READY FOR THE NEW PARTNERSHIP AUDIT RULES: TAX, REGULATORY, AND PRACTICAL CONSIDERATIONS
As the September 15th tax deadline approaches, we want to make sure you and your clients are ready for the new partnership audit rules which go into effect for the 2018 tax year. This webinar will cover the new Partnership Representative regulations from three perspectives—legal, tax, and client service. Our team of panelists will also cover the regulations, practical considerations, and the risks of non-compliance.LEARN MORE
GET STARTED WITH CSC
This recorded webinar is a must for any tax professional or partnership seeking to understand the requirements of designating a Partnership Representative. View our recorded webinar to get the answers, tips, and deeper insight you require regarding this new regulation.
What is the end goal of the IRS?
What are the legal and tax implications of Partnership Representative?
What if a Partnerhsip Representative is NOT appointed?
Who can serve as your Partnership Representative and how can they be designated and replaced, if necessary?
What issues have been resolved and what questions are still unanswered?
Disclaimer: Please be advised that this recorded webinar has been edited from its original format, which may have included a product demo. To set up a live demo or to request more information, please complete the form to the right. Or if you are currently not on CSC Global, there's a link to the website in the description of this video. Thank you.
Annie: Hello, everyone, and welcome to today's webinar, "Ready for the New Partnership Audit Rules? Tax, Regulatory and Practical Considerations." My name is Annie Triboletti, and I will be your moderator. Joining us today are Dean Krishna of Stradley Ronon, Chris Spiegelman of Andersen Tax, and Dave Straub of CSC. And with that, let's welcome Dean, Chris, and Dave.
Dave: Thank you, Annie. This is Dave Straub with CSC. My responsibility at CSC is business development but specifically to the partnership rep service. I was part of a legal team here at CSC that worked with a law firm to determine that we would be able to offer this service and develop our service agreement.
Part of that responsibility was meeting with the IRS in Washington, D.C., and reviewing with them what would make good best practices. So I will be talking about today's subject matter from a partnership rep service perspective.
And with that, Dean, could you give us some information about your background and your firm's focus? And then we'll move on to Chris.
Dean: Sure. Thanks, Dave. This is Dean Krishna. I'm a tax lawyer with Stradley Ronon, a Philadelphia-based firm. We have eight offices in the U.S. and a network of affiliate firms in 94 countries through the Meritas Legal Alliance. We routinely draft and comment on partnership agreements, mostly in the context of M&A and our investment management and funds practices.
Chris: Hello, everybody. Thanks, Dean. Hey, everybody. I'm Chris Spiegelman, a managing director in Andersen Tax's Greenwich office, and the National Client Group Lead for the alternative investment practice here at Andersen, with over 25 years of diverse tax experience, including extensive knowledge of alternative investments in partnership, federal, and multi-state taxation.
I'm happy to be able to use that knowledge at a firm with 19 offices in the United States and 73 offices globally. Andersen is able to provide a wide range of tax, valuation, and related consulting services to all stakeholders in an alternative investment fund ecosphere, through our alternative investment, commercial, and high net worth individual practices.
Our firm is the one that's going to be completing the tax returns and putting the partnership representative in the information. And please feel free to reach out to me after the webinar for any additional information to place you in touch with any of the Andersen offices.
So now that the introductions are done, let's dive in. This is Chris Spiegelman, and let's talk about our agenda for the day. We thought we'd start with the new partnership audit rules and take you through a little history of how these came about; talk specifically about the partnership representative, which is what we're here to dive into today; talk about considerations when appointing the partnership representative; a little bit about, through some Q&A, who should serve as the partnership representative; and discuss a little more in detail the provisions and how that would look in your limited partnership agreement.
So let's dive in now and talk about these new partnership audit rules. So in history, the IRS has not done a very good job of auditing partnerships, or I should say they really don't have a good track record. There's a very low number of partnerships that were audited. And even when they were audited, they had a very low collection percentage of recovery on any adjustments.
