IRS And Treasury Issues Needed Guidance on Centralized Partnership Audits: Proposed Regulations Issued

By: Jerald David August

This will be Part One of a Three Part Series of Posts on the New Proposed Regulations; This Part One Will Focus on the Background to the Proposed Rule-making, Qualifications for Electing-Out, the Designation of the Partnership Representative and Related Items. Part Two Will Focus on the Imputed Underpayment Rules and Modifications while Part Three Will Address the Push-Out Election and Other Procedural Rules.

Introduction

The Bipartisan Budget Act of 2015, Pub. L. No. 114-74, Act §1101 (the “Budget Act”), which the President signed into law on November 2, 2015, (as modified by the Protecting Americans from Tax Hikes Act of 2015, Pub. L. No.114-113 (the “PATH Act”)) makes fundamental changes in how the Internal Revenue Service (“Service”) will conduct audits of partnerships.  The Budget Act repeals the partnership audit provisions of the Tax Equity and Fiscal Responsibility Act of 1982 (“TEFRA”) and electing large partnership regimes and replaces them with a new set of rules for partnership audits and judicial review of partnership audit adjustments under a new centralized or consolidated partnership audit regime. While the new rules may have had a specific purpose in mind, the language and principles contained in the new legislation may suffer from several defects, some of which are major.

Prior to the enactment of the TEFRA rules, all partnership audits were conducted at the partner level as part of the audit of one or more partners. The Internal Revenue Service determined that this was an unsatisfactory method to audit partnerships although non-partnership issues would still be determined at the partner level.  Generally, TEFRA audit rules apply to a partnership with 11 or more partners at any one time during the partnership’s tax year. Many partnerships with 10 or fewer eligible partners have been able to avoid the TEFRA audit rules and be subject to audit on a partner-by-partner basis.

The TEFRA entity level audit rules mixed both entity and aggregate theories into a complex web of procedural rules and protocols that were supposed to supersede the normal set procedural rules applicable to taxpayers in general.  This dual system for auditing partnerships had a well-intended design but generated much complexity and uncertainty in how the two sets of rules, entity and partner level deficiency (and tax refund) procedures were to be applied. For example, there were different statutes of limitations applicable, one at the partnership level and one at the partner level.

For years in which the issue was one of the proper allocation of income, for example, the adjustments did not yield a positive revenue to the Service. These years would simply yield a refund for those partners receiving an excessive allocation of income for a particular year and a deficiency in tax for those partners required to pay tax on the underpayment in tax to account for the erroneous allocation of income.  The Internal Revenue Service collected tax at the partner level. The Internal Revenue Service would have to pursue each partner’s several liability for the years that resulted in an assessment in tax. For multi-member partnerships, this could prove to be a multi-jurisdictional collection project. TEFRA, while resolving some of the problems under the “open audit” approach of auditing partners in partnerships, still suffered from defects from a tax administration standpoint. This was primarily attributable to the fact that even under the unified audit rules, any resulting assessments in tax were not payable at the entity level, but only at the partner level. The partnership TEFRA audit could yield no “tax revenue” fruit if the Internal Revenue Service cannot collect the resulting tax liability.

TEFRA had many issues in practice. The Service often had difficulty dealing with complicated statute of limitation issues under TEFRA. There was added concern with the ability to collect taxes from partners’ deficiencies after adjustments had been determined. Again, the multi-tiered partnerships having hundreds (or more) partners in an investment fund situated in different parts of the U.S. as well as in foreign countries posed formidable collection burdens to the IRS.  The Internal Revenue Service encountered administrative difficulties under TEFRA when working with large partnerships with many partners and when working with tiered partnerships. The Internal Revenue Service notoriously audits a very small proportion of large partnerships (about 0.8% annually). The Internal Revenue Service presumably will have to increase its audit activity for partnerships if the new audit rules are to realize their promised potential of dramatically raising revenues.  The new rules “streamline” the unified partnership audit rules by replacing the TEFRA provisions with new “consolidated” audit, assessment and collection rules, including rules for administrative and judicial review.

