be an employee of the partnership.
- A partnership/LLC and each of its partners/members have the unilateral power to revoke a PR designation, including those made by the IRS, as long as the partnership receives IRS consent to do so.
- A partnership may change its designated PR through revocation without IRS consent only when it receives notification that its tax return has been selected for IRS examination/audit.
- Certain small partnerships may qualify to annually elect out of the PR designation requirement when they have 100 or less direct or indirect partners, who are either individuals, C Corporations, foreign entities treated as U.S. C Corporations, S Corporations, or estates of deceased partners. If an entity fails to elect out of the law, it must designate a PR.
With enactment of the partnership audit rules taking effect in 2018, parties to a partnership should meet with experienced advisors and accountants to review their operating agreements and take steps, as needed, to make changes to protect themselves from personal liabilities that may result from any decisions the PR makes on the partnership’s behalf. Under certain circumstances, it may be beneficial to specify in partnership/LLC agreements that any IRS audit decisions require a vote of the partners/members. In addition, meeting with professional advisors can help ensure that all partners/members understand their responsibilities to correct underpayments and remit taxes at the highest individual rate plus penalties and interest in effect during the adjustment year, rather than the audit year, regardless of whether or not they were in fact partners during the audit year.
About the Author: Dustin Grizzle is an associate director of Tax Services with Berkowitz Pollack Brant, where he provides tax-planning and compliance services to high-net-worth individuals and businesses in the manufacturing, real estate management and property investment industries. He can be reached at the CPA firm’s Boca Raton, Fla., office at (561) 361-2000 or via email at firstname.lastname@example.org.
Information contained in this article is subject to change based on further interpretation of tax laws and subsequent guidance issued by the Internal Revenue Service.