Recent Developments in Partnership Audits (Part 2)

November 2, 2021 by Leave a Comment

In yesterday’s post Rochelle Hodes, Principal with Crowe LLP, provided background on BBA, emphasizing what makes its rules unique in tax procedure. Today’s post will briefly discuss two important BBA developments, the IRS’s Large Partnership Compliance Program and significant ABA Tax Section comments on proposed BBA regulations. Les

Large Partnership Compliance (LPC) Program

The IRS is scheduled to begin the LPC Program this month, starting with the 2019 tax year.  The LPC Program is modeled off of the Large Corporate Compliance (LCC) Program, which replaced the Coordinated Industry Case (CIC) Program. 

LB&I has provided its employees interim guidance dated October 21, 2021 to implement an LPC Pilot Program.  The four-part framework for the Pilot set forth in the interim guidance is consistent with the information IRS executives have previously provided regarding the program.

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1. Identification

According to the interim guidance, the first part of the framework is “[i]dentifying the largest partnership cases by focusing on the characteristics of the largest Form 1065 filers.”  The  IRS will identify “large partnerships” and then use data analytics to determine partnership returns with compliance risk.    When asked at a recent ABA Tax Section panel about what factors contribute to a partnership being included in LPC (and thus being considered “Large”), the IRS official identified factors such as asset and revenue size, volume and size of foreign investments/investors, as well as items reflected on the Schedule K-1.  The interim guidance notes that the identification process and factors to determine what is a large partnership may change as more information is gained through the examination process.

2. Modeling and Classification

The second part of the framework is “[d]eveloping improved methods to identify and assess the compliance risk presented by [large partnerships].” The IRS official at the ABA Tax Section panel explained that after the identification of the partnership as “large”, a human “classifier” does a further risk assessment.  In addition, the assigned revenue agent will do her own risk assessment of the return.

The IRS official also provided color around the use of data analytics, stating that IRS is using information that it has been gaining from partnership examinations and, presumably, returns and Schedules K-1.  The IRS has recently required more detailed information be included with partnership tax returns and Schedules K-1.  That data will only be enhanced when the Schedules K-2 and K-3 are filed with 2021 partnership tax returns. 

3. Exam Procedures

The third part of the framework is “[c]onsidering examination processes and tools that will allow [the IRS] to better audit this population.” According to the interim guidance, IRM procedures applicable to LB&I, partnerships, and the BBA will generally be followed, including LB&I exam planning procedures in IRM 4.46.3.10.  The interim guidance identifies exceptions to the procedures, including one that provides that LPC returns cannot be merely “surveyed”; they must be examined.  Another exception provides that the exam team must consider or develop all issued identified ahead of time by the classifiers. This will limit the assigned revenue agent’s discretion and could result in longer, more detailed examinations than might otherwise be warranted. 

4. Feedback

The fourth part of the framework is enhancing the IRS’ understanding of large partnership compliance issues through feedback.  The interim guidance describes procedures whereby technical and procedural feedback will be gathered to improve data analytics and risk identification, including a sharepoint site for LPC, as well as LPC networking calls.

One of the things that representatives can expect from BBA examinations, regardless of whether the examination is under LPC, is an early request for what might seem as a longer extension of the period of limitations on adjustment.  The reason for this is largely a function of the statutory requirement that partnerships must be allowed 270 days after the notice of proposed partnership adjustment is issued to request modification.  Additional time constraints on the examination include two opportunities for the PR to request Appeals consideration (the first to request Appeals consideration of the adjustments and the second to request Appeals consideration of a denial of a request for modification).  For more on these processes, see the graphic the IRS has posted on its website depicting the BBA examination process. 

Representatives should be prepared for revenue agents who lack experience with BBA, and in some cases, who lack experience in partnership tax.  The IRS official at the ABA Tax Section panel stated that they have hired a number of new revenue agents with partnership experience and assigned experienced revenue agents to partnership audits.  It is too early to evaluate how this will affect BBA examinations.

Even before this month, representatives have seen a significant uptick in the number of partnership audits.  It is likely that this trend will continue, amped up by the rollout of the new LPC Program.

ABA Tax Section Comments on the November 2020 Proposed Regulations

As Greg Armstrong and I discussed in our prior blog post entitled Treasury and IRS Release New Round of BBA Partnership Audit Proposed Regulations, on November 24, 2020, Treasury and the IRS published proposed regulations under the centralized partnership audit regime enacted by the Bipartisan Budget Act of 2015 (BBA).  The ABA Tax Section provided comments on the proposed regulations in a letter dated October 8.  The comments address provisions in the proposed regulations that would implement special enforcement provisions enacted as part of the technical corrections, proposed changes to the cease to exist rules under section 6241(7), and proposed changes that would include partnership-related items that do not result in an adjustment to income, gain, loss, deduction, or credit (“non-income adjustments”) to be included in the imputed underpayment, among other topics. Following are some highlights of the comments:

Special enforcement matters

Section 6241(11), providing rules for special enforcement matters, was added to the BBA regime as part of the technical corrections enacted in 2018.  Essentially, these rules allow the IRS to adjust a partnership-related item at the partner level without having to open an examination of the entire partnership. Prop. Reg. § 301.6241-7 implements this provision.  The comments include several recommendations regarding Prop. Reg. § 301.6241-7, including recommendations not to finalize three areas identified as special enforcement matters:  Prop. Reg. § 301.6241-7(b) regarding partnership-related items underlying or related to non-partnership-related items; Prop. Reg. § 301.6241-7(f) allowing adjustment of partnership-related items at the partner level even if the period for adjustment at the partnership level has expired if the period of limitations at the partner level is still open or they agree in writing; and Prop. Reg. § 301.6241-7(g) regarding a partnership’s liability for chapter 1 taxes, penalties and interest.

Cease to exist

The cease to exist rules under section 6241(7) generally provide that if the partnership is unable to pay the imputed underpayment, the adjustments are allocated to former partners who will have to pay tax due as a result of taking these adjustments into account.  This is a round-about way for the IRS to collect tax if the partnership won’t pay because it requires allocation of the adjustments to the former partners and computation of the tax due from each partner as a result of taking the adjustments into account.  The technical corrections added section 6232(f) which allows collection of an unpaid imputed underpayment from the former partners.  There are no regulations describing how section 6232(f) will work. 

The proposed regulations make several revisions to the cease to exist regulations to, as the Preamble explains, coordinate the cease to exist rules with section 6232(f).  The primary recommendation made by the comments is to provide guidance on section 6232(f) before changing the regulations under section 6241(7).

Non-income item adjustments

Adjustment of certain partnership-related items do not result in a change to any party’s tax liability.  For instance, a change to a partner’s capital account maintained by the partnership, by itself, does not result in a change in a partner’s tax liability unless and until an event occurs that causes that capital account information to matter in determining tax liability.  Prior to the proposed regulations, there was no guidance specifically addressing non-income item adjustments.  The proposed regulations would include non-income item adjustments in the computation of the imputed underpayment, regardless of whether the adjustment results in a change in tax liability of any party.  This means that if the only adjustment to the 2018 return is a $100 positive adjustment to a non-income item, there would be a $37 imputed underpayment.  This is true even if no partner’s tax liability would have change had the item, as later adjusted, been taken into account when the 2018 return was filed.