So in 2005, under the Bipartisan Budget Act, they established new laws for auditing partnerships. Now, these new laws take effect for taxable years beginning on or after January 1st of 2018.
The new approach will, in many cases, result in the tax interest and penalties from an audit adjustment being imposed upon the partnership instead of its partners. So it's not looking out to the partners in this instance, but the partnership is responsible for it.
So we're all kind of used to in the partnership world this concept of a Tax Matters Partner, but this position of Tax Matters Partner under the old rules has been replaced by the position of a Partnership Representative. Each partnership must designate a person to serve as the partnership representative under these new rules, and the partnership representative controls all partnership audit proceedings with the IRS.
A partnership rep has duties, responsibilities, and authority that are vastly more significant than those of the tax matters partner. And as we stated, the partnership representative is effective for the 2018 tax return year, so this is perfect timing in doing this webinar as a lot of the extended partnership returns are going to be filed in the next two months. So if you haven't already, you're going to have to be naming your partnership representative on those returns that are getting filed.
And another big difference that the Bipartisan Budget Act of 2015 put in place was this new concept of the partnership representative. The person does not have to be a partner in the partnership, which is different than what we were used to in seeing the tax matters partner. The tax matters partner was generally a partner in the partnership and/or a member of the LLC. So that's yet another difference that we see in the new Bipartisan Budget Act.
So let's dive in a little more to some of the provisions of the Bipartisan Budget Act of 2015. Any adjustments to items at the partnership level are determined at that partnership level. And when an audit concludes, the IRS, in terms under the BBA, computes an imputed underpayment that the partnership is responsible for paying to the IRS. And that's one of the big differences that we've been mentioning. The partnership is responsible for paying that.
And that amount that is due will be roughly equal to any understatement of income that is found upon the audit. And they're going to go ahead and multiply that by the highest tax rate in effect for the reviewed year.1
So think about where this parity comes in right now. If you have a corporate client and an individual client, you've got rates all over the place, but they're going to use the highest tax rate in effect.
And in addition, why they're doing this is collection from the partnerships, it avoids, as we were discussing, needing to track through the tiers of partners to ultimately the top tier tax paying partner, and trying to collect from that individual. They've shifted the liability from the partners to the partnership.
So all these rules, these new rules, are applicable to all partnerships. So anybody who's filing a partnership return in the United States will be subject to these rules.
It's important to note that the tax assessment is made for the adjustment year and not the reviewed year. In terms of definition between an adjustment year and a reviewed year, the reviewed year is the partnership tax year or the actual year of return under audit. And the adjustment year is the year in which the adjustment for the reviewed year is made.
To give an example, we file a 2018 return and it goes under examination in 2021. The reviewed year is 2018, but the adjustment year is 2021. So there's a difference between those two years. And the assessments come in that adjustment year.
It's also, as I noted, that penalties are determined at the partnership level. There are no partner-level defenses that can be made to reduce those penalties. And only the partnership level statute of limitations is relevant here. There are no partner statutes of limitations. They're no longer taken into account when looking at an audit.
It is worth noting that the partnerships may elect out if they issue less than 100 Schedule K-1s. But the key, it's not just less than 100. There are some rules around that. All of those K-1s have to be issued to individuals, corporations, or estates of deceased partners. So there's no election out if you have K-1s issued or addressed to partnerships, trusts, or other disregarded entities.
So it's worth noting that this election out is an annual election. So if your partnership population changes, there is an ability later on to elect out.
It is also worth noting that even a schedule K-1 addressed to a disregarded entity solely owned by an individual will prohibit electing out of the new partnership audit rules.
Dean: Chris, this this is Dean. On that point, there was a lot of commentary when these proposed regs came out that if you have a disregarded entity owner that is ultimately owned by someone who would qualify under the ability to elect out, for example, a disregarded entity that has an individual that owns it, that that should be a permissible owner under this 100 partner rule, and the partnership should still be allowed to elect out.
