The IRS recently finalized regulations relating to the implementation of the new partnership audit regime. The new partnership audit rules were enacted in 2015. For prior coverage of these new rules, see our prior discussions here and here. The recently promulgated regulations make final previously proposed regulations relating to the partnership representative provisions. In particular, the final regulations address who may be designated as the partnership representative and the scope of authority of the partnership representative. In addition, certain temporary regulations relating to the early opt-in election have been removed.
I. Appointment of the Partnership Representative
These final rules clarify who may be designated the partnership representative. The partnership representative can be any person with a substantial presence in the United States, including a disregarded entity. In addition, a partnership can be designated as its own partnership representative. Where any entity is designated as the partnership representative, including a disregarded entity, an individual with a substantial presence in the United States must also be designated on the partnership’s tax return as the sole individual through whom the partnership will act in the connection with the IRS audit.
These final rules also clarify what constitutes a substantial presence in the United States. The final regulations mostly adopt the proposed rules requiring a partnership representative to have a U.S. tax identification number (e.g., a social security number, EIN or an ITIN), a U.S. phone number and a U.S. mailing address. The final regulations eliminate the requirement of the partnership representative to be available to the IRS during normal business hours, although the partnership representative must still make itself available to meet IRS auditors at a time and place determined by the IRS. Therefore, a non-U.S. partnership representative need only have a U.S. tax identification number, a U.S. phone number (which can be a “voice over IP” phone number) and a U.S. mailing address (such as a registered agent).
Additional changes were made to the proposed regulations relating to the changing, resignation or revocation of an appointment of a person as the partnership representative. In addition, the final regulations include rules relating to the circumstances when the IRS can appoint a partnership representative.
II. Authority of the Partnership Representative
The preamble to the final regulations clarifies that if a partnership representative exceeds the authority granted to it under applicable state law or a contract, including a partnership agreement, the partnership will still be bound with respect to an IRS audit. In such a circumstance, the partnership representative may have liability for breach of contract or breach of a duty imposed by a state statute.
Additionally, the final regulations clarify that a partnership representative can appoint another person acting under power of attorney (IRS Form 2848). However, such power of attorney does not constitute an appointment of the partnership representative.
III. Considerations for Investment Fund Managers
Fund managers should consider these new rules when drafting partnership agreements and side letters. Although you do not have to designate a partnership representative or designated individual until you file your 2018 partnership tax returns, you should think about whom you may want to designate. Non-U.S. managers without U.S. employees may choose to designate a partnership representative that uses a registered agent’s mailing address provided that any IRS correspondence will be forwarded to manager non-U.S. office.
While we expect in many cases that your funds’ operative documents contain adequate provisions in respect of the new partnership audit rules, it may be worthwhile to revisit your funds’ documents and side letters. You may want to add language limiting potential liability exposure as a result of the partnership representative’s actions in an IRS audit.
The new partnership audit rules are effective for taxable years beginning on or after January 1, 2018. The IRS has still not issued all of the final regulations that will interpret these rules, but it is anticipated that additional final regulations will be issued over the next several months. We will of course keep you apprised of any developments in this area.
For additional information on the partnership audit rules, please contact please contact Ronald P. Cima (212-574-1471), Jonathan P. Brose (212-574-1615), James C. Cofer (212-574-1688), Peter E. Pront (212-574-1221), Daniel C. Murphy (212-574-1210) or Brett R. Cotler (212-574-1269).