Effective Date of the Budget Act Partnership Audit Rules

The repeal of the TEFRA partnership audit rules is effective, in general, for partnership years beginning after 12/31/2017. As mentioned, the repeal of the TEFRA partnership audit rules includes the repeal of the electing large partnership provisions. That means that the current TEFRA rules, regulations, and pertinent case law remain in effect until the applicable statutes of limitation on assessment in tax, as well as claims for refunds for overpayments in tax (at either the partnership or partner levels) for all prior tax years have expired. Partnerships may, however, elect to apply the new rules with respect to tax years beginning after 11/2/2015. Even in such instance, the TEFRA rules continue to apply until the applicable sunset date is reached as to all open years.

Early Election-In Notice Issued by the Service

The Service recently published temporary and proposed regulations, T.D. 9780 (8/5/2016) on electing into the new partnership audit rules by a partnership for tax year beginning after November 2, 2015 (the date of enactment) and before January 1, 2018.  The ability to make an “early” election into the new Budget Act centralized audit rules authorized under Section 1101(g)(4) of the Budget Act.  As previously mentioned, the new centralized audit rules generally apply for tax years beginning after December 31, 2017.

Where a partnership files an “early, elect-in” election in accordance with the temporary regulations, it is not permitted to elect out under the small partnership exception under Section 6221(b) for that return. Temp. Reg. §301.9100-22T(a) further provides that an election made not in accordance with these temporary regulations is not valid, and an election, once made, may be revoked only with consent of the Service. In some instances the elect-in now election will be treated as invalid where it frustrates the purposes of the Budget Act. [1]

Guidance In the Form of Interim Notices and Regulations Had Been Pending

In Notice 2016-23, 2016-12 IRB the Internal Revenue Service requested comments concerning the new partnership centralized audit and assessment rules enacted under the Bipartisan Budget Act of 2015, P.L. No. 114-74, section 1101. Notice 2016-23 lists 12 general categories on which guidance is requested. [2] The Regulations were issued in Proposed Form on January 18, 2017 (REG-136118-15).  

Preamble to Proposed Regulations: Explanation of Provisions.

  1. Scope of the Centralized Partnership Audit Rules. Proposed §301.6221(a)-1(a) provides that the new audit rules apply to any adjustments to items of income, gain, loss, deduction or credit of a partnership and any partnership’s distributive share of such items . Moreover any income tax may be subject to assessment and collection at the partnership level. See new §6221(a). Thus, taxes not covered by the new audit rules includes chapter 2 (tax on self-employment income), chapter 2A (unearned income medicare contribution), chapter 3 (withholding), chapter 4 (FACTA) and chapter 6 (consolidated returns).  Accordingly, the IRS may separately examine the partnership or its partners outside the centralized partnership audit regime for purposes of determining and assessing these types of taxes. The phrase “income, gain, loss, deduction or credit” under the new consolidated audit rules includes issues related to the character, timing and source of the partnership’s activities; contributions to and distributions from the partnership; the partnership’s basis in its assets and the value of those assets, the amount and character of partnership liabilities, the application of the foreign tax credit provisions, partnership election; application of the disguised sales rules and guaranteed payments, items related to the termination of a partnership and partners’ capital account. The determination of whether a penalty, addition to tax or additional amount which     relates to an adjustment of any item or distributive share is determined at the partnership level.  In a change from the TEFRA audit rules, only the partnership representative may raise defenses to penalties, additions to tax, or additional amounts, including the partnership's defenses and defenses that relate to any partner. Otherwise a waiver is deemed to occur.

     2. Election Out of the Centralized Audit Regime. An important feature of the new rules is the expansion of the “small partnership exception” contained in present law under TEFRA [3] with the election out for a partnership which has 100 or fewer eligible partners at all times. Prop. Reg. §301.6221(b)-1(b)(3).  In applying the 100 or fewer K-1 statement rule under the regulations only required to be issued K-1s are taken into account.

