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The IRS issued Regulations significantly altering partnership audit rules for partnership tax years beginning after December 31, 2017. These new rules are called the Consolidated Partnership Audit Regime (CPAR). They are intended to allow the IRS to efficiently audit, assess, and collect taxes at the partnership level.

Partnership agreements may need amendments to address several critical elements to changes in the law and associated regulations to avoid negative consequences.

When the IRS audits a partnership under CPAR, the IRS may assess a partnership level “imputed underpayment,” at the top available tax rate (individual or corporate) in effect at the time of the net audit adjustments. The tax may be paid at the partnership level with certain adjustments. The partners may then elect to amend returns to reflect the audit adjustments, or the imputed underpayment may be passed out to the partners for payment. An audit of the partnership does not bar the IRS from opening an examination of the partners to seek tax assessments at the partner level.

As noted above, the partnership may pay the tax on the imputed underpayment at the top tax rate with no offsets for suspended passive losses, capital losses, net operating losses, etc., which may be available if the partnership attributes were pushed out to the partners. There is neither self-employment tax nor net investment tax assessed on the imputed underpayment.

For assessments of imputed underpayments at the partnership level, adjustments are allowed if any of the partners are tax exempt under 168(h)(2).

How Is the Law Changing?

The first important change in the law and supporting regulations which may require an update to partnership agreements is the creation of a new position of authority called the “Partnership Representative” (PR). The PR can bind the partners—similar to the old Tax Matters Partner, but with more power.

CPAR sounds like a simple, efficient, and straightforward way for the government to collect taxes at the common, partnership level at which the income is earned. That is, until you consider several facts:

  • The members who are in the partnership in the period defending the partnership examination may differ from the members invested in the partnership in the period under audit.
  • Not all investors in the partnership will be subject to tax at the highest available tax rate. Therefore, using the highest available tax rate will likely lead to the government collecting excessive taxes.
  • If there are tax-exempt members in the partnership, and the PR claims exemption from the portion of the imputed underpayment on behalf of the exempt partners, the partnership agreement must allow for a special allocation to provide the benefit of the exemption to flow to the tax-exempt partner(s). Failing to provide the PR with this authority may lead to the PR and other partners being assessed penalties for receiving private inurement from a public charity, or engaging in self-dealing if the non-profit is a private foundation.

Mitigating the CPAR Rules’ Impact

There are three ways to mitigate the impact of the CPAR rules:

  1. If the partners are qualifying members, elect out of the CPAR rules by filing an election each year with the timely-filed partnership return;
  2. Partners may amend tax returns for the imputed underpayment (partner by partner choice); or
  3. “Push out” – The partnership may elect to force the partners who were partners in the year under review to report the audit adjustment at the partner level by furnishing to each partner a statement showing their share of adjustments items.

We believe most partnerships will want to exercise option #1 and elect out of the CPAR rules, if possible. This forces the IRS back to the pre-CPAR rules auditing under the old TEFRA rules, where assessments are made at the partner level rather than at the partnership level.

Only eligible entities may elect out of CPAR. An eligible entity is a partnership with 100 or fewer K-1s (includes underlying S corporation owners), and the owners can only be individuals, deceased partner’s estates, C corporations, S corporations, and foreign “per se” corporations.

If the partner group for the year includes any of the following, the partnership cannot elect out of CPAR: trusts (including grantor trusts), partnerships, disregarded entities (single member LLCs), nominees or other types of estates. It should also be noted that married couples are counted as two members. Tax exempt partners look not to their tax status, but their organizational status.

If the organization is a corporation, the organization is not a disqualifying member. In this circumstance, the PR may elect out of CPAR, assuming there is no other disqualifying factor. However, if the tax-exempt partner is a trust, it is a disqualifying member precluding the PR’s election out of the CPAR rules.

What Should Your Partnership Do Now?

Partnerships need to review and update their partnership agreements immediately to:

