Business and International Tax Blog

Proposed Regulations Previously Issued on the Partnership Representative: Changes Made in Final Regulations

            Selection of Partnership Representative: Selection of Entity as the Partnership Representative

The Service and the Treasury issued proposed regulations under Section 6223 (REG-1316118-15) (82 FR 27334) on June 14, 2017 (June 14 NRPM) pertaining to a host of provisions contained in the BBA. Among the provisions covered was the partnership representative rule. The proposed regulations on the partnership representative rule covered a broad range of topics, including eligibility to serve as the partnership representative, designating and changing a partnership representative, and the binding effect and authority of the partnership representative. For example, Prop. Reg. §301.6223-1(b)(1) states that a partnership may designate any “person”, as defined in Section 7701(a)(1), including an entity, that meets the requirements under the regulations to serve as the partnership representative. Section 7701(a)(1) defines “person” to include an individual, trust, estate, partnership, association, company or corporation. Provided the person is otherwise eligible, the partnership may appoint a partner or a non-partner, including the partnership's management company, as the partnership representative. Under Prop. Reg. §301.6223-1(b)(3), if an entity is designated as the partnership representative, the partnership must identify and appoint an individual (the “designated individual”) to act on the entity's behalf. If the partnership does not appoint a designated individual, the IRS may determine that the partnership representative designation is not in effect and the IRS can appoint a successor partnership representative. The proposed regulations stated that a “person” for this purpose did not include a disregarded entity such as a single member LLC that does not make a so-called “reverse default election” to be regarded as an association taxable as a corporation under the check-the-box regulations. This rule drew a fair amount of criticism in the comments. The final regulations in Treas. Reg. §301.6223-1(b)(1) permit a disregarded entity to act as a partnership representative provided it appoints a designated individual to act on behalf of the disregarded entity. [1]The final regulations require both the disregarded entity and designated individual to each have a substantial presence in the United States per Treas. Reg.§301.6223-1(b)(2).

In a welcome reform, Prop. Reg. §301.6223-1(b)(1) has also been revised  in the final regulations to clarify that a partnership may designate itself as its own partnership representative. This change permits the partnership to then designate the individual person it believes is most appropriate to serve,(presumably a majority partner or designated individual by a majority in interest of the owners), provided the designated person satisfies the “substantial presence” test and is an eligible “designated individual.” The partnership, if designated as the partnership representative, must also have a substantial presence in the U.S. Where a partnership elects-out of the BBA under Section 6221(b), The final regulations state that a partnership is not required to designate a partnership representative.

The partnership representative (individual) must be designated at all times by the partnership. In this regard the Service rejected a comment which suggested that a partnership not be required to appoint a designated individual to act for an entity partnership representative until of notice of audit   is issued or the partnership files a valid administrative adjustment request under Section 6227. This suggestion was not adopted. The final regulations maintain the rule that in the case of an entity partnership representative, the partnership must appoint a designated individual at the time the partnership representative (i.e., the partnership) is designated. The partnership representative makes the initial designation of the partnership representative on the partnership’s return. A separate designation is required for each taxable year of the partnership.

Another comment made to the Service suggested that the entity partnership representative itself, and not the partnership as a whole, should appoint the designated individual. The final regulation requires the partnership must appoint a designated individual, and the designated individual must be identified on the partnership’s return for the applicable taxable year. The Preamble to the final regulations stated that this rule ensures, to both the partnership and the IRS, at the time the partnership return is filed who has the authority to act on behalf of the partnership for the taxable year for which the return is filed for purposes of the centralized partnership audit regime. It should be noted that an entity which is the partnership representative does not have the ability to act under the BBA.

            Substantial Presence in the United States Requirement

Where an entity is designated as a partnership representative, as mentioned, both the entity partnership representative and the designated individual must meet the substantial presence test, which is not the same standard as that use for establishing residency under Section 7701(a)(3).