          a. S Corporations Partners. Under Prop. Reg. §301.6221(b)-1(b)(2)(ii), any statements required to be furnished by the S corporation partner per §6037(b) for the taxable year of the S corporation ending with or within the partnership's taxable year are taken into account for purposes of determining whether the partnership is required to furnish 100 or fewer statements for the taxable year. Thus, where an S corporation with 50 shareholders is a partner in a partnership, in addition to the statement the partnership is required to furnish to the S corporation, the 50 statements that the S corporation is required to furnish to its shareholders under §6037(b) are taken into account for purposes of determining whether the partnership is required to issue 100 or fewer statements.  See Prop. Reg. §301.6221(b)-1(b)(2)(iii), Ex. 5.

          b. Eligible Partners. The professional community had long awaited the approach to be taken in the regulations on the scope and meaning of the term “eligible partner” for purposes of the electing out rules. In starting out, Prop. Reg. §301.6221(b)-1(b)(3)(i) defines “eligible partner” as "eligible partner" as any person who is an individual, C corporation, eligible foreign entity, S corporation, or an estate of a deceased partner. Under this proposed rule, a C corporation is an entity defined in §1361(a)(2), including a regulated investment company (RIC) under section 851 and a real estate investment trust (REIT) under section 856. A tax exempt organization under §501(c)(3) and is treated as a corporation under §7701(a)(3) will be treated as an eligible partner”. See Rev. Rul. 2003-69, 2003-1 C.B. 1118 (tax-exempt corporation treated as C corporation for purposes of the TEFRA small partnership exception).  An “eligible foreign entity” includes a per se corporation under the check-the-box regulation and a foreign entity classified by default as an association taxable as a corporation or, alternatively, as a foreign entity classified by default as a partnership which makes an election to be treated as a corporation. See Treas. Regs. §§301.7701-2(b)(1), (3)-(8). Unfortunately Prop. Reg. §301.6221(b)-1(b)(3) clarifies that the term “eligible partner” does not include partnerships, trusts, foreign entities that are not eligible foreign entities, disregarded entities, nominees and other similar persons that hold an interest on behalf of another person and estates that are not estates of a deceased partner. On this last point, many had hoped that since S corporations, for example, are permitted to have trusts as shareholders, that certain trusts would be permitted to be eligible partners. The Treasury and IRS received much comment on liberalizing the reach of the eligible partner. Commentary asked for the ability to use entities such as disregarded entities, trusts, partnerships, and partners who use nominees as eligible partners for purposes of the election out rules. The commenters also suggest that there may be certain partnership structures that could be efficiently examined at the ultimate taxpayer level even if a partner is not one of the eligible partners listed in  §6221(b). In complying perhaps with the “notice and comment” aspects of the rule-making process under the Administrative Procedures Act, the Preamble specifically notes that the Treasury Department and the IRS considered these comments, but have declined in these proposed regulations to exercise the authority under §6221(b)(2)(C) to expand the types of entities that are eligible partners for purposes of the election out rules or to create separate election out provisions for specific partnership structures. Were the proposed regulations to broaden the scope of the election out provisions to include additional types of partners or partnership structures, the IRS will face additional administrative burdens in examining those structures and partners under the deficiency rules.

          c. Making the Election Out. The proposed regulations set forth the time, manner and form for the partnership making an election out (annual requirement). First the election must be made (only) on a timely filed partnership (including extensions) return. Once made, the election out may only be revoked by the partnership with the consent of the IRS. Prop. Reg. §301.6221(b)-1(c)(1). Second, partnership “electing out” must disclose to the IRS the names, correct TINs, and federal tax classifications of all partners of the partnership and, if there is an S corporation partner, the names, correct TINs, and federal tax classifications of all persons to whom an S corporation partner is required to furnish statements during the S corporation partner's taxable year ending with or within the partnership's taxable year at issue, and any other information regarding those partners (and shareholders) as required by the IRS in forms and instructions. Such disclosure rules extent to identification of foreign partners. See §6221(b)(2)(B)(grant of authority to the Secretary to provide for alternative identification of any foreign partners). Finally, Prop. Reg. § 301.6221(b)-1(c)(3) requires the partnership electing out must notify each of its partners that the partnership made the election. This notification must be made within 30 days of making the election. No specific notice form is stated in the proposed regulations other than that the notice may be in writing, electronic, or other form chosen by the partnership. Prop. Reg. § 301.6221-1(e) provides that an election-out  not fully compliant with all the applicable rules, including an election by a partnership not eligible to make the election, may still be relied upon by the partnership unless challenged by the IRS, and the IRS may also rely upon an election in determining whether a partnership is subject to the centralized partnership audit regime. As a result, it will be clear to partnerships, direct and indirect partners, and the IRS which examination and adjustment regime should apply to the items otherwise subject to the centralized partnership audit regime.

