Friedman’s tax experts have stayed on the pulse of changes surrounding the Centralized Partnership Audit Regime (“CPAR”), enacted as part of the Bipartisan Budget Act of 2015 (“BBA”). Many of you have sought guidance on how and when to act in response to the CPAR, effective for tax years beginning January 1, 2018. While we previously advised you to wait for definitive guidance from the IRS and Treasury, we now know enough to help you move forward. With the recent IRS release of final regulations governing partnership representatives under CPAR, the time to act is now.
What is CPAR?
The CPAR is meant to simplify examinations of partnership tax returns. In many cases, it also results in any additional tax due paid by the partnership rather than at the individual partner level. Under CPAR, partnerships no longer have a “tax matters partner.” Rather, they will have to designate annually a “partnership representative” (“PR”) who will have extraordinary powers in the event of an audit.
Who can be a Partnership Representative?
Essentially, anyone who has a substantial presence in the U.S. can be the PR. To meet the substantial presence test, the PR must have the following:
- a U.S. taxpayer ID
- U.S. street address
- a telephone number with a U.S. area code, and
- availability to meet with the IRS in the U.S. at a reasonable place and time
An entity may be a PR as well. This includes disregarded entities and even the partnership itself! If an entity is the PR, the partnership must also appoint a Designated Individual (“DI”) to act on behalf of the PR. The DI must also meet the substantial presence test.
It is important to note that the PR does NOT have to be a partner (or LLC member).
How is the Partnership Representative designated?
If the partnership elects out of the CPAR, there is no need to designate a PR. When the partnership does not elect out, or cannot elect out because, for example, there is a disregarded entity as a partner, the PR and possibly the DI is designated on the partnership’s Form 1065 for the year. It is possible to have a different PR for each year. The PR/DI may be changed upon receipt of a Notice of Administrative Proceeding (“NAP”) from the IRS. The PR and/or DI may resign, but only after NAP is received. The PR/DI may also be changed on an Administrative Adjustment Request (“AAR”) that is being filed by the partnership for reasons other than simply changing the PR/DI.
More significant than the mechanics of the designation is the question of who may make this decision on the partnership’s behalf? Few if any partnership agreements entered into prior to 2016 will have a mechanism for appointing or changing a PR/DI. Most agreements will have to be amended to accommodate this new concept.
What is the authority of the Partnership Representative?
The PR has broad, almost unlimited, authority to act on behalf of and bind a partnership during an IRS examination. The final regulations make clear that the federal rules trump any state law limitations as to who may have the authority to act on behalf of or bind the partnership and its partners. The rules do allow the partnership and the PR to enter into agreements making the PR/DI accountable for any actions taken and the partnership agreement may include indemnification provisions.
The proposed regulations seemed to imply that the IRS would deal solely with the PR/DI. The final regulations make clear that the PR/DI may elect to delegate authority via a Power of Attorney (“POA”). Because the PR/DI is so powerful, partnerships should proceed with caution in selecting one.
Who makes other tax decisions for the partnership?
The role and authority of the PR/DI exists only in the context of an IRS examination. The states are looking at how they will respond to this new regime, but most have not yet enacted legislation, so it is unclear whether an additional, or different, designation will be required or allowed on state returns. In the meantime, the partnership is still operating and still filing tax returns, and may have tax elections or decisions to address. In the past, most partnership agreements delegated authority to make such decisions and elections to either the Tax Matters Partner (“TMP”) or the General Partner/Managing Member. Since the partnership agreement needs to be amended anyway, now would be a good time to decide who should be making other partnership tax decisions.
What should I do now?
It’s time to meet with legal counsel and your Friedman LLP tax advisor to amend the partnership agreement. You will want to consider the following:
- Determine if your partnership is eligible to elect out of the CPAR and how such a decision should be made.
- If you can’t elect out, who gets to designate the PR/DI, what should the criteria for the selection be, what agreements should be made with the PR/DI to protect the partnership?
- What other aspects of the CPAR may require changes to the agreement?
As always, please contact your Friedman LLP tax advisor to discuss how these new rules affect you and your partnership.