Unfortunately, Treasury indicated that they would not take that comment and they indicated that they wanted to keep the new regime as broad as possible. But it did, in its Treasury decision, indicate an openness to . . . as audit enforcement unfolds over the next few years and as they get some experience, they did indicate a willingness to go back and revisit that. But for now, if you have any partner that's a disregarded entity, absolutely you're not able to elect out of a new regime.
Chris: Great. Thanks, Dean. It's also worth noting for S-corporations there's another kind of carve out rule. And that is you actually have to do a look through the S-corporation to the actual shareholders in determining the amount of schedule K-1s.
So for example, one shareholder equals one K-1 in this inclusion number. So if you have an S-corp partner, and that S-corp, in turn, has five shareholders, you've got a plus five in that inclusion number in determining the 100 Schedule K-1s number to come in under.
The other thing that's worth noting is that participation in the exam is really limited to the partnership representative. There's no more any of the other LPs or anybody partaking in this. It's strictly limited to the partnership rep.
And there are various selections that need to be made, and Dean is going to discuss some of those elections later on.
So now on to a little more about the partnership rep and some questions. So the first one we're looking at here is "Who needs a partnership representative?"
So when we look at this, we can say that all U.S. partnerships and all foreign partnerships filing U.S. returns are going to need to name a partnership representative. So each partnership must designate that partnership representative for each taxable year. And there may be only one designated partnership rep in any given taxable year.
And that partnership representative must be a person. The "person" we are defining as an individual, trust, estate partnership, association, company, or corporation. And as we're seeing, there are some entity types in there. The partnership can appoint an entity partnership representative, and that's known as an ERP, to be the partnership representative only if an individual referred to as the designated individual is chosen to act on the entity's behalf.
So the partnership, not the partnership representative, appoints the designated individual. That designated individual must meet the substantial presence in the United States test that we're going to talk about in a minute. And that designated individual, as in the case of any partnership rep, does not have to be an employee or a related party, and in this case, not a related party to the partnership representative either.
So let's talk for a minute now about this partnership representative having a substantial U.S. presence. So a person and/or the designated individual must have what they define as a substantial U.S. presence. And what that means is you need to be available to meet with the IRS in the United States at a reasonable time and place. You have to have a street address in the United States, a telephone number with a U.S. area code, and have a U.S. Taxpayer Identification Number.
Now, what do we mean by a U.S. Taxpayer Identification Number? That would be a Social Security Number, a preparer Tax Identification Number, or if you're a foreign individual and have applied and gotten a tax identification number.
Now I'm going to turn the presentation over to Dean.
Dean: Thank you, Chris. Now we're going to speak about some considerations in choosing a partnership representative. And the first thing, and you can see it there highlighted, we can't emphasize it enough that choosing a partnership representative, it's a big deal. And that's probably even an understatement.
So here are some snippets of the Treasury regulations that outline the powers of a partnership representative. The big takeaway is a partnership representative's actions are conclusive and binding on the partnership.
And I wanted to note that that doesn't mean the partnership representative can't go back and contract with others. And that's one of the themes that will emerge in the rest of the presentation, is that the partnership agreement and inside agreements really can limit and shape what the partner representative can or can't do.
But with respect to the IRS, the partnership representative has broad powers that it can't be limited. But again, other agreement amongst the partnership representative and the partnership itself or partners can limit what the partnership representatives can do.
And the next bullet is that nobody who's not a partnership representative has any automatic right to participate in IRS matters. And this is different, for the previous regime was the tax matters partner regime. And a lot of times in partnership agreements you simply saw one sentence that designated who the tax matters partner was. And by law, the tax matters partner needed to give notice to the other partners when there was an audit. Frequently, the other partners could participate in an audit. But here, the other partners cannot do that. They don't have a per-se right to do that. It's all on the partnership representative.
Moving on to the next slide. The first point there is that the partnership representative designation is specific to a tax year. In other words, it's a year-by-year designation, and the regulations make it clear.