Prop. Reg.§ 301.6223-1(b)(2) instructs that a person will satisfy the substantial presence test if three conditions are satisfied: (i) 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; (ii) the partnership representative must have a street address in the United States and a telephone number with a U.S. area code where the partnership representative can be reached by U.S. mail and telephone during normal business hours in the United States; and (iii) the partnership representative must have a U.S. taxpayer identification number.

Comments were received by the Service stating the first two conditions were ambiguous or vague as to what is considered a reasonable time and place for meetings between the partnership representative and the IRS. The final regulations responded to this concern in issuing revised Treas. Reg. §301.6223-1(b)(2) by granting the partnership and the IRS maximum flexibility to determine mutually convenient times to meet. Also relevant to the IRS as to the place for the examination is Treas. Reg. §301.7605-1(a), which provides “[T]he time and place of examination…are to be fixed by an officer or employee of the IRS…to schedule a time and place...reasonable under the circumstances.” The Preamble further discussed comments it received endorsing a “safe harbor” for meeting the substantial presence test that would allow the partnership to designate a location in the U.S. for purposes of communications between the partnership representative and the IRS. The safe harbor rule was rejected. Curiously, frequently the partnership representative will execute a power of attorney (Form 2848) in favor of one or more individuals of a law or accounting firm to represent the partnership at the audit or administrative appeal.

            Partnership Representative’s Capacity-to-Act Rule Repealed

Prop. Reg. § 301.6223-1(b)(4) listed five specific events that would result in a partnership representative’s incapacity to act as a partnership representative and included, as a residual category, any unforeseen circumstances in which the IRS reasonably determined a person may no longer have the capacity to act. If a partnership representative lost the capacity to act under Prop. Reg. § 301.6223-1(b)(4), the IRS could determine that the designation of the partnership representative or appointment of a designated individual was not in effect.

Despite receiving many comments in this area to expand the types of situations where capacity to act no longer was present, such comments were not adopted.rejected. Instead, theThe final regulations went one step further and removed the capacity-to-act requirement from the final regulation so that the capacity issue would be approach on a facts and circumstances basis.  and with such removal, provisions setting out the various circumstances resulting in a failure to have capacity-to-act. Nevertheless,  In other words, the Preamble notes that the IRS may still determine that a designation of the partnership representative is not in effect due to circumstances that would have resulted in a partnership representative not having capacity to act because at least some of the capacity-to-act requirements overlapped with substantial presence. For instance, the IRS may determine that a partnership representative designation is not in effect if the partnership representative is incarcerated and therefore unavailable.

            Removing and Replacing the Partnership Representative

Under Prop. Regs. §§ 301.6223-1(d)(2) and (e)(2), a partnership representative designation can only be changed after the IRS mails a NAP or in conjunction with the filing of a valid AAR by the partnership under Section 6227. Comments were received by the Service that partnerships be permitted to change their designated partnership representative at any time by written notification to the IRS of such change. The IRS disagreed with granting partnerships complete flexibility to change partnership representatives. Accordingly, the final regulations maintain the rule that a partnership representative may only be changed in the context of an administrative proceeding or in conjunction with the filing of a valid AAR.

The final regulations allow a partnership to change its partnership representative prior to the beginning of the administrative proceeding. In general, the IRS will issue the partnership, but not the partnership representative, a notice of selection for examination prior to mailing the NAP to inform the partnership that it is being selected for examination. Under the proposed regulations, the partnership was not able to change the partnership representative until it received the NAP. The rule requires the partnership to be notified of the pending audit and to make the change in designation without involving the currently appointed partnership representative.

            Resignation of the Partnership Representative

Prop. Reg. § 301.6223-1(d) addressed the issue of resignations of partnership representatives and designated individuals. Prop. Reg. § 301.6223-1(d)(1) provided that a resignation by a partnership representative “may” include a designation of a successor partnership representative. However, when the resignation is made with the filing of an AAR, Prop. Reg. § 301.6223-1(d)(2) provided that the partnership representative “must” designate a successor partnership representative. Prop. Reg. § 301.6223-1(d)(3) provided that a resigning designated individual “may, but is not required to,” designate a successor. The final regulations remove the ability of a resigning partnership representative or designated individual to designate a successor. Accordingly, where a partnership representative or designated individual resigns or is removed, such should be the final action of the person under the BBA. Consistent with this principle, the final regulations prohibit a resignation at the time of the filing of an AAR.