Conclusion

For many years, the partnership audit rate was very low, especially when compared to corporations.  All that is changing.  With LPC and BBA, IRS is increasing its focus on partnership compliance and enforcement.  Taxpayers and practitioners should be prepared for increased partnership audits and compliance initiatives.

Filed Under: BBA, BBA Partnership Regime Tagged With:

Recent Developments in Partnership Audits (Part 1)

November 1, 2021 by Leave a Comment

When Congress passed the Bipartisan Budget Act of 2015 (BBA) in 2015 I rejoiced, thinking that my struggles with TEFRA had ended. My joy was short-lived, as many partnerships have years still subject to TEFRA provisions. Now as examinations of BBA-subjected partnerships start to ramp up, there are new complexities and struggles. Luckily, Rochelle Hodes, a Principal with Crowe LLP and a former Associate Tax Legislative Counsel in Treasury’s Office of Tax Policy, is here to provide background and highlight important developments. I am fortunate to work with Rochelle in Saltzman and Book, IRS Practice and Procedure, where she and my longtime colleagues on the treatise Marilyn Ames and Greg Armstrong are principal authors on the relatively new and excellent chapter dedicated to BBA issues. Les

A new centralized partnership audit regime was enacted as part of the Bipartisan Budget Act of 2015 (BBA) to replace the TEFRA and electing large partnership audit regimes.  Technical corrections were enacted in March of 2018.  The BBA is generally effective for partnership taxable years beginning on or after January 1, 2018, though certain partnerships were able to elect into the regime early.  Before discussing recent developments in Part 2 of this post, here’s a reminder of what makes BBA so unique:

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  • Under BBA, the partnership is liable for tax due as a result of adjustments to partnership-related items unless the partnership elects under section 6226 to “push out” those adjustments to the partners for the year to which the adjustments relate (reviewed year).  The tax imposed on the partnership under BBA is called the imputed underpayment (IU).  A partnership may be able to request certain modifications to reduce the IU.  See section 6225.  Similar to TEFRA, under BBA adjustments to partnership-related items are made at the partnership level.  However, BBA differs from TEFRA regarding assessment and collection of the tax.  Under BBA the IU is assessed and collected at the partnership level, whereas under TEFRA the tax due had to be assessed against and collected from the ultimate tax paying partners. 
  • Unlike TEFRA, BBA applies to all partnerships unless the partnership is eligible to, and does, make an election out of BBA under section 6221(b).  The election out is an annual election made on the partnership’s timely filed original return.  The rules do not provide an ability to make a late election out of BBA.  Generally, a partnership with more than 100 partners or with partners that are passthrough entities or disregarded entities, grantor trusts, or nominees are ineligible to elect out of BBA.  Special rules apply that allow partnerships with S corporation partners to elect out of BBA (basically, the S corporation and each of its shareholders is counted for purposes of determining whether the 100-partner threshold is exceeded).
  • BBA replaced the tax matters partner (TMP) under TEFRA with a partnership representative (PR) who has the sole authority to act on behalf of the partnership and whose action binds the partners and the partnership under the BBA.  See section 6223.  The PR is designated annually on the partnership return.  Unlike the TMP, the PR does not have to be a partner, but it does have to have a substantial presence in the US (generally, a US TIN, phone number, and reasonable availability to meet with the IRS).  If the PR is an entity, the partnership must also appoint an individual who can act on behalf of the PR called the designated individual (DI), who also must have a substantial presence in the US.
  • Amended partnership returns and amended Schedules K-1 are generally not permitted under BBA.  Instead, adjustments to partnership returns that have been filed must be made on an administrative adjustment request (AAR) under section 6227, which must be signed by the PR.  A partnership can either pay the IU (and apply some of the modifications to reduce the IU) or push out the adjustments to the partners for the year being adjusted.  A partnership generally has three years from the date the partnership return is filed to file an AAR, except no AAR may be filed for a tax year after the IRS sends a notice of administrative proceeding (NAP) under section 6231(a)(1) for that tax year (IRS Letter 5893/5893A).
  • Partners receive their allocable share of adjustments from a push out on a Form 8986. 
    • Under section 301.6226-3 of the regulations, partners that are not passthrough partners (generally individuals and C corporations) are required to determine the increase or decrease in tax in the reviewed year (and any intervening year) as a result of taking their allocable share of adjustments on the Form 8986 into account (plus interest and penalties, if applicable) and report that amount as an additional (or reduction in) chapter 1 tax on their income tax return for the year the initial partnership making the push out election furnished the Forms 8986 to their direct partners (reporting year).
    • Under section 301.6226-3(e), passthrough partners (including partnership partners and partners that are S corporations) must file a Form 8985 to the IRS and either pay the IU attributable to their allocable share of adjustments or push those adjustments out to their partners for the reviewed year.  In the case of push out, the passthrough partner must also file Forms 8986 and furnish a copy to its reviewed year partners. 

Tomorrow I will discuss two recent significant BBA developments.

Filed Under: BBA, BBA Partnership Regime Tagged With:

BBA, Partnerships and Schedule UTP

February 10, 2021 by 1 Comment

We welcome back Monte Jackel, Of Counsel at Leo Berwick. Since 2010, Schedule UTP has been used by certain corporations to report uncertain tax positions. In today’s post Monte discusses whether the BBA centralized audit partnership regime supports mandating Schedule UTP for partnerships. Monte discusses the history why partnerships were not originally required to furnish the form, as well as whether BBA subjects partnerships to additional financial reporting, and the current AICPA position on the latter issue. Les

For over a decade now, Schedule UTP has been mandated for corporations with $10 Million or more in assets and who maintain an audited financial statement and has one or more disclosable tax positions. See Schedule UTP Instructions. When initially issued a decade or so ago, the IRS indicated that similar reporting may be required of partnerships in the future. However, corporations with the requisite assets and financial statements who were partners in a partnership from which the return position arose were required to disclose that partnership position on the schedule as originally issued. 

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About a year or so later, it was reported that IRS Chief Counsel Wilkins had decided not to extend the schedule reporting to partnerships (See Jeremiah Coder, IRS Not Considering UTP Reporting for Passthroughs, Wilkins Says, 41 Ins. Tax Rev. 16, July 1, 2011, Wilkins Tax Notes Story) because, as the story quotes the former Chief Counsel, “the UTP reporting process relies heavily on the reporting that financial accounting rules already require of entities, Wilkins said. Thus, unless the accounting literature changes, the UTP reporting technique really doesn’t address positions that might exist in passthroughs, he said….For now the UTP reporting approach ‘does not fit that well with passthroughs as the accounting practices exist today,’ IRS Chief Counsel William J. Wilkins said.” 

ASC 740 applies only to business entities subject to income taxes. (See Alistair M. Nevius, Journal of Accountancy, June 1, 2011, ASC 740 excerpt.) If that is the case, then those entities would be subject to the financial accounting rules and maintain a financial statement. 