In the given example, for example, if 2019 the partnership return chose a partnership representative, but in the 2020 partnership return, the partnership chose a second partnership representative, that choice of the second partnership representative does not supersede the choice with respect to the first year with respect to 2019.
Although we do give the advice that . . . a lot of times partnership audits span multiple years. For example, if there is one item like depreciation which could affect different years, you really want the same partnership representative. You want some continuity, because there might be some decisions to be made across years.
The second bullet on the page is that you can use the power of attorney to interact with the IRS. So the partnership representative can bring in outside consultants as needed, and those outside consultants could speak with the IRS. Again, the regulations make it clear that just because somebody is able to speak with the IRS, none of that dilutes the power, or the partnership representative. It's only the partnership representative that has binding authority, and it's only the partnership representative that can speak on behalf of the partnership to the IRS.
The rest of the slide concerns how do you change a partnership representative. Some options are either the partnership representative resigns, or the partnership could revoke who the partnership representative is.
But in both of these instances, the resignation and the revocation could only happen, essentially, after an audit begins. So if a partnership changes its mind, but an audit hasn't commenced yet, the regulations give a good example that that is an invalid revocation by the partnership, and partnership representative designation would stay in effect.
And if a partnership were to revoke a partnership representative for a particular year, that revocation needs to be signed by a partner in the reviewed year. So to use Chris' terminology and example from earlier, if we have 2018 as the reviewed year, but it's currently 2021, i.e. it's currently the adjustment year, if a partnership wants to revoke its partnership representative with respect to that 2018 reviewed year, the revocation needs to be signed by a partner who was a partner in 2018.
And the IRS has reserved the right to determine that a partnership representative destination is not in effect. We haven't seen how that plays out yet, but certainly if a blank is left on a return, for example, the IRS could choose a partnership representative. We'll get into that later.
And I should note also that this is a form, Form 8979, which is used to revoke a partnership representative designation. Again, this new partnership audit regime only started for the year 2018, so we haven't really seen audits yet for the year 2018. So most people would not have filed this form yet, and we're going to see how this plays out in real life.
A couple more points on this slide. The partnership revocation of a partnership representative has to be in writing to the IRS. And same thing if a partnership representative were to resign, the regulations require the IRS to, within 30 days, let the partnership and the partnership representative know if the IRS has accepted the revocation. And again, we haven't really seen examples of why the IRS might reject a revocation or resignation. And so it'll be interesting to see how that plays out.
And one last point on this slide is that if a partnership were to cease to exist, since the reviewed year . . . and again, we're going to keep the example of 2018 being the reviewed year. And let's say it's 2021 now. The IRS has broad discretion to determine that the partnership doesn't exist anymore, or that it ceased all its activities. And if that is the case, then the IRS could seek out the partners for the reviewed year similar to the old regime.
And before we began the next slide, let me ask, Dave, what do you see with respect to your new customers signing up and getting comfortable with the fact that the partnership representative, in other words, in your case, CSC, has binding authority?
Dave: Yeah, great question, Chris. So actually, it's one of the reasons why we're actually sought out to be the partnership representative, because that binding authority. But in reality, most of our new customers are coming from jurisdictions outside of the U.S. because one of the requirements for the partnership rep is they have to be principally located in the U.S. and able to meet with the IRS when they want to meet.
So most of our new customers are from jurisdictions outside of the U.S. for those partnerships that don't have someone principally located in the U.S.
But we have also had conversations with U.S. partnerships that, as a result of that binding authority element, the partnerships, the partners themselves, don't want to give one partner binding authority. Instead, they look to have a third party fulfill that role, which really levels the playing field amongst all the partners.
And the way that we give comfort to our clients is there's a service agreement that stands between us and the client, and actually gives us directions on the actions that we're able to take and that we would take once we receive a letter from the IRS. So it's really the service agreement that serves as a contract between us and the partnership that gives them that comfort, Dean.
