Key Takeaways:

  • A tax matters partner (TMP) is the partner responsible for communicating with the IRS on behalf of the partnership under the old TEFRA audit rules.
  • The Bipartisan Budget Act of 2015 (BBA) largely replaced the TMP with a partnership representative, who has broader authority to bind the partnership in IRS matters.
  • Partnerships can face tax assessments at the entity level, shifting liability from individual partners to the partnership itself, but can elect to push the liability to reviewed-year partners.
  • Designation requirements for a TMP or partnership representative include being a U.S. person with a domestic address and availability for IRS meetings.
  • Partnerships can limit the representative’s authority in their operating or partnership agreement and may opt-out of the BBA rules if qualified.
  • Proper designation of a representative is critical for avoiding IRS-selected representatives and for managing audits, elections, and litigation.

What is a tax matters partner? This individual is a member of a partnership who is responsible for representing the business to the IRS in a specific tax year. This includes providing tax information to other members, preparing and filing tax returns, and managing audits and investigations. The partnership may also give them additional responsibilities, such as making tax elections on behalf of the business. The IRS has specific requirements that specify how the tax matters partner is designated.

Bipartisan Budget Act of 2015

The Bipartisan Budget Act of 2015 made substantial changes to rules for partnership IRS audits, including replacing the tax matters partner with a partnership representative. This individual has expanded responsibilities compared to a tax matters partner, so it's important to indicate the responsibilities you want your tax representative to have in your operating or partnership agreement.

Tax matters partners have limited authority and are currently only used for TEFRA auditing processes. In contrast, partnership representatives have nearly unlimited authority to deal with the IRS on behalf of the partnership. This includes binding legal processes such as audits, litigation, and settlement authority.

While a tax matters partner must be a member of the partnership, the partnership representative does not. If you do not designate a representative, the IRS may select one on your behalf.

Companies can limit the authority of their partnership representative with provisions in the operating agreement, such as requiring a partnership vote for certain actions, establishing how this individual is elected and removed, and imposing a level of duty to make an unbiased decision.

Transition from Tax Matters Partner to Partnership Representative

Under the BBA audit rules, the concept of a tax matters partner is largely historical. A partnership representative (PR) now serves as the primary point of contact for all IRS audit activity. Unlike the TMP, the PR has exclusive authority to bind the entire partnership in tax matters, including:

  • Receiving IRS audit notices
  • Negotiating and settling audit findings
  • Making tax elections on behalf of the partnership
  • Deciding whether to pursue litigation or accept IRS adjustments

Key differences from a TMP include:

  • Scope of authority: A TMP had limited authority under TEFRA; a PR can make decisions without consulting other partners unless the partnership agreement restricts that authority.
  • Eligibility: While a TMP had to be a partner, a PR can be any individual or entity with a substantial U.S. presence.
  • IRS fallback: If no PR is designated, the IRS can appoint one, who may make binding decisions without partner input.

Updating partnership and LLC operating agreements to reflect this change is essential to ensure the correct designation and avoid unwanted IRS selection.

Partnership Level Liability

Another major change in the legislation removes the burden of tax collection from the IRS and places it on the partners. They, in turn, must determine who contributes funds to pay the business taxes.

The partnership representative has sole authority to bind the partnership and must have a substantial living and/or working presence in the United States. This is defined as:

  • Being available for in-person IRS meetings in the U.S.
  • Having a U.S. street address and phone number.
  • Having a taxpayer ID number in the U.S.

Partners no longer need to participate in audits. As of January 1, 2018, partnerships must either designate a representative for the tax year or opt-out of the new rules. The latter option is available for partnerships that have fewer than 100 partners, based on the number of K-1 forms issued by the organization each year. All partners must be either individuals, S or C corporations, estates of deceased partners, or foreign entities with C corporation election. If the business opts out, the IRS will assess each partner's tax on an individual basis.

Responsibilities and Risk Management for Partnerships

The shift to partnership-level liability has practical implications for how partnerships manage tax risk:

  1. Tax Burden Shifts: The partnership may bear liability for underpayments, potentially affecting current partners rather than those from the reviewed year.
  2. Push-Out Election: Partnerships can elect to shift the tax burden to the reviewed-year partners by issuing statements to each partner outlining their share of adjustments.
  3. Operating Agreement Updates: Agreements should define:
    • How the partnership representative is appointed or removed
    • Voting requirements for key tax decisions
    • Procedures for allocating audit-related liabilities among partners
  4. Risk Mitigation: Proactive planning, including opt-out elections for eligible small partnerships and clauses for capital contributions in case of entity-level assessments, can protect partners from unexpected financial exposure.

Tax Assessment at the Partnership Level

Before the new legislation, the IRS collected any tax liability from individual partners. Now, if taxes are underpaid, the assessed balance will be collected from the partnership itself. This business entity has never before been required to pay federal income tax.

Underpayment for the tax year in question, referred to as the reviewed year, will be assessed and collected in the year in which the audit takes place (the adjustment year). This means that partners during the adjustment year — not those who were partners in the reviewed year — will bear the brunt of the economic tax burden. However, this burden can be reallocated in the partnership agreement.

Underpayment can be avoided if a partner files an amended return for the reviewed year and pays the past-due tax or if the company can prove that the underpayment can be allocated to a partner who has tax-exempt status or a C corporation. Partnerships can also transfer liability from the business to the partners with a push-out election. This requires a statement that reflects each historic partner's share of the audit adjustment.

Partnerships that plan to opt-out of the new laws should add a provision to their operating agreement limiting the transfer of partnership shares. This prevents the partnership from being unable to opt-out by taking on a partner who does not qualify, such as a flow-through tax entity like a limited liability company (LLC).

Opt-Out Eligibility and Strategic Considerations

Certain partnerships may opt out of the centralized partnership audit regime if they meet the following conditions:

  • Fewer than 100 partners, with the count based on K-1s issued.
  • All partners are eligible entities such as individuals, C corporations, S corporations, or estates.
  • No pass-through entities (like other partnerships or disregarded entities) are partners.

Benefits of opting out include:

  • IRS audits are conducted at the individual partner level.
  • No partnership-level liability for adjustments.
  • Partners retain direct control over their tax reporting and disputes.

However, opting out may increase administrative burdens if multiple partners are audited individually. Partnerships with frequent ownership changes may also risk ineligibility, so limiting transfers to eligible partners in the operating agreement is recommended.

Frequently Asked Questions

1. What is a tax matters partner? A tax matters partner (TMP) is the designated partner who represents a partnership in IRS tax matters under the former TEFRA audit rules.

2. Who can serve as a partnership representative? Any person or entity with a substantial U.S. presence can serve as a partnership representative, including non-partners.

3. Do partnerships still need a tax matters partner? Only partnerships under old TEFRA audits might use a TMP. Most partnerships now operate under the BBA regime with a partnership representative.

4. Can the IRS choose a representative for us? Yes. If no representative is designated, the IRS can appoint one, and their decisions are binding on the partnership.

5. How can a partnership opt out of entity-level audits? A partnership can opt out if it has fewer than 100 eligible partners and no pass-through entities as partners. The election must be filed annually with the partnership return.

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