          d. Effect of Election Out. For partnerships that elect out, the IRS will be required in turning the “clock” back so to speak to the pre-TEFRA rules, to open deficiency proceedings at the partner level to adjust items associated with the partnership, resolve issues, and assess and collect any tax that may result from the adjustments. Each partner-level deficiency proceeding is subject to its own statute of limitations and venue, which often results in separate partner-by-partner determinations with respect to the same item. Nevertheless, the IRS intends to increase the number of partnership audits for both partnerships that are subject to the centralized partnership audit regime and partnerships that have elected out of the partnership audit regime. In addition, to ensure that the election out rules are not used solely to frustrate IRS compliance efforts, the IRS intends to carefully review a partnership's decision to elect out of the centralized partnership audit regime. This review will include analyzing whether the partnership has correctly identified all of its partners for federal income tax purposes notwithstanding who the partnership reports as its partners. For instance, the IRS will be reviewing the partnership's partners to confirm that the partners are not nominees or agents for the beneficial owner. Perhaps most significantly in terms of what’s included in the guidance, the Preamble states that the IRS intends to carefully scrutinize whether two or more partnerships that have elected out under §6221 should be recast under existing judicial doctrines and general federal tax principles as having formed one or more constructive or de facto partnerships for federal income tax purposes. As one “different” partnership the separate elections out would fail. There is also an issue on the statute of limitations for the IRS to attack the election out. Is it simply based on whether the partnership tax year is otherwise still open or if the election out fails, then the statute of limitations on assessment of partnership tax is tolled (remains open).  The types of arrangements that the IRS will carefully review include those where the profits or losses of partners are determined in whole or in part by the profits or losses of partners in another partnership, and those that purport to be something other than a partnership, such as the co-ownership of property. If it is determined that two or more partnerships that have elected out of the centralized partnership audit regime have formed a constructive or de facto partnership for a particular partnership taxable year and are recast as such by the IRS, that constructive or de facto partnership will be subject to the centralized partnership audit regime because that constructive or de facto partnership will not have filed a partnership return and, therefore, will not have made a timely election out as required under § 6221(b)(1)(D)(i) and these proposed regulations.

3. Consistency In Partner Reporting of Tax Items Reported on Partnership Return.

          a. Retention of Consistency Requirement.  In maintaining the consistency in reporting rules for partners, Prop. Reg. § 301.6222-1(a)(1) provides that a partner's treatment of each item of income, gain, loss, deduction, or credit attributable to a partnership must be consistent with the treatment of those items on the partnership return, including treatment with respect to the amount, timing, and characterization of those items. It is important to note that Prop. Reg.  § 301.6222-1(a)(2) provides that a partnership-partner is subject to §6222 and the regulations thereunder regardless of whether the partnership-partner has made an election out of the centralized partnership audit regime under §6221(b). Prop. Reg. § 301.6222-1(a)(3) provides that a partner's return is automatically deemed  inconsistent if the partnership does not file a return, unless the partner notifies the IRS of this inconsistency in accordance with proposed § 301.6222-1(c). The term treatment of items on a partnership return includes any  amendment or supplement to such return, such as an administrative adjustment request filed under §6227, or as to the treatment of an item on any statement, schedule or list, and any amendment or supplement thereto, filed by the partnership with the IRS, including statements filed pursuant to §6226.

