The vast power given to partnership representatives under the centralized audit regime could make them the target of lawsuits, particularly if partners aren’t kept informed about audits.
Limited partners left in the dark could sue representatives under various theories of liability if they’re hit with a surprise tax bill, but succeeding on those claims could be difficult. “We’re trying to prove here that it’s difficult to get redress even if you’ve been wronged,” Diana L. Wollman of Cleary Gottlieb Steen & Hamilton LLP said January 15 at the New York State Bar Association’s annual tax section meeting in New York.
Breach of contract claims are one possibility for redress, but that depends on what protections were afforded to the limited partners in the partnership agreement, Wollman said, adding that claims for breach of fiduciary duties are another possibility.
The centralized partnership audit regime, enacted in the Bipartisan Budget Act of 2015 (BBA), allows the IRS to audit partnerships at the entity level. Under section 6223, the partnership representative has the “sole authority to act on behalf of the partnership” during an audit — a level of power some find disconcerting. The IRS released final rules (T.D. 9839) on the partnership representative in August 2018.
Private Right of Action?
Megan L. Brackney of Kostelanetz & Fink LLP said it’s possible the BBA creates a private right of action against the partnership representative and that prior case law on tax matters partners (TMPs) and the 1982 Tax Equity and Fiscal Responsibility Act could be instructive.
For example, Transpac Drilling Venture 1982-12 v. Commissioner, 147 F.3d 221 (2d Cir. 1998), suggested there could have been a private right of action under TEFRA, Brackney said. “In the Transpac case, the court describes the TMP as equivalent to a class representative of a class of plaintiffs and says that just as a class representative in a class action owes the plaintiffs a fiduciary duty, so does the TMP owe a fiduciary duty to not just the partnership but also the limited partners,” she explained.
Brackney noted that under TEFRA, partners had a right to notice of the audit and some of the TMP’s actions. While there are no equivalent requirements under the BBA, Brackney said this could cut either way in the courts. “A court could say clearly there’s no benefit to the individual partners intended by the BBA provisions, or on the other hand, they could say because there is nothing defined, clearly [the partnership representatives] have a higher obligation because there’s not a technical list . . . of their only obligations,” she said.
Contractual Obligations
But Wollman noted that a goal of the new audit regime is that the partners themselves decide what obligations they want to impose on the partnership representative and put in a contract.
Wollman outlined an example in which a general partner serves as the representative and hires a lawyer to handle an audit. The general partner instructs the lawyer to quickly resolve the audit by paying the imputed underpayment without seeking modifications. The limited partner first learns of the audit and related lawyer’s fees upon receipt of the Schedule K-1, at which point Wollman said the limited partner could have various causes of action for financial damages.
If the partnership agreement required the representative to keep limited partners informed about an audit or consult with them before settling, the representative’s actions could give rise to a breach of contract claim, said Bryan C. Skarlatos, also of Kostelanetz & Fink. But he added that the damages the limited partner could collect may vary by state because some, like New York, will attribute the tax bill to the tax law rather than the breach.
But Wollman said it’s a “brave new world” under the BBA in which tax liabilities aren’t as fixed and can vary depending on the representative’s choices. “I’d be surprised if even in New York you couldn’t bring a cause of action under those circumstances,” Skarlatos said.
Lawyers who advise partnership representatives could also be opening themselves up to malpractice claims, Skarlatos said. He said lawyers should clearly communicate to the parties involved whose interests they represent. While the lawyers may not be obligated to contact limited partners and keep them informed, they may have a duty to advise the representative to do so, he said.
Another potential remedy would be to sue the IRS under the theory that allowing the representative to resolve the audit unilaterally was arbitrary and capricious and in violation of the Administrative Procedure Act. Skarlatos called this the argument “du jour” and said that while people will likely try it, he thinks it’s unlikely to be successful.