Who is Your Partnership Representative?
When you think of representative, first words that come to mind are sales representative, customer service representative, or the obnoxious automated robot you get when trying to call your bank. However, when it comes to partnership tax law, the word “representative” is going to take on a whole new meaning when dealing with the IRS, with drastic implications.
While companies that deal with marijuana on the grow side and retail side already have plenty of issues to worry about with the tax man, it’s only going to get more complicated due to Sec. 1101 of the Bipartisan Budget Act of 2015. The change in law is due to one concept that will alter the manner in which partnerships are audited by the IRS, that being the “partnership representative” (PR). Current law requires a tax partnership to appoint a “tax matters partner” (TMP) as the primary liaison between the IRS and the partnership. The TMP does not have much authority other than being the person who receives tax notices in the mail. In addition, the IRS rarely has the time or resources to audit partnerships because each partner has the ability to contest IRS adjustments; the IRS may be tied up for years asserting their position against partner protest claims. However, this will change effective for tax years beginning on or after January 1, 2018. Beginning in 2018, the IRS will now be making audit adjustments and recovering tax underpayments from the partnership, as oppose to each individual partner. Furthermore, the IRS will only resolve claims and communicate with the PR, who is granted the sole authority to resolve issues with the IRS.
Under the new law, the partnership is bound to the decisions made by the PR and each individual partner will no longer be able to represent themselves in their own capacity as a partner. Given the exclusive ability of the PR to bind the partners and the partnership to actions taken, it is crucial that partnerships make a concerted effort to determine who is best suited to represent the partner group in the event of an IRS examination. Generally speaking, the partnership should take ample time to appoint an individual who is ideally: knowledgeable of tax law, or at least has prior experience with tax partnerships, financially sophisticated, and most importantly knows the marijuana industry as well as the ongoing operations of the company. If a PR is not appointed by the partnership, the IRS may have the ability to appoint one on the partnership’s behalf, which may have serious considerations and set unwanted precedent with your company and the industry if the issue is litigated.
Given the infancy of the industry and the tax landscape with the cannabis industry, including IRC Sec. 280E, the partnership should take immediate action to 1) determine who will be their PR, and 2) how much authority will be granted to the PR. While the PR does have the ability to resolve IRS issues by themselves, the partnership may dictate the PR to first seek legal counsel, or consult the other partners prior to the PR and IRS negotiations. In the event the PR is to take a position contrary to that of the other partners, the partners may seek damages against the PR. However, the actions taken by the PR are resolute and binding. Partnerships that choose to limit the PR’s ability to act autonomously during IRS controversy should strongly consider revising the operating agreement to delineate the capacity of the PR. The operating agreement should also mention how the PR will be replaced in the event the PR were to no longer be involved in the partnership.
Due to the steps taken by congress and the IRS, it is very likely the IRS will be pursuing the audit of partnerships given the prevalence of LLCs over the past decade and increasing private equity investments in the cannabis industry. Partnerships will need to carefully consider the most suitable candidate for the PR responsibility, as the decisions made by the PR may even affect partners who were not a partner in the year of controversy (a prior year underpayment of tax is assessed in the year of the adjustment). Given the billions of dollars being invested in cannabis grow and retail operations, new investors should also conduct an adequate amount of due diligence to ensure they don’t inherit the adverse consequences of a company with aggressive, or poorly documented tax positions (i.e. lack of a 280E analysis); new partners inherit the tax consequences of prior year adjustments. As a result, partnerships should now begin to consult with their CPA to make sure that the partners and the partnership are properly represented.