When the centralized audit partnership regime came into being in 2015, the question became whether partnerships subject to these new audit rules would now be subject to ASC 740 because the default position for partnerships subject to these new audit rules was that the partnership would pay an imputed underpayment (section 6225). This could then make those partnerships subject to federal income tax and subject to the accounting rules, and then perhaps the rationale for not subjecting partnerships to schedule UTP would no longer exist. Partnership reporting on Schedule UTP would presumably then help the selection of partnership tax returns for audit by the IRS, which has been one of their stated public goals. 

The potential impact of the centralized partnership audit regime on financial accounting was addressed by the AICPA in March 2018 (See AICPA Technical Practice Aids, TIS section 7200.09). In the case of partnerships subject to this centralized audit system, the question presented was whether the imputed underpayment that could be paid by the partnership was a federal tax imposed on the partnership directly in its taxpayer capacity or, alternatively, whether the tax underpayment is being made on behalf of the partners. If the former, the ASC 740 rules would apply and mandating a schedule UTP for partnerships could then make more sense. If not, then those financial reporting rules would not apply and schedule UTP reporting arguably should not then be extended to partnerships. 

In the public announcement issued by the AICPA, it was stated: 

“How should a partnership account for amounts it pays to the IRS for previous underpayments of tax, interest, and penalties? Said another way, does the underpayment represent an income tax of the partnership or the partners? 

“Reply — In accordance with paragraphs 226–229 of FASB ASC 740-10-55, if income taxes paid by the entity are attributable to the entity, they should be accounted for under the FASB ASC 740, Income Taxes, accounting model. If, however, the income taxes paid by the entity are attributable to the owners, they should be accounted for as a transaction with the owners….In the case of the IRS partnership audit regime, the collection of tax from the partnership is merely an administrative convenience on the part of the government to collect the underpayment of income taxes from the partners in previous periods. Accordingly, the income taxes on partnership income, regardless of when paid, should continue to be attributed to the partners and, therefore, the partnership would not apply the FASB ASC 740 accounting model to account for amounts it pays to the IRS for previous underpayments of tax, interest, and penalties. Rather, a payment made by the partnership under the IRS partnership audit regime should be treated as a distribution from the partnership to the partners in the financial statements of the partnership.”

Is this statement of position by the AICPA correct? Section 6221(a) of the Internal Revenue Code states in part that any tax attributable to an adjustment by the IRS of a partnership-related item shall be assessed and collected at the partnership level. And section 6225(a)(1) states that if there is such an adjustment, the partnership shall pay an amount equal to the imputed underpayment. The regulations at reg. §301.6221(a)-1(a) reaffirm this by stating that any such tax under chapter 1 of the Internal Revenue Code shall be assessed and collected at the partnership level. However, section 701 of the  Internal Revenue Code states clearly that “a partnership as such shall not be subject to the income tax imposed by [chapter 1]”, and this provision was not amended when the 2015 centralized partnership audit regime was enacted into law. 

Whether the imputed underpayment is indeed a tax imposed on the partnership and not on behalf of its partners is an important question. However, if the financial accounting treatment will determine any action by the IRS in extending Schedule UTP to partnerships, should it otherwise decide to do so, then the financial accounting treatment would be driving the federal income tax treatment and that does not seem appropriate. 

The centralized audit regime is so focused on partnership level adjustments and related matters that if applying schedule UTP to partnerships is determined to otherwise be a good idea, it should not be tied to the financial accounting treatment. 

Would extending schedule UTP to partnerships be a good idea? What has the experience been over the past decade or so on corporate reporting? It would seem that if partnership audits are going to be treated more seriously today, these reporting questions should be addressed and resolved. 

Filed Under: BBA, BBA Partnership Regime Tagged With:

Treasury and IRS Release New Round of BBA Partnership Audit Proposed Regulations

December 14, 2020 by Leave a Comment

Today we welcome back guest blogger Rochelle Hodes, a Principal with Crowe LLP and a former Associate Tax Legislative Counsel in Treasury’s Office of Tax Policy.  Rochelle discusses the new proposed regulations under the BBA partnership audit rules that were released just before Thanksgiving.  While the proposed rules primarily address special enforcement matters, the proposed rules would also amend the final BBA regulations in significant and consequential ways that practitioners and taxpayers ought to be attune to.  Rochelle would like to thank her former government colleague Greg Armstrong, a Director with KPMG LLP, for his helpful review and comments.  Rochelle and Greg worked together on, and continue to update, Chapter 8A in Saltzman Book IRS Practice and Procedure regarding the BBA partnership audit rules. Les

On November 24, 2020, Treasury and the IRS published proposed regulations under the centralized partnership audit regime enacted by the Bipartisan Budget Act of 2015 (BBA).  The BBA regime generally applies to partnership tax years beginning in 2018.  This post addresses proposed §301.6221(b)-1(b)(3)(ii)(G) regarding eligibility to elect out of BBA if a partner is a qualified S corporation subsidiary (QSub), proposed §301.6241-3 regarding treatment of partnerships that cease to exist, and proposed §301.6241-7 regarding treatment of special enforcement matters. In general, the proposed applicability date for these rules is November 20, 2020.

These proposed regulations are being released at the end of a presidential administration.  It is unclear how finalizing these proposed regulations will fit into the new administration’s priorities and whether policy decisions embedded in the proposed regulations will be reconsidered.  However, even with this uncertainty, the proposed regulations are important because they give taxpayers and practitioners a window into the IRS’s thinking on the BBA rules at a time when it is increasing its focus on partnership reporting and compliance.

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QSubs

All partnerships required to file Form 1065 are subject to the BBA regime unless the partnership is eligible to elect out of the regime and does so on its timely filed original return.  The election out of BBA is an annual election.  

A partnership is eligible to elect out of BBA if the partnership has 100 or fewer eligible partners.  Partnerships, trusts (including grantor trusts), disregarded entities, and nominees are not eligible partners and therefore partnerships with these types of partners cannot elect out of BBA. 

Section 6221(b) specifically provides that an S corporation is an eligible partner.  However, in the case of an S corporation a special rule applies for purposes of determining whether the partnership has 100 or fewer partners.  Under the special rule, all shareholders to whom the S corporation is required to furnish a Schedules K-1, plus the S corporation itself, are counted as a partner to determine whether the number of partners exceeds 100.  

Under the proposed regulations, a QSub is not an eligible partner, and therefore, a partnership with a QSub cannot elect out of BBA.  This is a reversal of the position taken by the IRS and Treasury in Notice 2019-06.  In Notice 2019-06, the IRS identified partnerships that are owned by a QSub as a special enforcement issue because such partnerships could have more than 100 owners when looking through the QSub to the S corporation and its shareholders. Accordingly, Notice 2019-06 stated that generally a partnership with a QSub as a partner would not be eligible to elect out of BBA, but that Treasury and the IRS intended to publish proposed regulations to allow partnerships with QSub partners to elect out of BBA under rules similar to S corporations.   But why did Treasury and the IRS reverse its position in Notice 2019-06?  It appears that a long simmering debate among practitioners about the nature of a QSub may be the cause.  The preamble includes a discussion of two comments addressing a rationale not to prohibit partnerships held directly by a QSub from electing out of BBA: one that relies on the fact that a QSub is a C corporation and the other that relies on the fact that for partnership reporting the S corporation, not the QSub, is treated as the partner.  The preamble then describes the reason for changing the government’s position in Notice 2019-6 as follows:

“Although Notice 2019-06 states that the proposed regulations would have applied a rule similar to the rules for S corporations under section 6221(b)(2)(A) to partnerships with a QSub as a partner, the Treasury Department and the IRS have reconsidered that approach.  Under § 301.6221(b)-1(b)(3)(ii), partnerships that have disregarded entities as partners may not elect out of the centralized partnership audit regime.  QSubs are treated similarly to disregarded entities for most purposes under the Code in that both QSubs and disregarded entities do not file income tax returns but instead report their items of income and loss on the returns of the person who wholly owns the entity.”  