          b. Mathematical or Clerical Error Adjustments.  As per §6222(b) when a partner fails to treat items attributable to a partnership consistently with the treatment of those items on the partnership return, the IRS may assess and collect any underpayment of tax caused by the inconsistency as if it were on account of a mathematical or clerical error appearing on the partner's return; however the ability to request an abatement of the assessment under §6213(b)(2) does not apply. This allows the IRS to immediately assess and collect tax that arises on account of a mathematical or clerical error appearing on a taxpayer's return, notwithstanding the general restrictions on assessment and collection of deficiencies under §6213(a).  Prop. Reg. §301.6222-1(b) provides that the IRS may assess and collect any underpayment of tax that results from adjusting a partner's inconsistently reported item to conform that item with the treatment on the partnership return as if the resulting underpayment of tax were on account of a mathematical or clerical error appearing on the partner's return. A partner may not request an abatement of that assessment. See Prop. Reg.§ § 301.6222-1(b)(2). See also §6232(d)(1)(B)(consistency reporting obligation for partnership that is a partner in another partnership).

          c. Notice of Inconsistency. The consistency rules yield in situations where a partner properly discloses and identifies that it is treating one or more items in a manner inconsistent with the partnership return. See Prop. Reg. §301.6222-1(c). This is accomplished by the partner’s attaching a statement identifying the inconsistency to the partner’s return.  Prop. Reg. § 301.6222-1(c)(2) coordinates the rules regarding notice of inconsistent treatment under Prop. Reg. § 301.6222-1(c)(1) where a partner is bound to the treatment of an item under § 6223 for actions taken by the partnership or as a result of a final decision of a court. See Prop. Reg. § 301.6226-1(d). Prop. Reg. § 301.6222-1(c)(2) provides that if a partner's treatment of the partnership item is not consistent with the treatment to which the partner is bound under §6223, then Prop. Reg. § 301.6222-1(a) (consistent reporting requirement) and Prop. Reg. § 301.6222-1(b) (math error treatment) apply to that item, and any underpayment of tax resulting from the failure to treat the item consistently with the treatment to which the partner is bound may be assessed and collected in the same manner as if such underpayment were on account of a mathematical error.

          d. Final Administrative or Judicial Proceeding. Under §6223(b), a final decision in an administrative or judicial proceeding with respect to a partnership under the centralized partnership audit regime is binding on the partnership and all partners of the partnership. In contrast, under §6222(d), a final determination in an administrative or judicial proceeding with respect to a partner's identified inconsistent position is not binding on the partnership if the partnership is not a party to the proceeding. The IRS may conduct a proceeding with respect to the partner, that is, a proceeding that does not involve the partnership, where the partner notified the IRS of an inconsistent position under §6222(c). Section 6222(d) does not, however, preclude the IRS from conducting a proceeding with respect to the partnership.

          e. Multiple Level Processes. The Preamble to the proposed regulations states that the IRS may determine that conducting a partnership proceeding subchapter C of chapter 63 is appropriate, for example, when the IRS disagrees with both the partner's and the partnership's treatment of the item or when multiple partners treat an item inconsistently from the treatment by the partnership. In other cases, the IRS may determine that a partner level proceeding under the normal deficiency procedures in subchapter B of chapter 63 of the Code is more appropriate. This could occur the IRS determines that the partner's inconsistent treatment is incorrect. Accordingly, Prop. Reg. § 301.6222-1(c)(4)(i) clarifies that in the case of an identified inconsistency, the IRS may conduct both a proceeding with respect to the partner (a proceeding in which the partnership would not be involved) and a proceeding with respect to the partnership. Prop. Reg. § 301.6222-1(c)(4)(ii) provides that any final decision with respect to an inconsistent position identified in a notice to the IRS under§ 6222(c) in a proceeding to which the partnership is not a party is not binding on the partnership.

4. Partnership Representative. The new important person under the BBA partnership level audit rules is the partnership representative. A partnership representative has sole and exclusive authority to represent the partnership before the IRS in a BBA audit, appeal or in litigation. A partnership representative is not required to be a partner or member of an LLC taxable as a partnership but is required to have a substantial presence in the United States. It is a new factor introduced by Congress in the BBA that is bound to be controversial and requires careful drafting in the operating agreement of the rights and obligations to the partners or members by the partnership representative. The agreement should also address issues as to the selection and removal of the partnership replacement and the appointment of a successor. The proposed regulations provide further details of the partnership representative.