Dean: Thank you, Dave. And moving on to the next slide that begins with the "Powers of the Partnership Representative," some of these we've touched on before, and now we're giving you some citations to the code and the regulations.
The partnerships representative represents the partnership before the IRS. And here, we have a list of what the partnership representative specifically can do. It can extend the partnership statute of limitations. It could bind all the partners to a settlement agreement. It can accept offers, reject offers. And the last thing on there is it can make a push-out election.
There are a number of elections in this new partnership audit regime that the partnership representative can make. One of them we talked about earlier, which is the election out. And I think that the prevailing advice and advice we certainly give is if a partnership can elect out of the new partnership audit regime, it should just for simplicity sake. But also, if there's a push-out election that's made, that would be perhaps second best.
And a push-out election is similar to an election out where we have this adjustment year. Again, let's say it's 2021. And a push-out election is made by the partnership representative to push the liability of the partnership for the reviewed year back to the partners. In other words, [inaudible 00:25:10] back in the old regime.
And a lot of times, in deal work, you will see if a buyer comes in for a company, the buyer might require an election out if it hasn't been made yet for a particular year, or if a return has already been filed, it might require a push-out election. And that push-out election is made within 45 days after a final adjustment by the IRS in an audit.
One downside of the push-out election is that there's a 2% interest charge above and beyond the normal interest charged. So in other words, typically it's a short-term AFR plus 3% for interest, but in this case, it would be short-term AFR plus 5%.
But again, most importantly, it relieves the partnership of any liability and it pushes it back to the partners, similar to the old regime.
The next bullet is, again, the partnership representative is not required to consult or receive approvals of its actions, unless it's by contracts. That's a separate area that we spoke about earlier. The partnership represent can bind itself separately with the partnership or with partners. But with respect to the IRS, it's only the partnership representative that has all the powers.
And the last bullet on this point is some powers of the partnership representative. They can hire outside advisors, they could be in charge of the outside advisors, could bind a partnership to certain costs and expenses. And one change from the tax matters partnership regime is the partnership representative can charge the partnership for its time as well.
And the last part of this slide is what if there is no partnership representative designation in effect? In other words, what if one is not chosen on a return for a particular year? Typically, the IRS will send a notice to the partnership, and the IRS can appoint a partnership representative.
And another instance in which the IRS could appoint a partnership representative is if there are multiple revocations of a partnership representative in a 90-day period.
I should note the regulations do give factors that the IRS should consider in choosing a partnership representative if it comes to that. However, our advice is to always choose somebody rather than leave it in the hands of the IRS.
And with that, for the next slide, I'm going to turn it back to Chris.
Chris: Thanks, Dean. So the next two slides, we're going to ask some questions and come up with some answers here. We've been talking about the broad authority that's now being given to the partnership representative, so let's give some thought now to who should serve as that partnership representative.
The first question we've asked here is "Does the partnership have an applicable person in the United States, and are any of these the right person to be the partnership representative?"
You can't just automatically think, "All right, I've got somebody in the U.S. Boom, they're the partnership representative." A lot of foreign funds and foreign partnerships may have a sales officer or business development office here in the United States, but you really have to ask yourself if that's the right person to be given this broad authority under the rules of the partnership representative.
The next question is "Are potential conflicts fully vetted and addressed?" Generally, we're kind of used to picking a general partner as a tax matters partner or a managing member. But we need to kind of dive down and think about whether it's the designated individual or the actual individual we name as the partnership rep, what conflicts are there within this. And along with that, who will accept the possible liability going along with this?
Keep in mind that the partnership representative is going to be able to bind the partnership to an outcome under an audit. Again, the partners themselves do not have a right to participate in the process, which does leave you open for somebody to not be too happy with the outcome.
And again, the next point is "Who do you want to have that binding authority? Will binding authority upset any balance among the partners?" When I think about this, I think about a family partnership, a large family partnership, a family office. Everything is fine as long as everything is fine. But there's a very strong possibility that what's in the best interest of one family member, or one partner, will not be in the other. And you could upset that applecart really poorly in terms of the balance among the partners. In that case, could come within a general partner being the rep as well.
