Surviving a partnership audit: success depends on selecting the right tax matters partner.

• Author: Martin, M. Jill Lockwood

Auditing a partnership tax return is a complicated procedure because partnerships are not regarded as entities and, therefore, do not pay tax on the income they report. The tax is paid by the individual partners who report partnership income based on information provided by the partnership. When the accuracy of the partnership return is in question, it is impractical for the IRS to audit the return of each partner and assess a deficiency or refund. To solve this problem, the partnership itself is audited and deficiencies and refunds are applied to the partners' tax returns. The partnership designates a tax matters partner (TMP) to serve as the partnership's representative during the audit procedure. While only one partner can be designated as the TMP, other partners are entitled to receive notice of the start of the partnership audit as well as the final results. The skill of the TMP in performing his duties can have a great impact on the outcome of the examination. In order to select the "right" partner for the job, the partnership needs to be aware of the rules for the designation of the TMP.

This article will examine the TMP's influence on the outcome of a partnership audit, from his initial selection through the audit, its settlement and, if necessary, judicial review.

Selecting a Tax Matters Partner

The designated TMP must be a person who is a general partner in the partnership at some time during the tax year for which the designation is made. (1) Unless the IRS consents, the TMP must also be a resident or citizen of the United States. (2) If the partnership does not have a general partner who is capable of serving as the TMP, a person other than a general partner may be substituted in four circumstances recognized by the IRS.

1. The partnership's general partner is dead or bankrupt or, if the general partner is an entity, has been liquidated or dissolved. (3)

2. A court has declared the general partner incapable of managing his person or estate.

3. The general partner's partnership items (4) have been treated as nonpartnership items under Sec. 6231(b).

4. The general partner is no longer a member of the partnership. (5)

   Note: The TMP must be a partner in the partnership. In the absence of a general partner, the partnership cannot designate its accountant as the TMP if the accountant owns no capital or profits interest in the partnership. (6)

   The TMP's selection is usually made on space provided on From 1065, U.S. Partnership Return of Income. If the form does not contain space for making the designation, a signed statement may be attached to the partnership return containing the name, address and taxpayer identification number (TIN) of the designated partner. (7) If the partnership is audited and there is no designated TMP, the general partner holding the largest profits interest is designated as the TMP. If two or more partners have identical interests, the first partner listed in alphabetical order is selected. (8)

   If none of the partners qualify as a general partner, then the Service is allowed to select the TMP at its discretion. (9)

   Note: A partnership's termination under state law has no bearing on the outcome of partnership level proceedings pertaining to tax years in which the partnership was in existence. Since the proper operation of the proceedings depends on the existence of a TMP, the Service has the authority to appoint a TMP for a dissolved or terminated partnership before the filing of a Tax Court petition. The Tax Court has the authority to select the TMP after the petition has been filed. (10)

   If the partnership tax return has already been filed, there are three other ways to select the TMP. First, the current TMP may certify another partner to act as the TMP for the year. The written certification is sent to the service center with which the partnership tax return was filed. The certification of the successor TMP must contain the following information.

   * The name, address and TIN of the partnership, the partner filing the statement and the successor TMP.

   * The partnership tax year to which the designation relates.

   * A declaration that the partnership filing the statement has been properly designated as the TMP and that the designation was in effect immediately before the filing of the statement.

   * A certification that the successor designated TMP has been selected according to the partnership's procedure for making such selection.

   * The signature of the partner filing the statement. (11)

   Second, the general partners owning a majority interest in the partnership may designate the TMP by sending a signed statement to the service center with which the partnership return was filed. (12)

   Finally, partners owning a majority interest in the partnership (both general partners and limited partners) may designate the TMP. Selection by a majority of all partners is allowed only fi there are no general partners capable of making the selection. (13)

   Planning strategy: Unless the partnership wants the Service to be in a position to select the TMP, the partnership should make its own selection as soon as possible, via certified mail. Even if the partnership does not follow the specific procedures for designating a TMP, the partnership's designation of a TMP will be respected so long as the designation is communicated to the Service in a timely manner. (14) The partnership may also designate an alternate TMP who would be effective if the current TMP leaves the partnership, dies or becomes legally incapacitated. (15) Since Form 1065 does not contain space for an alternate selection, a statement must be attached to the return containing the following information.

   * The name, address and TIN of the partnership and the alternate TMP.

   * A declaration that the statement is a designation of an alternate TMP to serve in the event of the death or legal incapacity of the TMP for the year to which the partnership return relates.

   * The signature of the partner signing the partnership return.

   Planning strategy: The timely designation of the TMP (including an alternate) is important because if the Service mails a notice of an audit or other administrative procedure before a TMP has been selected, it is not required to honor such designation until 30 days after the statement is filed.

   A TMP may resign at any time by filing a written statement to that effect. The statement, which must be signed by the resigning TMP, should specify the partnership tax year to which the resignation relates and must identify the partnership and the resigning partner by name, address and TIN. The statement should be filed with the service center with which the partnership tax return is filed. (16)

   The partnership may revoke the designation of the TMP at any time after filing the partnership tax return. A written statement filed with the service center with which the partnership tax return is filed should contain all the information necessary to identify the TMP whose designation is being revoked and the year to which the revocation relates. The revocation must also be signed by the general partners who, at the close of the tax year, owned more than 50% of the aggregate interest in partnership profits held by all general partners as of the close of the year. (17)

   Notice Requirements

   While only one partner can be designated as the TMP, this does not mean that the other partners will have no knowledge of an IRS audit. Each partner is entitled to receive notice of the beginning of a partnership...