            Revocation of Partnership Representative by Partnership

Prop. Reg. § 301.6223-1(e)(3)(i) provided that a revocation must be signed by a person who was a general partner at the close of the taxable year for which the partnership representative designation is in effect as shown on the partnership return for that taxable year. The final regulations change the proposed regulations by provided that any partner of the partnership instead of only the general partner, can sign the revocation provided such partner certifies the partner has the authority to do so. No specific ground or reason has to be stated in supporting the revocation. There also was a proposed regulation, Prop. Reg. §301.6223-1(e)(3)(ii), that stated for purposes of who could sign a revocation for an LLC, a member-manager is treated as a general partner and any other member is treated as a non-general partner. The final regulations remove this proposed regulation since the general partner distinction has been eliminated. The final regulations have also been revised to allow any person who was a partner at any time during the taxable year to which the revocation relates to sign the revocation. The partner signing the revocation does not have to be a partner on the last day of the partnership’s taxable year. The final regulations were also revised to provide that the Treasury Department and the IRS may in the future provide forms, instructions, or other guidance that would allow the partnership to revoke.

            Effective Date of Revocation or Resignation

The proposed regulations provided that a resignation or revocation of the partnership representative (or designated individual, if applicable) is effective 30 days from the date on which the IRS receives written notification of the resignation or the revocation. Comments were received objecting to the 30 day wait. For example, the partnership representative could be adjudicated as incompetent or ordered to be enjoined from serving as the partnership representative. Alternatively, the partnership representative may be incarcerated, the subject of a criminal tax investigation, convicted of a felony or of a crime that involves dishonesty or breach of trust, or become the subject of bankruptcy or receivership proceedings. In response, Treas. Regs. §§ 301.6223-1(d) and (e) are revised to provide that generally a partnership representative’s resignation or revocation is effective immediately upon receipt by the IRS. In cases where there is a revocation of a partnership representative is designated by the IRS, the final regulations provide that the revocation is effective on the date the IRS sends notification that it determined that the revocation is valid.

            Time for Changing the Partnership Representative

Under Prop. Regs. §§301.6223-1(d)(2) and (e)(2), a partnership representative can only be changed after the IRS mails a NAP, or in conjunction with the filing of a valid AAR by the partnership under section 6227. The Service rejected a comment which recommended that the IRS monitor filed changes of the partnership representative so that the designation could be changed at any time. Development of such a system, in its view, would be very costly and with little benefit. The final regulations therefore maintain that a partnership may only be changed with respect to an administrative proceeding or in connection with the filing of an AAR.

The final regulations revised Prop. Reg. §1.301.6223-1(e)(2) to allow the partnership to change the partnership representative through a revocation when the partnership is notified that the return is selected for examination (NAP). In addition, the IRS will issue the partnership, but not the partnership representative a notice for selection for audit prior to mailing of the NAP. Under the proposed regulations, the partnership could not change the partnership representative until it received the NAP. The final regulations provide the partnership with the ability to change its partnership representative before an administrative proceeding commences. The NAP can then be issued after a new partnership representative has been appointed.

The designation of the partnership representative is required to be made annually on the partnership return for that year. Note also the specific revocation procedures contained in Prop.Reg. §301.6223-1(e).

            IRS Designation of Partnership Representative

Prop. Reg. §301.6223-1(f)(1) provided that where the IRS determines that a designation of a partnership representative is not in effect for a partnership taxable year, in accordance with Prop. Reg. §301.6223-1 (f)(2), the IRS will notify the partnership and the most recent partnership representative for that partnership taxable year that a partnership designation is not in effect and provide the partnership with the opportunity to designate a successor partnership representative that is eligible under paragraph (b) of this section. The determination that a designation is not in effect is effective on the date the IRS mails the notification. Generally, the partnership may designate a successor partnership representative within 30 days of the date of notification. If the partnership does not designate a successor within 30 days from the date of notification, the IRS will designate a partnership representative in accordance with Prop. Reg. §301.6223-1(f)(5). The final regulations maintain the provisions contained in the proposed regulations.