"Will the designated individual be around when the IRS sends a letter?" Great question. I'll use the three-year statute of limitations when I'm thinking about this. We could have five years, but we're going to assume that we're going to file correct tax returns here and there's going to be nothing materially wrong with them or no fraud, so we won't have an extended statute on them.
So when we're looking at this, is somebody going to be around when that IRS sends a letter? Are you going to name a CFO that is in the sunset of his career and may not be around? What happens when you name an employee and that employee is no longer an employee? Those are all factors to be considered.
"Who is best positioned to coordinate the right resources to get the best outcome?" Is that a managing member, or is that the general partner? Who is this that we have to think about? Who is this individual or entity that we're going to name that is the right resource to get the best outcome? We're all looking for the best outcome to be generally a no change letter issued.
"Will the designated individual have the bandwidth to perform the role?" That's a really good question right there. This is going to take whoever's time. Currently, right now, under the current rules, a lot of it is outsourced, but there's no way that everything can be outsourced. In this instance, that partnership rep is going to have to have big input any time that an audit goes underway.
And also, "If handled within the partnership, will the partnership rep have access to the books and records and have adequate tax expertise and be able to balance the binding authority of the rep with the normal job responsibilities?" That's another really big thing to think about, where your books and records are versus where that person is. Will they have the adequate expertise to understand what those books and records are saying? Do they have that proper accounting background? Do they have that proper tax expertise to take the entity completely through the audit?
So moving on, "Will the same person serve as partnership representative for subsequent tax years or on multiple partnerships?" A good question. As we mentioned earlier, that doesn't necessarily have to be the case. Every year on the tax return when it is filed, you get to make the designation of a partnership representative for that year. But it's worth noting is the person you choose going to be there and be on for subsequent tax years?
Dean was mentioning earlier about how it may make sense with respect to depreciation and other items that flow through to multiple years on a return.
And also, on multiple partnerships. As we know, a lot of the funds out there and a lot of entities have multiple levels of partnership. Are you going to use the same person on all of them? Are you going to split it up? How are you going to do that?
The next bullet point, "Is there an appetite for advisors to serve as partnership representative for their partnership clients, such as accountants and attorneys?" I'll answer on behalf of the accountants. I know that Andersen Tax does not and will not serve as a partnership representative. We are concerned with the conflict of interest. A firm of our size, we could be performing services for the entity to which . . . if we were to, the conflict would arise we're performing services for the partnership under audit, as well as we could have several of the limited partners as clients as well.
Dean, I'll let you answer on the attorney side.
Dean: Chris, we've seen something similar on the law firm side. I think when these rules first came out, the prevailing sentiment was that accounting firms and law firms would fill in the role of partnership representative when needed, but that just hasn't been how the market has developed for some of the reasons that you identify.
Firms, law firms or accounting firms, I think they just don't want to take on the liability. And there's also this conflict of interest piece with respect to who do you represent. We certainly do not take on that role.
Chris: Great. I haven't heard of any accounting firms or attorneys taking on that role yet. So that kind of answers the next bullet point, was "In the event of an audit, would the advisor acting as partnership representative have a conflict?" Definite possibility there.
The final bullet point here addresses "Does appointing an independent party as partnership representative help?" I'll definitely say yes, it does.
Dave, I think this might be an ideal time to say why did CSC decide to get into the partnership representative business as an independent party?
Dave: Well, initially it was because we received a call from a law firm that had probably well over 100 master and feeder funds that were offshore, and this attorney likened the service in his mind to that of a registered agent. So CSC provides registered agent services where we receive mail and then forward that mail.
The significant difference between registered agent and partnership rep services is we're not just . . . as a partnership rep, you're not just forwarding the mail, but you accept fiduciary responsibilities.