85 FR 74943 (November 24, 2020).

Treatment Where a Partnership Ceases to Exist

Section 6241(7) provides that if a partnership ceases to exist before a BBA partnership adjustment takes effect, such adjustment shall be taken into account by the former partners of such partnership under regulations prescribed by the Secretary.

The current regulations under §301.6241-3 generally provide that partnership adjustments take effect when all amounts due under BBA resulting from the adjustment are fully paid.  The current regulations also provide that the former partners are the partners for the adjustment year with respect to the reviewed year to which the adjustments relate, but if there are no partners in that year, the former partners are the partners during the last taxable year for which the partnership filed a return.

The proposed regulations would modify several parts of the cease-to-exist regulations, but the two most consequential are the rules for when an adjustment takes effect and who are former partners.  The proposed regulations provide that the partnership adjustments take effect when the adjustment becomes finally determined, when there is a settlement, or if the adjustment relates to an item on an administrative adjustment request (AAR), when the AAR is filed. 

Under the proposed regulations, former partners would be 1) the partners during the last taxable year for which the partnership filed a return or an AAR or 2) “the most recent persons determined to be partners of the partnership in a final determination (for example, a defaulted notice of final partnership adjustment, final court decision, or settlement agreement) binding on the partnership.”  The proposed regulations do not set up an order of priority of which condition would take precedence.

The preamble to the proposed regulations states that these changes are necessary to coordinate section 6241(7) with section 6232(f), which was enacted by the Tax Technical Corrections Act of 2018.  Section 6232(f) provides that the IRS can assess tax upon the adjustment year partners if the partnership fails to pay the imputed underpayment within 10 days of notice and demand.  Section 6232(f) includes a rule allowing assessment against former partners determined under section 6241(7) if the partnership has ceased to exist.  Though section 6232(f) has been on the Treasury and IRS Priority Guidance Plan for a while now, no guidance under this section has been issued to date.  

Special Enforcement 

Section 6241(11) generally provides that in the case of partnership-related items which involve special enforcement matters, the Secretary may prescribe regulations to provide that BBA does not apply to the items and that the items are subject to special rules necessary for the effective and efficient enforcement of the Code.  The statute lists certain special enforcement areas, including termination and jeopardy assessments, criminal investigations, and indirect methods of proof of income.  The IRS had similar statutory authority with respect to special enforcement matters under TEFRA.

In addition to the special enforcement areas described above, the proposed regulations identify other special enforcement matters:

  • Partnership-related items underlying non-partnership-related items.  This provision would allow the IRS to determine that the BBA rules do not apply to adjustments of partnership-related items if all of the following apply:
    • An examination is being conducted of a person other than the partnership,
    • A partnership-related item is adjusted, or a determination regarding a partnership-related item is made, as part of, or underlying an adjustment to a non-partnership-related item of the person whose return is being examined, and 
    • The treatment of the partnership-related item on the Schedule K-1 or the partnership’s books and records is based in whole or in part on information provided by the person whose return is being examined.  
  • Controlled partnerships and extensions of the partner’s period of limitations.  This provision would allow the IRS to adjust partnership-related items outside of BBA if the period of limitations to make partnership adjustments under section 6235 has expired but the partner’s period of limitations on assessment for chapter 1 tax has not expired.  This provision applies to direct or indirect partners that are related to the partnership under section 267(b) or section 707(b) or direct or indirect partners that consent to extend the period of limitations to adjust and assess any tax attributable to partnership-related items. 
  • Penalties and taxes imposed on the partnership under chapter 1.  This provision would allow the IRS to adjust any tax or penalty imposed on, and which is the liability of the partnership, under chapter 1 of the Code without regard to BBA.  It would also allow the IRS to “adjust any partnership-related item, without regard to [BBA], as part of any determination made to determine the amount and applicability of the tax, penalty, addition to tax, or additional amount being determined without regard to [BBA].  Any determinations under this [provision] will be treated as a determination under a chapter of the Code other than chapter 1 for purposes of § 301.6241-6 [coordination with other chapters of the Internal Revenue Code].”
Filed Under: BBA Partnership Regime Tagged With:

Disguised Sales to Partnerships, BBA Centralized Audits and Due Process

June 3, 2020 by 1 Comment

Returning to look at the BBA regime, Monte Jackel examines final BBA regulations and issues relating to a partner’s gain on a disguised sale with a partnership. Les

The final BBA regulations reflect that “partnership-related items” are the items that are subject to the uniform centralized partnership audit regime. (T.D. 9844; Reg.§301.6241-1(a)(6)(ii)-vi)). These “partnership-related items” are those shown or reflected, or required to be shown or reflected, on a partnership income tax return (form 1065), or is otherwise required to be maintained in the partnership’s books and records. On the other hand, an item shown or required to be shown on an income tax return of a person other than the partnership that results from the application of the Internal Revenue Code to a partnership-related item based upon the other person’s specific facts and circumstances, including an incorrect application of the Code or taking into account erroneous facts and circumstances of that person, is not a partnership-related item.

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On the surface, the distinction between non-partnership related items and partnership- related items seems clear in most cases. Examples 1 and 2 under reg. §301.6241-1(a)(6)(vi) are the most helpful in this regard. Example 1 stands for the proposition that even though an income producing event occurs between a non-partner person and the partnership, only the deduction or expense relating to the transaction, and not the income of the other person from the very same transaction, is a partnership-related item. Similarly, example 2 involves a purported loan to the partnership by a non-partner person whereby it is stated that although the treatment of the purported loan on the partnership’s return, which presumably includes whether it is debt or equity and related interest expense, is a partnership-related item, the treatment of the purported loan in the hands of the other person, which also presumably includes a debt versus equity determination, is not a partnership-related item. Further, that appears to be the case if the persons in examples 1 and 2 were instead partners of the transferee partnership. For example, if there was a disguised sale under reg. §1.707-3, the tax effects of a purchase must clearly be reported on the partnership return but the sales gain would apparently only be reported on the partner’s separate form 1040. 

Even though the very same transaction with the same parties is involved on both sides of the transaction, the final regulations push strongly in the direction noted immediately above, although it would have been very useful if alternative facts under examples 1 and 2 had tested the results if the other person had been a partner instead. 