          a. Eligibility to Serve as Partnership Representative. Prop. Reg. § 301.6223-1(b)(1) provides that a partnership may designate any person per §7701(a)(1), including an entity, that meets the requirements of Prop. Regs. §§ 301.6223-1(b)(2), (b)(3), and (b)(4), to be the partnership representative. The partnership representative must have a substantial presence in the United States and must have the capacity to act. If an entity is designated as the partnership representative, the partnership must identify and appoint an individual to act on the entity's behalf. The appointed individual must also have a substantial presence in the United States and the capacity to act. The partnership may appoint a partner or a non-partner, including the partnership's management company, as the partnership representative.

          b. Substantial Presence in the United States. Prop. Reg. § 301.6223-1(b)(2) provides that the partnership representative must have a substantial presence in the United States. As set out in Prop. Reg. § 301.6223-1(b)(2)(i) three criteria must be met.  First, the person must be able to meet in person with the IRS in the United States at a reasonable time and place as is necessary and appropriate as determined by the IRS. Second, the partnership representative must have a street address in the United States and a telephone number with a United States area code where the partnership representative can be reached by United States mail and telephone during normal business hours in the United States. Third, the partnership representative must have a U.S. TIN. For tax jocks who are used to keeping score, the substantial presence test used in identify a resident in §7701(b)(3) is inapplicable.

          c. Partnership Representative Entity Appointment of Designated Individual. Where the partnership designates an entity as the partnership representative (an entity partnership representative), Prop. Reg.  § 301.6223-1(b)(3) requires the partnership to appoint an individual (designated individual) as the sole individual to act on behalf of the entity partnership representative. The designated individual must meet the substantial presence requirements of Prop. Reg. § 301.6223-1(b)(2). If the partnership does not appoint a designated individual, the IRS may determine the partnership representative designation is not in effect. See Prop. Reg.  § 301.6223-1(f).

          d. Notice By IRS of Failure to Serve as Partnership Representative. Prop. Reg. § 301.6223-1(b)(4) identifies acts or events that will cause a person to lose the capacity to act and includes a catch-all provision for unforeseen circumstances in which the IRS reasonably determines that the partnership representative or designated individual may no longer have the capacity to act. In addition the partnership representative may resign or the partnership may revoke the designation. See Prop. Regs. §§301.6223-1(d), -1(e).  Alternatively, the IRS may view a designation is not in effect. There is a fair amount of detail set forth in the proposed regulations on the selection, removal and replacement of the Partnership Representative (and designated individual).

          e. Designating the Partnership Representative. Per Prop. Reg. §301.6223-1(c) a partnership must designate the partnership representative on the partnership's return filed for the partnership taxable year. A partnership must designate a partnership representative separately for each taxable year. A designation for one taxable year is not effective for any other taxable year. A designation for a partnership taxable year remains in effect until the designation is terminated , revoked or determined not to be in effect. See Prop. Regs. §§301.6223-1(d), -1(e), -1(f).  The proposed regulations provide, in a change from prior law, that a partnership representative designation may not be changed (either by resignation or revocation) until the IRS issues a notice of administrative proceeding to the partnership, except when the partnership files a valid administrative adjustment request (AAR) in accordance with  §6227 and Prop. Reg. §301.6227-1. The proposed regulations provide that the partnership or the partnership representative may change the initial designation of the partnership representative simultaneously with filing an AAR, but the form used for filing an AAR may not be used solely for the purpose of changing the partnership representative.

          f. Designation of the Partnership Representative by the IRS. Prop. Reg. § 301.6223-1(f)(1) provides that if there is no designation of a partnership representative in effect, the IRS may select any person to serve as partnership representative. The regulations require that the IRS notify the partnership of its designation by providing the partnership with the name, address, and telephone number of the new partnership representative.  See Prop. Reg. §301.6223-1(f)(5). Prop. Reg. § 301.6223-1(f)(5)(ii) allows the IRS to designate any person as the partnership representative based on factors set forth in the regulations.  Somewhat heavy handed perhaps, but the proposed regulations provide that once the IRS has designated a partnership representative, the partnership may not revoke that designation without the consent of the IRS. See Prop. Reg. § 301.6223-1(f)(3)(iii).

