For the last two years I have attended Financial Research Associates’ Private Investment Funds Accounting and Tax conferences in New York City. These events are a great opportunity to catch up on the latest trends and issues in private equity accounting. A few months ago, one of the conference organizers asked me to present. It took me a few weeks to get over my apprehension of presenting and say yes; after all, discomfort is the pathway to growth.
May’s conference focused on the impact recent changes in tax legislation will have on private equity and hedge funds. For the weeks leading up to the conference, I studied up on the new partnership audit rules for which I was a panelist.
These new partnership audit rules will impact all Redwood clients, so I will first share how these rules came about and then what Fund Managers should know about them.
From 1982 until the end of 2017, the Tax Equity and Fiscal Responsibility Act (TEFRA) served as the IRS audit regime. The IRS would audit the partnership and administer the tax down to the individuals and collect. This was a highly inefficient process and the government often ran into statute of limitations issues when attempting to enforce collections. A new audit regime was enacted as part of the Bipartisan Budget Act of 2015, effective for tax years beginning 2018, which repealed the previous procedures under the TEFRA regime. Highlights include:
- The Tax Matters Partner (TMP) is replaced by the Partnership Representative (PR)
- Adjustments to partnership-related items are determined at the partnership level and the corresponding tax is assessed and collected at the partnership level, as opposed to the individual level
- Adjustments are recognized in the year the audit is concluded, as opposed to year being audited
- Under TEFRA, partners generally retained notification and participation rights in partnership-level proceedings, but with the new rules, partners have no statutory right to receive notice of or to participate in the partnership-level proceedings.
The most critical thing to know when selecting the PR is that you are placing an incredible amount of trust in that person. Any actions they take are binding on the partnership and can be done without partner approval. If there were an IRS audit taking place, the PR would be the only person cognizant of this unless they choose to share the news downstream.
Any partnership formed in 2018 and forward should not have TMP language and should only have partnership language. It is recommended that all Fund Managers carefully review their operating agreements now to prevent future issues with investors such as the agreed upon steps in response to an IRS audit and indemnification provisions for former and future partners. Significant revisions to operating agreements may be necessary to document details including how the PR is chosen, their agreed upon due diligence process and remedies in the event that the PR or other partners fails to operate within the agreed parameters.
Due to the complexity of the PR’s role you may want to consult an attorney for guidance on structuring the key terms the fund’s operating agreement should address.
I hope that all our readers found this helpful (exciting may be a stretch). Stay tuned for my next article on highlights from the conference regarding what’s in store from the SEC and Opportunity Zones.
Erica England, C.P.A
Redwood’s Chief Accounting Officer Erica England C.P.A. has 10+ years of experience working in the private equity industry and is always happy to discuss how Redwood could help you with your fund administration needs. Reach out to Erica at firstname.lastname@example.org to learn more.