In both examples 1 and 2, the other person is clearly not identified as a partner in the partnership at issue. If that were otherwise the case, section 6222 would generally require the partner to follow the partnership’s treatment of the item. The most pertinent example of the case where the other person is in fact a partner, for purposes of this commentary, is a disguised sale by the partner to the partnership under section 707(a)(2)(B) and reg. §1.707-3. (It should be noted as an aside that the only significant set of BBA audit regulations that are still in proposed form are those relating to attribute adjustments under sections 704, 705, 706, 6225, and 6226, REG-118067-17, Feb. 2, 2018). 

The regulations are also unclear, and this relates to the main point at issue in this commentary, as to whether the computation of the imputed underpayment (IU) includes the sales gain that the partner will incur if it is determined in a partnership proceeding that a sale and purchase occurred under section 707(a)(2)(B) and its underlying regulations. 

As a technical matter, in computing an IU, there is first a determination of whether there is a “partnership adjustment” which is any adjustment to a partnership-related item. (Reg. §§301.6241-1(a)(6)(i), 301.6225-1(a)(1), 301.6225-1(b)). Thus, unless the item is a “partnership-related item”, it will not enter into the computation of an IU. 

Similarly, if an election is made under section 6226 to push out a partnership adjustment that is part of an IU, there first needs to be a determination of whether the item is a partnership-related item. 

For these reasons, it is critical to understand whether, in the case of partner-partnership transactions, the item attributable to the partner side of the transaction is a partnership-related item and a partnership adjustment. Given the fact that the proposed regulations specifically listed disguised sales and related items as partnership-related items (prop. reg. §301.6241-6(b)(5)) and the final regulations do not include that language but contain instead the “reportable on the partnership return” or “reportable on the other person’s return” standard, the apparent answer is that the partner sale gain on a disguised sale with a partnership will not be part of the computation of an IU.  

The preamble to T.D. 9844 is confusing and circular in how it describes what is a partnership-related item in these types of cases, particularly when there is a transaction between a partner and the partnership. It states, in pertinent part:

“[The proposed regulations] provided as an example of an “item of income, gain, loss, deduction, or credit” any items related to transactions between a partnership and any person including disguised sales, guaranteed payments, section 704(c) allocations, and transactions to which section 707 applies….One comment suggested that this provision inappropriately included partner items such as a disguised fee under section 707(a)(2)(A) and the gain or loss a partner may realize from a disguised sale under section 707(a)(2)(B). … Similarly, another comment expressed concern about situations where a partner was not acting in the partner’s capacity as a partner, but rather as a counterparty to a transaction with the partnership. …. These comments are addressed by the final regulations …regarding the definition of partnership-related item. …[T]he final regulations clarify that items or amounts relating to transactions of the partnership are items or amounts with respect to the partnership only if those items or amounts are shown, or required to be shown, on the partnership return or are required to be maintained in the partnership’s books and records. The final regulations further clarify that items or amounts shown, or required to be shown, on a return of a person other than the partnership (or in that person’s books and records) that result after application of the Code to a partnership-related item and that take into account the facts and circumstances specific to that person are not partnership-related items and, therefore, are not determined at the partnership level under the centralized partnership audit regime. ….”

There are a number of issues with how this particular provision (partnership-related item) is defined and the explanation given for it in the final regulation preamble as it relates to transactions between a partner and a partnership where the partner is acting in a partner capacity and, thus, the transaction is not governed by section 707(a)(1) (partner acting in non-partner capacity). In that latter case, the final regulation is worded properly because unless either res judicata or collateral estoppel apply to the other non-partner person, the determination at the partnership level has nothing to do with how the other person reports the transaction, which can be inconsistent with how the partnership treats it because that other person is not a partner.  An assessment of tax at the partnership level will have absolutely no effect on the assessment of tax of that other person in that case.

A transaction between a partner and the partnership invokes, first, section 6222 which generally requires the partner to report the transaction consistently with how the partnership reports it. Thus, if the partnership treats a contribution of built-in gain property to it as a purchase because it is determined to be a disguised sale under reg.§1.707-3, then the partner must also treat the transaction as a purchase by the partnership absent timely notice of inconsistent treatment by the partner. 

This would seem to mean that since the same factors are taken into account in determining whether there is a sale and a purchase under reg. §1.707-3(b)(1) and 1.707-3(b)(2), it would be difficult for a partner who files an inconsistent treatment statement under section 6222(c) to sustain a position that there is no sale by him even though the partnership either reports or is required to report that a purchase occurred as part of a partnership level proceeding. 

If the issue of whether the partner sold property to a partnership is determined first before the partnership level proceeding, section 6222(d) states that if the partnership was not a party to the partner proceeding then the partner determination is not binding on the partnership. Although such a determination is not technically binding on the partnership, it is difficult to see how a later separate partnership level proceeding based on the same facts with the same parties could lead to a different result but that is not discussed or explained in any set of BBA audit regulations. 

However, the reverse is not true. Thus, section 6222 does not prohibit a proceeding at the partnership level from binding the partner in a partner level proceeding relating to the same transaction with the same facts. It would seem that any partnership level proceeding as to whether there was a sale would bind the partner as well under common law rules given that the same prime legal issue (whether there was a sale) and the same facts as well as the same parties are involved. Section 6223(b) says as much by stating that “A partnership and all partners of such partnership shall be bound (1) by actions taken …by the partnership, and (2) by any final decision in a proceeding …with respect to the partnership.” See, also, reg. §301.6223-2(a). 

Now, for the “due process of law” question left unaddressed in the regulations. Assume, as it appears is most likely the case as discussed above, that the gain portion of the disguised sale is not a partnership-related item but only the purchase side of the transaction is a partnership related item. (If the sales gain was part of the computation of the IU, the liability for tax under section 6225 would then be shared by all adjustment year partners and would not be limited to the selling partner only. If, on the other hand, the push-out election is made under section 6226 in that case, then the partners with whom the partnership-related adjustment “is associated” will be required to include the amount in income. That push-out may allocate all of the sales gain to the seller although the regulations do not address that issue either). 

Left unresolved by the regulations, and here I think lies the due process question in a nutshell, is whether the selling partner may still contest in a separate proceeding whether he owes tax on the now determined (by the partnership) disguised sale to the partnership. It seems that the legal issue involved (sale versus contribution) will be resolved by how the partnership treats the transaction or is required to treat the transaction in a partnership level proceeding. And section 6222(b) seems to allow for immediate assessment as a mathematical error the inconsistent treatment by the partner as a non-sale if the partnership treats the transaction as a purchase and the partner does not file a notice of inconsistent treatment. And even if the partner does file a notice of inconsistent treatment, it is not clear whether the doctrines of collateral estoppel or res judicata or other common law doctrine will apply to prevent the selling partner from relitigating the question in a separate court proceeding.

But this is not all there is to the question. Only the partnership representative can represent the partnership in a proceeding with the IRS regardless of the limitations on the representative’s power in the partnership agreement. This seems to mean that the selling partner, if he is not the partnership representative, can be forced solely to pay tax on a transaction, the sale, without the partner’s participation in the IRS proceeding with the partnership. If the partnership proceeding occurs first, can inconsistent treatment by the partner result in an immediate math error assessment? If a notice of inconsistent treatment is given, is the prior partnership proceeding legally binding so that no challenge to the merits can occur anyway in the separate partnership proceeding? And, is this a violation of due process by the government taking property from the partner without any rights by the partner to contest or challenge the partnership proceeding?