The final regulations did clarify Treas.Reg. §301.6223-1(f)(1) in providing that the IRS is not required to notify the most recent partnership representative  if the partnership failed to designate one. The IRS rejected various comments for changes to the proposed regulations in this area including revisions concerning the IRS’ receipt of multiple revocations. Accordingly, the final regulations provide that if the IRS determines a designation is not in effect in the case of multiple revocations, the IRS will designate a partnership representative, and, unlike the general rule for IRS designation of a partnership representative, the partnership will not be given 30 days to designate a partnership representative. See the multiple revocation rule under Treas. Reg. §301.6223-1(e)(7)(ii).

The final regulations, in Treas. Reg. §301.6223-1(f)(5) provide that that IRS may not designate an IRS employee, agent or contractor as the partnership representative unless the individual is a partner in the partnership subject to an administrative proceeding although the IRS will generally avoid designating such individual as the partnership representative. Prop. Reg. §301.6223-1(f)(5)(ii) addresses factors the IRS should weigh in selecting a partnership representative. The final regulations clarify that the IRS is not obligated to search for information about the factors to be considered and is not obligated to select a particular person as partnership representative. The Preamble notes that this clarification is particularly important where a partnership is nonresponsive because the IRS may not be able to consider certain factors where some partners are unreachable and certain information is not readily available.

The final regulations note that the IRS ordinarily considers one or more of the factors when determining whom to designate as a partnership representative, with no single factor being determinative and that a person may be designated by the IRS as the partnership representative even in instance were no factor listed is applicable. See Treas. Reg. §301.6223-1(f)(5)(ii). Many comments were received concerning the partnership’s ability to revoke a partnership representative designated by the IRS where there is a bona fide dispute over the capacity of the partnership representative designated by the IRS. The rule in the proposed regulations is that the IRS must approve before the designation may be revoked.

The IRS was not impressed with this problem. First, the IRS was required to make the designation because the partnership failed to designate or made multiple revocations. Second, allowing the partnership to revoke an IRS designation undermines the purpose of the IRS designation. The final regulations retain the rule that a partnership may revoke a partnership representative designated by the IRS only with the consent of the Service.

            Authority of Partnership Representative

One of theThe unfortunate aspects of the BBA are is contained in Section 6223. First, Section 6223(a) provides that the partnership representative has the “sole authority” to act on behalf of the partnership under this subchapter. Perhaps we could live with that if that’s all that Section 6223 provided, and the new rules allowed certain partners having a certain percentage of ownership to participate in the proceedings, just as in TEFRA. Then, the second principle in Section 6223(b) demands that a partnership and all partners of such partnership “shall be bound” by any actions under this subchapter by the partnership and by any final decision in a proceeding brought under this subchapter with respect to the partnership. The partnership in effect has literally shrunk from have voting members that may number 10, 25, 50 or over 100 to simply one - just the partnership representative or, if applicable, the designated individual.

The statutory impressed power of the partnership representative seems hard to justify other than solely for the convenience of the IRS. Is that sufficient basis for enacting tax procedural rules? After all, taxpayers are supposed to be entitled to procedural and substantive due process. Section 6223 using just a few words takes due process away from the partners and centralizes the entire gob of rights into one individual. What then can the regulations under Section 6223(b) accomplish? Nothing right? Just repeat the statute.

Prop. Reg. §301.6223-2(c) attempts to prevent partners from otherwise controlling the acts and omissions of the partnership representative in representing the partnership before the IRS. It provides that no state law, partnership agreement or other document could limit the authority of the partnership representative.  Comments still were received that the final regulations should adopt principles of agency law to apply to the partnership representative and therefore, if the partnership representative acts outside of the scope of such agency or in derogation of the requirements of the agency, such action on the part of the partnership representative or designated individual would be ultra vires.