And that's why we engaged a law firm to help us understand what our potential liabilities or risks are associated with taking on that role. And once we felt comfortable with that risk, that's when we finally made the decision to be a partnership representative.
And the reason we felt comfortable with the risk is my group offers a number of other services where we start in a passive capacity and then move to an active . . . we take on an active role when an event happens. And we're interacting with governmental bodies, accounting firms, law firms, other financial experts to get the best solutions for our clients.
So the short answer is we felt comfortable with the risk, and, two, we have similar expertise that makes us a good choice to be the partnership rep.
Chris: Great. Thanks, Dave. And now at this time, I'm going to turn it back over to Dean.
Dean: Thank you, Chris. Now we're going to focus on what you see in agreements with respect to the partnership representative. And typically, this is what you see in agreements. The agreement would say who the partnership representative is, or short of that, the partnership agreement would say who gets to choose the partnership representative.
And similarly, the same designation would be made with respect to a designated individual in the case a partnership representative is an entity.
And the third bullet, we frequently see this in well-drafted limited liability company or partnership agreements, on whether or not a partnership should elect out in the case it's audited. And I mentioned earlier that the prevailing wisdom is if you can elect out, you should. And part of the reason for that is that a partner typically does not want to be responsible for periods when the partner was not a partner.
So in other words, again, if the adjustment year is 2021 and there's an audit going on, and the reviewed year is 2018, well, the partnership makeup might have changed in the last three years. And under the new rules, the partnership in the year 2021 is liable for any adjustments with respect to the year 2018.
And just out of sense of fairness, partners who make up the partnership, everybody tends to agree that you ought to elect out and kind of push it back to the old regime, which is when the 2018 partners are responsible.
There are other ways to do that. I mentioned the push-out election. There's also something called a pull-in procedure. But the push-out election has this interest charge. And both of those methods have some complexity with them, and that's part of the reason people tend to elect out if they can.
The other point here, and this doesn't really get discussed much, is that sometimes the partnership representative itself could have a conflict of interest.
For example, if the partnership representative in the adjustment year has a smaller percentage of the partnership than the partnership representative did in the reviewed year, the partnership representative has an incentive not to make the election out or not to make a push-out election, because the partnership representative would rather pay taxes with respect to its smaller share in the year 2021 rather than with respect to a bigger share in the year 2018.
So the election out regime can be a bit fraught and the partnership agreement, frequently a well-written one, would kind of address these conflict of interest rules and address what the partnerships and the partners desire.
Similarly, what you see in agreements is what happens if a designated individual or a partnership representative were to die? Who gets to choose the next one? And again, these choices are made only when an audit happens. That's when the partnership representative could revoke its old designation.
And the market has adjusted that. The partnership representative itself, similar to managers or the general partner, or anybody else who does any services for the partnership, they're typically added to the list of indemnified persons in the partnership agreement.
And other duties of the partnership representative. These are not by statute. These are just what you typically see because the partnership representative is already handling some tax-related roles. You frequently have the partnership representative also manage state and local and foreign audits and also be responsible for filing returns and really doing anything else on an administrative level with respect to taxes.
And moving on to the next slide, here's the list of items that we typically see in partnership agreements on what the partnership representative can or can't do. Again, whether you want to elect out, whether the partnership representative has the power by contract to extend the statute of limitations, whether it can engage outside advisors, what are its powers in litigation.
Again, here, we see the push-out election. A lot of times, you see that election mandated in a partnership agreement, but sometimes, especially if it's a de minimis amount, the partners might decide that they'd rather not have the whole push-out election and the interest charge and just pay it in the current year. And again, a lot of times that needs to be spelled out in the agreement.
Again, one of the themes is that if you don't have a lot of this language in your partnership agreement, you're really delegating all of these decisions to the partnership representative. And sometimes, that's okay. But oftentimes, the partners, their interests aren't necessarily aligned and they want to spell it out in the agreement.