  • Ensure the partnership agreement names a Partnership Representative. The Partnership Representative need not be an owner in the partnership. If an entity is the Partnership Representative, the partnership is required to name a “Designated Individual,” which can be an individual who holds a specified position, such as CFO of XYZ corporation. If the partnership has not designated a Partnership Representative, the IRS, on examination, may appoint a Partnership Representative to represent the interests of the partnership. If this occurs, the partnership may not change the Partnership Representative without the consent of the IRS.
  • Because the IRS will name a PR if the partnership has not done so, the partnership agreement should not only name a PR, it should outline the process to appointing the successor representative. This ensures there is never a void in the position.
  • Amend the partnership agreement to enumerate the duties and responsibilities (power) the IRS regulations confer on the Partnership Representative. The CPAR regulations give broad authority to the PR. The partnership may want to provide additional responsibilities. If the partners desire to limit the PR’s authority, it will not be binding on the IRS. However, it may be possible to bind the Partnership Representative to the other partners through an indemnification clause if the PR engages in unauthorized activities or acts in ways the partnership has expressly prohibited.
  • Examples of issues the partners may want to address in the partnership agreement include:
    • What permissions do the partners want to confer on the Partnership Representative?
    • What elections should be made and when?
    • What portion of the partners must approve the IRS settlement (technically none in the eyes of the IRS)?
    • When does the partnership require the partners to amend their tax returns (again this is a decision the IRS empowers the PR to unilaterally decide on behalf of the organization)?
    • When can the partnership elect to “push out” imputed underpayments?
  • We recommend the Partnership Representative develop and document a process for keeping a list of all partners and the type of entity they are, including tax status, over time. Each time the list changes, the Partnership Representative should mark the date and the change in ownership. These records should be maintained in accordance with the organization’s document retention policy—normally 6-8 years.
  • If there are 100 or fewer partners, and there are no disqualifying classes of partners, the Partnership Representative should consider opting out of the new audit rules by filing an election on a timely-filed Form 1065 each year. The partnership agreement may formalize the decision it wants the PR to make, but it is not binding except through a civil action against the PR.
  • Each year, the Partnership Representative should notify the partners with a statement attached to their K-1. The statement should state whether the partnership has elected out of the federal consolidated audit provisions for the tax year reporting the Schedule K-1 tax information. This could affect the value of the partnership investment for the year and let the investors in the partnership know what level of documentation they must maintain.
  • If an IRS audit occurs and there is an imputed adjustment, the partnership should know how the Partnership Representative handles the distributions (for current & past partners).
  • The partnership may also want to consider possible restructuring to meet the elect-out provisions for an eligible entity.

The Bottom Line

The implications of these partnership agreement changes can have an important impact on their partners. Now is the time to make sure the partnership agreement is in alignment with what all the partners want and need, considering future changes to the partnership itself and its respective partners.

Please contact or email us at if you would like to discuss changes in the partnership audit rules or review your planning opportunities.

© Clark Nuber PS and Developing News, 2017. Unauthorized use and/or duplication of this material without express and written permission from this blog’s author and/or owner is strictly prohibited. Excerpts and links may be used, provided that full and clear credit is given to Clark Nuber PS and Developing News with appropriate and specific direction to the original content.

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Articles and Publications

Peace, Love, and Family Harmony: Safeguarding the Long-Term Interest of Your Family Business

As a family business advisor, I often provide consultations on maintaining family harmony as the family successfully transitions the business from one generation to the next. Various research has found that only 30% of family businesses transition successfully to the 2nd generation, 12% to the 3rd generation and 3% to the 4th generation. Further, 60% of transition failures were caused by a breakdown of communication and trust within the family unit. With these statistics in mind, how can you safeguard the long-term interest of your family business?

How Family Roles Affect Business

Why do communication and trust breakdowns often occur within a family that’s operating a business? The greatest challenge family businesses face is the multiple roles each individual plays: management, ownership, and family. Depending on which roles an individual plays, their viewpoint about the business may be different. For example, in the management role, an individual may be focused on achieving business growth. Those in an ownership role, however, may demand a certain level of return through dividends. Further, a family member who is not actively engaged in the business may value family harmony and fairness at all costs. These different—and sometimes overlapping—roles may contradict at times and add greater risk to the family business’s continued success—especially during leadership transition.

Governance Structure

Governance is the system of rules, practices, and processes by which a company is directed and controlled. Your family business should implement a governance structure for three reasons:
  1. To effectively balance the interests of the many stakeholders—owners, management, and family members;
  2. To ensure the continuity of the business; and
  3. To promote family harmony.
Many business owners understand governance as the board of director’s fiduciary responsibility to represent the interests of shareholders. In a family business, however, the family is a key stakeholder and should not be ignored. Good governance provides clarity on roles, rights, and responsibilities for all stakeholders; encourages family members, business management, and owners to act responsibly; and regulates appropriate family-and-owner inclusion in business discussions.

Who Should Implement a Governance System?

Businesses that rely on any of the three following business structures should implement a governance system. The structures include:

Board of Directors

The board of directors is a group of individuals with the fiduciary responsibility to protect the interests of the shareholders. They do this by working with management to set the strategic direction of the company and oversee the operations of the business. In a family-owned business, the board also has the important responsibility of ensuring that management is directed by values and principles the family deems important. The board’s duties include monitoring performance of the business, approving major acquisitions, approving the strategic plan and operating budgets, guiding succession planning, and advising the CEO. The board of directors is governed by the bylaws of the company. The bylaws include policies describing the size and composition of the board, term limits, addition of independent directors, and family versus non-family board members.