          g. Authority of the Partnership Representative. As set forth in §6223 under the BBA, as repeated in Prop. Reg. §301.6223-2, the partnership and all partners are bound by the actions of the partnership and the partnership representative and by any final decision in a proceeding brought under subchapter C of chapter 63. The partnership representative binds the partnership and its partners by the partnership representative's actions, including: agreeing to settlements, agreeing to a notice of final partnership adjustment, making an election under §6226, and agreeing to an extension of the period for adjustments under §6235. In addition, all persons whose tax liability is determined, in whole or in part, by taking into account, directly or indirectly (such as indirect partners), adjustments to any item within the scope of the centralized partnership audit regime under §6221(a), by the IRS in a notice of final partnership adjustment in a proceeding brought under subchapter C of chapter 63, or in a final decision of a court under subchapter C of chapter 63 are similarly bound. This binding authority extends to all partners, including those partners who have elected out of the centralized partnership audit regime under §6221(b). Prop. Reg. §301.6223-2(c)(1) provides that partners may not participate in or contest the results of an examination or other proceeding involving a partnership without permission of the IRS unless acting at the Partnership Representative or designative representative. Proposed § 301.6223-2(c)(1) also provides that no other person, regardless of whether that person's tax liability is affected by the actions of the partnership, may participate in the partnership proceeding under subchapter C of chapter 63.

          h. Fiduciary Obligations Of the Partnership Representative? Perhaps some good news finally? Well the answer is no at least with respect to the IRS. Prop. Reg. § 301.6223-2(c)(1) states that the broad authority of the partnership representative may not be limited by state law, partnership agreement, or any other document or agreement. Any action taken by the partnership representative with respect to the centralized partnership audit regime under the Code and federal tax regulations is valid and binding on the partnership for purposes of tax law regardless of any other provision of state law, partnership agreement, or any other document or agreement. Prop. Reg. § 301.6223-2(c)(2)(i) provides that the partnership representative, by virtue of being designated, has the authority to bind the partnership for purposes of the centralized partnership audit regime. Similarly, under proposed § 301.6223-2(c)(2)(ii), the designated individual's authority to bind the partnership representative and the partnership is derived by virtue of the appointment of that designated individual.


[1] See, in general, August and Cuff, “The TEFRA Partnership Audit Rules Repeal: Partnership and Partner Impacts”, ALI-CLE Video Webcast (7/17/2016); August, “The Good The Bad, and Possibly the Ugly in the New Audit Rules: Congress Rescues the IRS From Its Inability to Audit Large Partnerships”, Business Entities (WG&L)

(May/June 2016);  August, “Entity-Level Audit Rules Continue to Pose challenges for Partners”, Parts 1 and 2,  Business Entities (WG&L) (Nov./Dec. 2014) (July/Aug. 2015). Section 1101, Pub. L. No. 114-74, the Bipartisan Budget Act of 2015. Section 1101 repeals the current rules governing partnership audits with a new centralized partnership audit regime that, in general, assesses and collects tax at the partnership level. On the new audit provisions generally, see New York State Bar Association, Tax Section, Report No. 1347, “Report on the Partnership Audit Rules of the Bipartisan Budget Act of 2015” (May 25, 2016).

[2] See IRS Notice, 2016-23, supra, section III.01

“(1)The election out of the new centralized partnership audit regime under section 6221(b) for partnerships that are required to furnish 100 or fewer Schedules K-1, including whether any type of partner, other than those types of partners specifically identified in section 6221(b)(1)(C), should be treated under rules similar to the special rules applicable to S corporations…”

(2) Designation of the partnership representative under section 6223, including:

a. Any limitations on who may be designated as a partnership representative;

b. The definition of substantial presence in the United States; and

c. Designation of the partnership representative by the IRS in cases where the partnership fails to designate a representative or the designation is not in effect.

(3) The determination of the imputed underpayment under section 6225, including:

a. How the netting calculation under section 6225(b)(1) should work; and

b. How character changes, restrictions, and limitations under the Code are taken into account.