So what's happened is that you used to see maybe one or two sentences or maybe a paragraph dedicated to the tax matters partner. But now, because the partnership representative has so much power under this new regime, I'm frequently seeing two, three, even four pages just on the partnership representative.
It depends on how much somebody wants to think this through, but there are a lot of different ways that a partnership can agree to limit the powers of the partnership representative.
Further down on the list, the partnership representatives may or may not have the power to require partners to file returns, give notices. If there is an audit, a lot of times the agreement itself says that the partnership representative should let everybody know, keep everybody informed. Sometimes in an agreement you'll even see other partners with the ability to . . . they have to give consent before the partnership representative can agree on anything with the IRS. So again, a lot of different ways to do this.
And moving on to the last slide in this section, it begins with mentioning that the agreements oftentimes spell out the responsibilities of the other partners who may not be the partnership representative. And a lot of times, the agreement mandates that the other partners are timely in their responses, that sometimes there are transfer restrictions with respect to who the partners can transfer their interests to.
Oftentimes, that is with the election out rules in mind. For example, if a partner where to transfer its interests to a disregarded entity, that would stop the partnership from qualifying for the election out regime. And that might be an impermissible transfer if that's what the agreement says.
The federal regulations do make it clear that a partner could take an inconsistent tax position from the partnership, but the partner would need to disclose that on its return.
Post-audit considerations. A lot of times, agreements discuss this. Sometimes they don't. But when they do, oftentimes, again, it's the partnership representative because that's kind of the person wearing the tax hat and that has the authority to make allocations after an audit. For the reviewed year, who gets allocated what responsibility, or if the liability is put on the adjustment year, who gets allocated what liability?
So there's a lot of potential power, even outside the statutory power, that you frequently see given to the partnership representative.
The last bullet there is certainly this can be contentious, and the calculation of who owes what could be difficult, so the more people understand and agree on ahead of time, the smoother things should go.
And with that, I'll turn it over to Dave.
Dave: Thank you, Dean. Additional considerations. So when CSC was preparing to offer the service, these two items, the first two items here, are certainly something we took a hard look at. And so, on our service agreement, there are certain indemnifications that protect us, but also in the service agreement, there is language there that protects the partnership from us taking actions until we are directed to do so.
CSC provides their own director and officers insurance that will protect our designated individual.
And when we receive a letter from the IRS, we also ask that our client name the designated individual on their own policy.
And with regard to state audits, Dean, I know in preparing with you for this presentation, you brought up some information that you found. So how about if you give us that with regard to the state audits?
Dean: Sure, Dave. There's something called the Multistate Tax Commission, and they formed a model that really conforms with the federal rules. And you're seeing a lot of states implementing that model, where they're mirroring the federal legislation where states can come after the partnership itself.
And just for some examples, recently we've seen West Virginia has now conformed with the federal rules, I believe, beginning in 2019. Oregon earlier this year, a few months ago, also is now going to conform with the federal rules. Most states have not yet acted or they are in the process of coming up with their own legislation, but that certainly seems to be the trend.
Dave: Thank you, Dean. So I guess with regard to the states, it's not a matter of if. It's probably a matter of when they make this adoption.
So CSC partnership representative service. Why choose CSC? So we took a hard look at answering this question before we made the decision, and it really ties back to a lot of the information presented in this presentation.
One, will we be around when the letter is sent by the IRS? So CSC has been around for 120 years, and the plan is to be here for another 100 years. So we know that we would be here, which is something our clients would have an interest in.
We're truly independent. We're privately owned. And therefore, our mission is to act in the best interest of our client. There's no self-interest that we would be directed by.
To the best of my ability or knowledge, we processed over a million pieces of mail last year, so we have a process in place. When we receive a piece of mail, we're able to act on that very quickly. And so we would be able to address any issues that are raised to us by the IRS.
And we've been providing similar services for the last 25 years where we moved from a passive to an active role. And I believe we're still the only company that has been asked to meet with the IRS so that they would understand what we believe are the best practices for fulfilling this role.