The answer to this question is not clear. On the one hand, the partner has agreed to enter into the partnership and will be charged with the knowledge that the partnership representative is the sole party representing the partnership with the IRS. Thus, it may be argued, the partner has given his consent to the consequences of not being able to participate in his own audit in this kind of case. On the other hand, are the terms of the statute and regulations sufficient to override fundamental notions of no taking of property by either the federal government or the states “without due process of law” as set forth by the Fifth and Fourteenth amendments to the U.S. Constitution? 

It should be noted that the regulations could most likely have eliminated this issue by stating that the seller partner side of the transaction is also a partnership-related item along with the partnership purchase side of the transaction. In that case, the tax liability would be shared by all adjustment year partners under section 6225 and there would be no meaningful due process question. (Otherwise, the entire BBA audit regime would be unconstitutional). But the regulations seem to say just the opposite, as this commentary has explained. 

I know that both sides of this argument have been taken by a number of practitioners. I have previously taken the position that there is a clear violation of due process in this case and the BBA statutory regime is invalid to that extent. I still think so. What do others think?  

Filed Under: BBA, BBA Partnership Regime Tagged With:

BBA Partnership Tax Provisions and Bankruptcy– A Recipe for Disaster, Part 1

May 26, 2020 by 1 Comment

We welcome back guest blogger, A. Lavar Taylor.  Lavar’s practice is based in Southern California though you can find him pursuing cases around the country.  He spent the early days of his career in the General Litigation Division of Chief Counsel’s office where he learned the intricacies of the intersection of tax and bankruptcy.  We enjoy his insights today on a new issue that could vex bankruptcy and tax attorneys in the coming years.  Keith

Some of us practitioners are old enough to have endured the transition to the TEFRA Partnership audit provisions from the unwieldy pre-TEFRA rules that required the IRS to audit the tax returns of all partners in a tax partnership in order to assess deficiencies resulting from adjustments to Forms 1065 filed by those partnerships.  That transition required a considerable learning curve. Even 30+ years after the enactment of the TEFRA Partnership audit provisions, we have still been “learning through litigation” about the proper interpretation of some of the more poorly drafted TEFRA Partnership audit provisions.  See, e.g., Petaluma FX Partners, LLC v. Comm’r, 792 F.3d 72 (D. C. Cir. 2015).

The intersection between the TEFRA Partnership audit provisions and the bankruptcy/insolvency world has also proven to be quite interesting, as illustrated by the Ninth Circuit’s opinion in Cent. Valley Ag Enters. v. United States, 531 F.3d 750 (9th Cir. 2008). In that case, the taxpayer/debtor was allowed to challenge a claim filed by the IRS based on a TEFRA Partnership audit even though the IRS had issued an FPAA and the deadline for filing a Tax Court petition with respect to the FPAA had expired without any petition having been filed.  Outside of bankruptcy, no judicial challenges to the audit assessment made against that partner as the result of the TEFRA Partnership audit would have been permissible as of the date on which the Chapter 11 bankruptcy case was filed. But once inside Chapter 11, per the Ninth Circuit, the taxpayer/debtor/partner was entitled to challenge the merits of the audit assessment under section 505(a)(2) of the Bankruptcy Code.  The filing of the Chapter 11 by the partner allowed the debtor/taxpayer/partner to escape the otherwise preclusive effect of the failure of any party in interest to file a Tax Court petition in response to the FPAA.

Now, thanks to Congress, we are faced with learning an entirely new set of partnership audit provisions: the BBA Partnership audit provisions. Learning how these new provisions will operate in the real world is likely to be no less painful than it was to learn how the TEFRA Partnership audit provisions operate in the real world.

This learning process will be even more painful where a bankruptcy is involved. How much more painful? That remains to be seen, but masochists and sadists will likely rejoice.

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This post discusses one of the many problems that are going to arise when the BBA Partnership audit provisions collide with the Bankruptcy Code, namely, how to classify, for purposes of the Bankruptcy Code, claims for audit assessments of income taxes arising under the BBA Partnership Audit proceedings. I plan to follow up this post with additional posts which will further discuss the problems that are going to arise as the result of the intersection of these two statutory schemes. A discussion of these issues appears timely in light of the current economic climate.

Classifying income tax claims under the Bankruptcy Code is important. How income tax claims get classified under the Bankruptcy Code determines matters such as: a) the order in which such claims get paid in Chapter 7 relative to other types of claims, b) whether such claims must be paid in full in a Chapter 11 case or in a Chapter 13 case, c) the terms on which such claims can or must be paid in a Chapter 11 case or in a Chapter 13 case, and d) the extent to which such claims can be discharged in bankruptcy.

Without getting too technical, there is a big distinction under the Bankruptcy Code between income tax claims that are for tax periods that end prior to the date of the filing of the bankruptcy petition (“pre-petition tax claims”) and income tax claims for tax periods that end after the date of the filing of the bankruptcy petition (“post-petition tax claims”).  Pre-petition income tax claims, if not secured by the proper filing of a tax lien notice, are either “general unsecured” claims or “priority” claims. See, e.g., Bankruptcy Code 507(a)(8)(A), which determines what pre-petition income tax claims are treated as “priority” tax claims.

Post-petition income tax claims are sometimes (but not always) entitled to be paid as an administrative expense in the bankruptcy case.  In other cases, post-petition income tax claims are not treated as administrative expense and cannot be paid out of proceeds held by a Chapter 7 Trustee and cannot be paid at all under a Chapter 11 plan.

In any bankruptcy case, unsecured pre-petition tax claims, whether treated as “priority” tax claims or as “general unsecured” claims, do not get paid until all administrative expense claims have been paid in full. Also, “priority” tax claims get preferred treatment over general unsecured claims in all types of bankruptcy cases.  

Thus, determining whether an income tax claim is a pre-petition claim or is instead a post-petition claim is important. Also, if an income tax claim is a pre-petition claim, determining whether that claim is a “priority” tax claim or is instead a “general unsecured” tax claim is important. Similarly, if an income tax claim is a post-petition claim, determining whether or not that post-petition income tax claim is an administrative expense claim is important.  See, e.g., Towers for Pacific-Atlantic Trading Co. v. United States (In re Pacific-Atlantic Trading Co.), 64 F.3d 1292 (9th Cir. 1995), which dealt with all of these issues in the context of an IRS claim for taxes for the tax year during which a corporate debtor/taxpayer went into chapter 11 bankruptcy.

Those of you who have some familiarity with the BBA Partnership audit provisions should already have an idea of where this discussion is headed.  Under the BBA Partnership provisions, an audit of a partnership return for the year 2019 which ends in the year 2023 and which generates a deficiency can result in any of the following:  1) deficiency assessments against the 2019 partners for the 2019 tax year, 2) a deficiency assessment against the partnership for the tax year 2023, or 3) deficiency assessments against the 2023 partners for the tax year 2023. 

