Recent Changes to the Tax Matters Partner Designation May Prove Costly to the Unwary

One choice all joint venture devotees face in negotiating each new venture is who to designate as the tax matters partner. Recent changes to the law make this decision much more important and may prove costly to those who are not aware of the new audit rules.

The Current Regime

In 1982, Congress passed TEFRA, which created the tax matters partner designation to facilitate the Service's ability to audit partnerships. Generally speaking, the tax matters partner is vested with the duty to communicate with the Internal Revenue Service and to keep his partners informed of all administrative and judicial proceedings. Notwithstanding the Government's desire to streamline the audit process, TEFRA has proven to be too cumbersome to achieve this objective.

Congress Further Streamlines the Audit Process, Which May Place Tax Liability on Current Partners

With the proliferation of partnerships and limited liability companies as a means to conduct business and structure investments, Congress passed the Bipartisan Budget Act of 2015, which is intended to further streamline the Service's ability to audit partnerships. The new rules provide for the appointment of a partnership "representative," who has far greater powers than those provided to the tax matters partner. In fact, the partnership representative is vested with the sole authority to act on behalf of the partnership during an audit.

This new designation is extremely powerful as the new rules provide if the IRS has determined that an underpayment has occurred, the default rule is that the partnership will be liable for the deficiency. If there has been no change in ownership since the inception of the partnership, then the consequences of the partnership satisfying the deficiency may make little economic difference. However, if partners have been redeemed or new partners admitted, the burden may be placed on parties who had no interest in the partnership in the year to which the tax liability is attributable. In other words, the new rules may result in one partner indirectly bearing the burden of a tax liability that should be borne by a former partner.

The partnership can elect out of the default rule with respect to underpayments if it timely furnishes to each partner for the year under audit a statement of such partner's audit adjustment. This allows the partnership to push the tax burden to the partners who should bear such underpayment, even though they may no longer be partners or their interests in the partnership have changed.

Transition

Although the new rules will govern partnership audits beginning after 2017, partnerships may elect to apply them on an expedited basis. Given the potential economic consequences of the new regime, it is advisable to address these issues in all new venture agreements and amend old venture agreements as needed based on the anticipated life of the venture.