Did the final regulations buy into this “agency” concept? The answer is a firm “no”. The Preamble didn’t just stop with saying “no”, it went further. It states that “the authority of the partnership representative under federal law preempts any state law requirements.” Therefore, as set forth now in Treas. Reg. §301.6223-2(d), the final regulations provide that the failure of the partnership representative or designated individual to adhere to state law requirements “has no effect on actions taken by the partnership representative with respect to the centralized partnership regime.”  Why was it necessary for the Service and the Treasury to invoke the doctrine of “federal preemption” as to eliminate any infusion or relevance of state law on the permitted actions of the partnership representative? [2] It doesn’t matter if the partnership representative is giving the government full concessions on tax issues worthy of dispute, even litigation. What if the partnership representative has a family member under audit or a criminal investigation, and compromises the interest of the partners with the intent to help his family or perhaps it’s another partner in a different partnership that has a problem? The problem is with the partnership representative giving away bona fide issues, or agreeing to relatively unfavorable settlements, and then proceeding with push-out elections mandating payment by all reviewed year partners without any process provided to object. We get this all because the former Commissioner needs more leverage in auditing large partnerships?

The Preamble did not stop at this point it further states:

“Section 301.6223-2(d) is not intended to prevent partnerships from taking advantage of state law remedies for partnerships who wish to restrict a partnership representative's authority under state law. Rather, the regulations leave the enforcement of such restrictions to the relevant parties, which simplifies the administrative proceeding consistent with the design of the centralized partnership audit regime. Under TEFRA, significant resources were often expended by the IRS and the partnership to determine what state law restrictions might affect who could act for the partnership and under what circumstances. The centralized partnership audit regime removes this aspect of TEFRA.”

The quote tells us the government got exactly what it wanted in the BBA. It wanted to audit a partnership through one person regardless of the number of partners, and regardless of the issues involved, the tax knowledge and experience of such person, and whether such person had a fiduciary duty to the partners in representing the partnership before the IRS.

 This is one area in which TEFRA’s entity level audit regime is far better than the new law, and also fairer. Perhaps increasing the percentage of ownership required to be a notice partner would be an improvement that would make things easier on the Service. Furthermore, the law could provide that venue for an appeal lies solely in the circuit in which the partnership’s primary office is located. That change would eliminate the potential for the Service to be whipsawed by different appeals courts hearing the same issue arising from the partnership audit.

             Other Changes Made in the Final Regulations

The final regulations made several additional clarifications and amendments to the proposed regulations including:

1. A partnership representative may engage a person to act under power of attorney during an administrative proceeding and such power of attorney can participate in meetings or receive copies of correspondence. See Treas. Reg. §301.6223-2(d).
2. Despite the withdrawal of a NAP, such action has no effect on any actions taken by a partnership representative after the issuance of the NAP and before the NAP was withdrawn are still binding on the NAP. See Treas. Regs. §§301.6223-2(d), -2(e).

Summary

The final regulations issued under Section 6223 are worthy of some degree of applause in the sense that the Preamble reflects the many comments that the Service received in the project and it essentially addresses what it felt were the more important comments made. In certain instances, the Service and the Treasury took to heart a particular comment and incorporated the point in the final regulations. In many other instances, the Service and Treasury discussed many other comments it had received which did not require adoption in the final regulations and the reasons why the positions taken in such comments were either already addressed in the proposed regulations or were simply points for which the Service and the Treasury did not agree. A good job overall, but when the actual centralized partnership audits starts there this writer predicts there will be a clamor over section 6223, the partnership representative provision.

[1] Nothing in the regulations requires that the designated individual be an employee of the entity partnership representative. As set forth in the Preamble to the June 14 NPRM, an entity with no employees is permitted to be the partnership representative provided the partnership appoints a designated individual to act on behalf of that entity and both the entity and the designated individual have substantial presence in the US.

[2] The Service and the Treasury were not unaware of the adverse impact of §6223 on all partners. It simply states that the regulations facilitate the partners flexibility in setting forth their agreement and in pursuing state law remedies that may be available for a partner or third person who is in reach of a contractual obligation, fiduciary duty or was negligent in acting on behalf of others for whom he had a duty under law.