Suppose, then, that the tax partnership files for chapter 11 at the end of 2022 and that this Chapter 11 case remained pending as of the end of 2023 without a chapter 11 plan being confirmed.   If an IRS audit of the partnership’s 2019 tax return comes to an end in 2023 and the taxes are assessed against the partnership for the year 2023 in 2024, how should that claim be classified under the Bankruptcy Code?  The claim is for the 2023 tax year, a post-petition year.  That suggests that the claim is a post-petition claim. But the claim is clearly based on pre-petition activity. Thus, there is an argument that the claim against the partnership should be treated as a pre-petition claim, even though the claim is for a post-petition tax year.

If the claim is to be treated a pre-petition claim, is the claim entitled to priority treatment under section 507(a)(8) even though that section only applies to claims for tax years that ended before the date on which the bankruptcy was filed? If the claim is to be treated as a post-petition claim, is the claim an administrative expense claim allowed under section 507(a)(2) of the Bankruptcy Code? Resolution of these issues will be important not only to the IRS, which will want to be paid what it is owed, but also to the 2023 partners of the partnership, who can be held personally liable for the partnership’s 2023 income tax deficiency assessment if it is not paid by the partnership.

Sorting out these classification issues in this very simple fact pattern, based on the law as it presently stands, will take years of litigation. There will undoubtedly be variations of this fact pattern, and there will be bankruptcy cases involving the partners in a partnership subject to the BBA Partnership audit provisions in which claim classification issues arise.  Such claim classification issues are but a small fraction of the issues that will arise in bankruptcy cases involving individuals and entities subject to the BBA Partnership audit provisions.

Conclusion of Part I

It will be far more efficient to solve these problems through legislative and administrative action, rather than through litigation. The first step in this process, however, is to identify the problems that need to be solved. I hope to identify additional problems in future posts, and I invite the PT Community to help identify the problems that are out there. (For those of you interested in reading a short article which identifies some of the due diligence that bankruptcy professionals must perform as the result of the enactment of the BBA Partnership audit provisions, I invite you to review the following article which appeared in Business Law News, published by the California Lawyer’s Association, which can be found here.

Filed Under: BBA Partnership Regime Tagged With:

The Newest Time Machine

May 5, 2020 by 1 Comment

Yesterday in Part 1, Monte A. Jackel, discussed issues relating to the extension of deadlines due to COVID-19. In today’s post Monte considers whether in light of retroactive law changes in CARES the IRS can force a partner to amend a return when the original tax return filed was correct. Les

Revenue Procedure 2020-23 (originally discussed on PT by Marilyn Ames) sets forth the terms and conditions for a partnership subject to the BBA audit regime to file an amended tax return for the 2018 and 2019 tax years. The revenue procedure provides welcome relief for cases where the retroactive law changes allowing 5-year loss carrybacks and the technical correction for QIP (qualified improvement property) would not otherwise have been available because section 6031(b) generally disallows amended returns by such partnerships; AARs are the preferred route. 

The revenue procedure, however, assumes that all partners would favor such retroactive relief. However, that may not always be the case. This brings to the forefront the issue of whether one or more partners of such a partnership that wants to file an amended form 1065 must also ensure that all of its partners file amended form 1040s. That is not directly addressed in the revenue procedure. There is only a reference to section 6222 and the amended form 1065 substituting for the original form 1065. This strongly suggests that the IRS believes that the partners have a legal duty to file amended form 1040s. 

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Revenue Procedure 2020-25 sets forth the options for taxpayers, including partnerships, to obtain relief due to the retroactive law change making QIP eligible for bonus depreciation under section 168(k). This revenue procedure essentially provides for amended forms 1040 or 1065 or automatic changes via a form 3115 to obtain relief due to the retroactive QIP change in the law. The revenue procedure assumes, without citing any supporting law, that when the law relating to a timing of income statute, such as section 168(k), is retroactively changed by Congress, that the taxpayer is now using an impermissible method of accounting. There does not appear to be any law that expressly supports that treatment although it may be the correct policy result. 

Further, there does not appear to be any law that expressly supports mandating the filing of an amended tax return where the original return  was true and correct at the time it was filed. Both reg. §§1.451-1(a) and 1.461-1(a)(3) state that to correctly treat an item of income or deduction in a different tax year than originally reported, the taxpayer “should”, if within the period of limitations, file an amended return. The word “shall” is not in the regulations; only “should”. (See, also, reg.§1.453-11(d) (an amended return for an earlier year “may” not “must” be filed.)

Further, under sections 6662 and 6694, the taxpayer tests a position of substantial authority either at the end of the tax year or when the tax return is filed, and the return preparer tests the level of authority when the tax return is filed. And, at those times, the method of accounting for QIP over a long useful life was the only permissible method to use. The retroactive law change does not change that. And neither Circular 230 or the ABA model rules of professional conduct change that result either.

If the taxpayer does not want to amend either a form 1040 or a form 1065 and the government cannot force the taxpayer to amend its tax return, what is the government remedy? There has been no change in method initiated by the taxpayer and the taxpayer properly adopted the original method and never changed that method. How is the government to force the taxpayer from the retroactively determined impermissible method to the now permissible method? And AARs are voluntary. It is not uncommon for revenue procedures to mandate accounting method changes where there is a prospective change in the law. And, at times, accounting method changes have been mandated (such as the Rule of 78s issue in the 1980s) where the method change applies to a tax year but a return for the prior year may or not have been already filed before the mandate to change (the issue is not discussed). However, I am not aware and could not find any authority that deals with a statutory retroactive law change and applying that change to a prior year where a true and correct tax return containing the prior treatment has already been filed. 

If the taxpayer  cannot be forced off the 39-year method, what does the taxpayer report for future years? Zero or 1/39? If the property is sold after year one but before year 39, section 1245 will only recapture the depreciation actually taken. It would seem that the duty of consistency would mandate continuing to depreciate over a 39-year period although the same tax adviser for year one may not be able to continue to advise the taxpayer because that person would arguably be perpetuating an error. 

The solution may be to mandate the filing of an amended return because the government can only collect from the partnership an imputed underpayment spread over the remaining years in the 39-year period because presumably there is no underpayment in year one by imposing bonus depreciation in that earlier year. But forcing an amended return will create a huge quagmire.

AndA, as noted earlier, what if one or more partners do not want to amend their 1040s but the partnership does amend its form 1065 under Rev. Proc. 2020-23? This revenue procedure does reference the duty to file consistent returns under section 6222, but is this to be read as mandating the filing of an amended tax return? It seems so but doing that would be an issue of first impression to me under existing law. A true time machine.

Filed Under: Amended Returns, BBA Partnership Regime Tagged With:

Tax Court Adopts Final Rules For BBA Partnership Audit Regime

September 5, 2019 by Leave a Comment

Today we welcome Greg Armstrong and Rochelle Hodes to the community of Procedurally Taxing guest posters. Greg is a Director with KPMG, LLP Washington National Tax in the Practice, Procedure, & Administration group in Washington D.C. and former Senior Technician Reviewer with the IRS Office of Chief Counsel. Rochelle is a Principal in Washington National Tax at Crowe LLP and was previously Associate Tax Legislative Counsel with Treasury.  Both Greg and Rochelle in their immediate prior positions with IRS and Treasury respectively spent considerable time working on the new partnership audit regime enacted to replace TEFRA as part of the Bipartisan Budget Act of 2015 (BBA) and as revised in subsequent technical legislative corrections. Rochelle is a Contributing Author on the BBA chapter that will be published this fall for Saltzman and Book IRS Practice & Procedure, and Greg has contributed over the years in updating and revising the treatise.