Stockholders hold one or more shares in the company and have a right to vote on certain company matters. They are invested in protecting their ownership interest and focus on a return on investment, liquidity needs of the company, risk management, business acquisitions, and company growth plans. The stockholders are governed by the stockholder’s agreement, which is an agreement amongst the stockholders of a company. The agreement should document restrictions on transferring shares and rights of first refusal in relation to shares issued by the company—often called a buy-sell agreement. The agreement should also include specific rights for control and management of the company. For example, it should designate certain individuals to the board. The agreement should also include provisions for managing dispute resolutions.

Family Constitution

The family doesn’t just include those active in the business as managers or owners; it includes others who are impacted by the family business operations, but who don’t own stock. Who is considered family? Does family include spouses, step-children, second cousins, estranged siblings? This answer is different for every family and should be defined in the family constitution. The family constitution is a valuable governance document that addresses the human and emotional side of operating a family business. The process of developing a family constitution can strengthen the family by helping them see a vision for the future. It also helps each family member understand their role in assuring family and business continuity. A family constitution should address policies such as employment and interpersonal relationships. Some questions to consider include:
  • What qualifications, if any, does a family member need to meet before they can work in the business?
  • What is the decision-making process and how are conflicts resolved?
  • What are the family values and what is the vision for the future?
The constitution is a living document and should be reviewed and revised as needed to meet the needs of the changing family, ownership group, and business.

Bottom Line

All businesses have challenges that need to be addressed to ensure continued growth and sustainability. When you add the complexity of family dynamics to the mix, however, the risks are higher. Anticipating these challenges before they arise and proactively developing written guidance, or procedures to resolve them, sets a family business up for success. As you navigate those challenges, we are here to operate as an experienced, trusted advisor. Could your family business benefit from assistance in safeguarding its assets while maintaining family harmony? Please contact our professionals at  to get the process started. © Clark Nuber PS, 2017. All Rights Reserved

The Control Environment: The Foundation of an Effective Organizational Internal Control System

COSO defines the Control Environment as the “set of standards, processes and structures that provide the basis for carrying out internal control across the organization.” This component comprises the tone at the top, communication about ethical behavior and internal control with all levels of staff, and the overall integrity and values of the organization. These components provide the overall basis for a successful system of internal control.

What is the Control Environment?

The Control Environment can be broken down into five distinct principles, or concepts, and each concept’s related risks. The concepts and risks are as follows:

1. The organization demonstrates a commitment to integrity and ethical values. This principle ultimately starts with tone at the top, which begins with the board of directors and management communicating—through both directive and their own behavior—the importance of an ethical work environment and its role in achieving organizational goals. Specific standards of conduct should be understood throughout all levels of the organization, and processes should be in place to evaluate performance and quickly address deviations from expectations.

Related Risks: Employees unaware of internal control, lack of approved policies and procedures, lack of employee accountability, systemic ethical problems or fraud.

2. The board of directors demonstrates independence from management and exercises oversight of the development and performance of internal control. Not only should the board of directors maintain independence—both in fact and in appearance—from management, but it should have the necessary expertise to fulfill individual roles. For example, it is critical to have someone in the Treasurer position who is familiar with financial statements and accounting. Otherwise, the controls around board-level financial analysis would be weak and thus a potential detriment to the organization’s objectives. The board of directors should also oversee the design and implementation of internal controls, which is carried out by management.

Related Risks: Perceived (or actual) conflicts of interest between the board and management, board members unable to perform assigned duties, lack of internal control design and oversight.

3. With board oversight, management establishes structures, reporting lines, and appropriate authorities and responsibilities in the pursuit of objectives. It is critical that management appropriately delegate authority and define responsibilities at the various levels of the organization. Primarily, this is done by establishing reporting lines to enable authority, responsibility, and flow of information. The board of directors should retain authority over significant decisions. They should also review management’s assignments and limitations of authorities and responsibilities.

Related Risks: Employees unaware of reporting relationships, duplication of duties, unchecked management decision making and control.

4. The organization demonstrates a commitment to attracting, developing, and retaining competent individuals in alignment with objectives. Monitoring staff competence is very important in maintaining a system of internal control, and evaluation should not be limited to the hiring process. Instead, competence is something that should be nurtured and reinforced through an ongoing plan to develop and train employees.

Related Risks: Lack of training, employees not qualified to perform assigned tasks.

5. The organization holds individuals accountable for their internal control responsibilities in the pursuit of objectives. Accountability is reinforced by establishing clear expectations, performance measures, and incentives that consider the pressures of achieving the related goals. It is also reinforced by taking corrective action when appropriate.