(4) Modification of the imputed underpayment under section 6225(c), including:

a. The mechanics and timing for requesting modification and documentation to be provided to support the request for modification;

b. Implementation of the modification, with respect to publicly-traded partnerships, for certain specified passive losses under section 469;

c. The effect of unrelated business taxable income of a tax-exempt entity on the modification procedure relating to tax-exempt partners; and

d. Any other issues and factors that should be considered when formulating the modification procedures.

(5) How an adjustment made by the IRS under section 6225 that does not result in an imputed underpayment should be taken into account by the partnership.

(6) The election to use the alternative to payment of the imputed underpayment by the partnership under section 6226, including:

a. How to make the election, the time for providing information to the IRS, the information that should be required to be included with the election, and the form and content of the statement of adjustments to be provided to the partners and the IRS;

b. When the statements should be filed with the IRS and furnished to partners;

c. How the adjustments in the final notice of partnership adjustment should be reflected if the adjustments are changed as a result of a court proceeding;

d. Generally, how tax attributes should be taken into account for intervening years between the reviewed year and the adjustment years;

e. How adjustments are taken into account by partners under the alternative to payment of the imputed underpayment by the partnership under section 6226; and

f. The consequences that result when a partner fails to account for adjustments as required under section 6226(b), including how tax attributable to those adjustments is assessed and collected.

(7) How a partnership makes an administrative adjustment request (“ AAR” ) under section 6227 and the effect of such a request, including:

a. The circumstances in which a partnership may want to file an AAR;

b. The mechanics for how to file an AAR and pay any imputed underpayment;

c. How partnerships should account for adjustments requested as part of an AAR;

d. What steps the IRS should take upon receipt of an AAR; and

e. What opportunities the partnership has for review of IRS actions taken with respect to an AAR.

(8) The effect of adjustments on the basis of the partners in their partnership interests and the basis of the partnership in its assets.

(9) The rules for consistent filing of partner returns, including:

a. The rules for notifying the IRS of an inconsistent position;

b. The treatment of partners that properly file such notification; and

c. Whether, and to what extent, the existing framework for inconsistent partner returns and notification of inconsistent partner returns under TEFRA should apply.

(10) The effect of bankruptcy and the treatment under the new partnership audit rules where a partnership ceases to exist.

(11) Procedural rules, including:

a. Notices of proceedings and adjustment;

b. Rules regarding assessment, collection, and payment of the imputed underpayment;

c. The computation of penalties and interest;

d. Judicial review of partnership adjustments; and

e. The period of limitations on making adjustments under section 6235.

(12) Any other issues relevant to the implementation of the new partnership audit rules, including topics related to any of the above listed issues but not specifically identified in the list above, e.g., the interaction of these rules with international tax provisions.” Written testimony of Commissioner of Internal Revenue, John A. Koskinen before the Senate Finance Committee on IRS Budget and Current Operations (2/3/2015); Government Accountability Office, “Large Partnerships: With Growing Number of Partnerships: IRS Needs to Improve Audit Efficiency”, GAO-14-732 (9/18/2014) that the audits of large partnerships, many of which are multi-tiered in ownership structure, had shrunk to an unacceptably low rate. Large partnerships were identified in the GAO Report as partnerships with $100 million or more in assets and 100 or more direct and indirect partners. The GAO further reported that from 2002 to 2011, the number of large partnerships more than tripled to more than 10,000 in number which hold trillions of dollars of assets. By 2011, approximately 73% of the “large partnerships” were in the finance and industry sectors. The audit rate for large partnerships was less than 1%.  

[3] Under TEFRA, §6231(a)(1)(B) (prior to amendment by the BBA) specifically states that a husband and wife were treated as a single partner for purposes of determining whether the partnership had 10 or fewer partners (the TEFRA small partnership exception). Under the BBA,  husband and wife are each counted. Prop. Reg. §301.6221(b)-1(b)(2)(iii), Exs. 1 and 2.


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Part Two, "IRS And Treasury Issues Needed Guidance On Centralized Partnership Audits: Proposed Regulations Issued"

Part Three, "IRS And Treasury Issues Needed Guidance On Centralized Partnership Audits: Proposed Regulations Issued"