Related Risks: Breakdown of internal control or cutting corners, unrealistic performance targets, lack of employee accountability, work environment conducive to fraud or waste.

As you evaluate your organization’s own control environment and unique risks, it is important that you consider all of these principles and whether they are all functioning successfully. For complete and detailed information about the Framework, Components, and Principles, we encourage you to explore and learn more on COSO’s website.


Questions about this article? Please contact us at 1COSO is an acronym for Committee of Sponsoring Organizations of the Treadway Commission. It was formed in 1992 as a joint initiative of five organizations, including the American Institute of CPAs and the Institute of Internal Auditors, among others. Since that time, the committee has been developing and refining frameworks and guidance around enterprise risk management, internal control and fraud deterrence, with the most recent revisions of the Internal Control – Integrated Framework model in 2013. © Clark Nuber PS, 2017. All Rights Reserved

Big Data, IT Controls, and Offsite Work: The Future of Auditing?

Some sources talk about changes to professional standards that would allow auditors to rely more on data analysis as direct audit evidence. Others foresee more automation, such as linking the accounting transactions from the general ledger directly to outside sources like bank records. And still others talk about Bitcoin, Blockchain, and the challenges and opportunities that digital currency brings – a topic that Clark Nuber Shareholder Ron Rauch addressed in a recent article. It’s clear that the auditing process and procedures, like the rest of the business world, will need to be refurbished to keep up with the ever-changing environment. But before we say goodbye to sampling forms and confirmations, what kinds of changes can we expect to see in the more immediate future?

Big Data

Data analytics are here to stay. Analytical procedures have always been a part of the audit process, but new technologies allow us to slice and dice transactions in more ways than ever. The Rutgers AICPA Data Analytics Research Initiative (RADAR), is studying integration of data analytics into the audit process, with the goal of demonstrating how this can lead to advancements in the public accounting profession. This fall, they will issue an update to the AICPA Analytical Procedures Guide that discusses audit data analytics at a foundational level, and provides examples of how to integrate tools and techniques into the audit process. Some plans for the future include developing a framework to sort through large populations of data to identify possible exceptions, researching process mining techniques to evaluate internal control effectiveness, and determining how to generate visualizations that can be used as audit evidence.

IT Controls

One constantly changing area is information technology. Accounting processes and related controls look a lot different than they used to, and so should auditing procedures over those processes. Gone are the days when auditors can review the physical cancelled check for a disbursement. First, no one gets cancelled checks back from the bank any more. Second, much of the cash disbursements and receipts process has gone paperless. There is no “signature” to review. Instead, auditors should look at who has authorization and access to generate an electronic funds transfer. Are multiple people needed to complete the transfer, or can one person make a payment single-handedly? Auditors should be testing various controls over your IT systems, including access controls, change management (for example, who can add a new user), and security protocols. Auditors need to be testing through the computer and no longer testing around it.

Direct Access to Transactional Details

Currently, your auditor probably requests a trial balance report from your general ledger (G/L), leaving the rest of the prepared-by-client schedules up to you to complete. This means you summarize the annual activity of various accounts into an easy-to-read roll-forward format. You also provide transactional detail of selected accounts, and the auditors make their requests for testing individual items from that detail. What if your auditor requests an accountant’s copy of your entire G/L package up front? Your auditor could use that detail to fulfill some of their own requests on the pre-audit list. For example, you wouldn’t need to export and send them a list of contributions for the year, nor would you need to prepare a roll-forward of pledges receivable. Data analysis on the entire population can be considerably more informative than just testing a sample of transactions. By utilizing analysis procedures in their audit planning and risk assessment, the auditor may be able to hone in on risk areas with the click of a button. Samples can then focus on the higher risk areas, providing more meaningful audit evidence instead of spending time testing less risky transactions. Giving your auditor all of the detail at once also often allows them to answer some of their own questions by diving in to the underlying transactions.

Offsite Fieldwork

Everyone in your office knows when the audit is going on. The best conference room is reserved for a week or two, the accounting department is working late, and the audit team has so many questions for so many people. While that may be a tried-and-true model for many organizations, not all of them like putting their day jobs aside for the duration of fieldwork. What if your auditors instead began the work from their own office, using the G/L detail you’ve provided as a starting point? They can gather questions and make requests for supporting documents before coming to your office. Their onsite time is then focused on staff interviews, reviewing source documents, and tying up loose ends.

The Bottom Line

For now, the financial statement audit process will likely continue to include vouching to external support, confirming balances with third parties, and sampling. But you can expect to see a larger emphasis on data analytics, IT controls, and creative ways of shaping the fieldwork process.


Please contact Victoria Kitts at if you have questions or would like more information about this topic. © Clark Nuber PS, 2017. All Rights Reserved

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