In this post, Greg and Rochelle discuss the Tax Court’s amendments to its Rules of Practice as relating to the BBA regime. Les

On July 15, 2019 the United States Tax Court announced that it had adopted final amendments to its Rules of Practice and Procedure to address actions under the new partnership audit regime enacted by BBA. The final amendments, which were first introduced as proposed and interim amendments on December 19, 2018, add a new Title XXIV.A (Partnership Actions under BBA Section 1101) and also make conforming and miscellaneous amendments.  New Title XXIV.A is effective as of December 19, 2018 and generally applies to partnership actions commenced with respect to notices of final partnership adjustment (FPAs) for partnership taxable years beginning after December 31, 2017.  The new rules also apply to actions commenced with respect to FPAs for partnership taxable years for which an election under §301.9100-22 is in effect.    

The following post offers a high level summary of the highlights of the Court’s new rules with respect to the BBA regime.  Because this post is focused on the new Tax Court rules, only a summary of the BBA provisions relevant to understanding the Court’s rules are discussed.  For a more robust discussion of the BBA provisions, see the latest update to Saltzman and Book, IRS Practice and Procedure, which includes a new chapter 8A entitled “Examination of Partnership Tax Returns under the Bipartisan Budget Act of 2015”.

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The Tax Court’s rules reflect the prominent and powerful role of the partnership representative (PR) under the BBA.  The PR is the individual or entity that has the sole authority to act on behalf of the partnership for purposes of the BBA and replaces the Tax Matters Partner (TMP) concept that existed under TEFRA.  Pursuant to section 6223(a) and the regulations thereunder, a partnership subject to BBA must designate a PR for each taxable year.  If the IRS determines that there is no PR designation in effect for the taxable year, the IRS may select the PR.  If the partnership designates an entity as the PR, the regulations require that the partnership also appoint a designated individual to act on behalf of the entity PR.

Rule 255.2 provides that a BBA partnership action is commenced like any other action in the Tax Court – by filing a petition.  The caption of the petition, and any other paper filed in a BBA partnership action, must state the name of the partnership as well as the name of the PR.  Rule 255.1(d).  This is consistent with TEFRA Rule 240(d), Form and Style of Papers, which requires the caption to state the name of the partnership and the partner filing the petition, and whether the partner is the TMP.  Since under BBA only a PR can bring a partnership action in Tax Court, and because no partner (unless they are the PR) can file a petition, it makes sense that the PR is named in the caption in addition to the partnership.  The body of the petition must also identify the PR’s place of legal residence or principal place of business if the PR is not an individual.  Rule 255.2(b).  Interestingly, Rule 255.2(b) does not require the petition to provide the name or address of the designated individual.  The rule does require the petition to indicate whether the PR was designated by the partnership or selected by the IRS.

Identification and Removal of a Partnership Representative by the Court

New Rule 255.1(b)(3) defines the PR for purposes of BBA partnership actions to mean the partner (or other person) designated by the partnership or selected by the IRS pursuant to section 6223(a), “or designated by the Court pursuant to Rule 255.6.”  Rule 255.6 sets out circumstances in which the Court may act to identify or remove a PR in a partnership action under BBA.  The first such circumstance is if at the time of commencement of the action the PR is not identified in the petition.  Rule 255.6(a).  The second such circumstance is if after the commencement of the case the Court “may for cause remove a partnership representative for purposes of the partnership action.”  Rule 255.6(b).  The Court’s rule requires that before removal there must be notice and an opportunity for a hearing.  Neither Rule 255.6(b) nor the explanation to the rule delineate what causes would warrant removal.

Rule 255.6(a) provides that where there is no PR identified in the petition at the beginning of the case, the Court “will take such action as may be necessary to establish the identity” of the PR.  Rule 255.6(a) is vague as to what action might be necessary to establish the identity of the PR.  If no PR is identified, one possible outcome may be that the case is dismissed on the ground that a proper party did not file the petition.

Rule 255.6(b) provides that “if a partnership representative’s status is terminated for any reason, including removal by the Court, the partnership shall then designate a successor partnership representative in accordance with the requirements of section 6223 within such period as the Court may direct.”  Rule 255.6(b) does not address what happens if the partnership is unable or unwilling to designate a successor PR.  It is also interesting that Rule 255.6(b), while referencing the requirements of section 6223, only cites the authority of the partnership to designate a PR, and does not cite the Commissioner’s authority to select a PR.  The ability of the Commissioner to select a PR for the partnership raises intriguing issues that also arose in the early days of TEFRA.  See, e.g., Computer Programs Lambda v. Comm’r, 90 TC 1124, 1127-28 (1988).

Per the explanation to Rule 255.6, the authority to identify or remove a PR “flows from the Court’s inherent supervisory authority over cases docketed in the Court.” The explanation to Rule 255.6 also states, however, that the rule “does not take a position on whether the Court may appoint a partnership representative.”  In the context of a TEFRA partnership action, Rule 250 permits the Court to appoint a TMP in certain circumstances.  Notably, Rule 250(a) provides that if there is no TMP at the outset of the TEFRA action, the Court “will effect the appointment of a tax matters partner.”  Similarly, Rule 250(b) provides that where the TMP has been removed by the Court or the TMP’s status has otherwise terminated, the Court “may appoint another partner as the tax matters partner” if the partnership has not designated one in the time frame prescribed by the court.  Consistent with the explanation to Rule 255.6, and unlike Rule 250, Rule 255.6 does not contain language permitting the Court to appoint a partnership representative.   However, the explanation to Rule 255.6 appears to leave the door open for the Court to appoint a PR if the facts warrant such action, though it is unclear what those facts might be.

Jurisdiction Over the Imputed Underpayment and Modifications

Rule 255.2(b) also reflects the fact that the partnership as a result of an action under BBA may be liable for tax, i.e., an imputed underpayment determined under section 6225.  An imputed underpayment is initially computed by the IRS during the administrative proceeding, but may be modified if timely requested by the partnership and approved by the IRS.  The modified imputed underpayment and any modifications approved or denied by the IRS will be reflected in the FPA mailed to the partnership. 

Rule 255.2(b)(5) requires that the petition reflect the amount of the imputed underpayment determined by the Commissioner and “if different from the Commissioner’s determination, the approximate amount of the imputed underpayment in controversy, including any proposed modification of the imputed underpayment that was not approved by the Commissioner.”  Further, Rule 255.2(b)(6) requires the petition to clearly and concisely state each error that the Commissioner allegedly committed in the FPA “and each and every proposed modification of the imputed underpayment to which the Commissioner did not consent.”  Rule 255.2(b)(7) provides the petition should also include “[c]lear and concise lettered statements of the facts on which the petitioner bases the assignments of error and the proposed modifications.”

The petition requirements set forth in Rule 255.2(b) make clear that the Tax Court will have jurisdiction to redetermine an imputed underpayment reflected in the FPA, including any “proposed modifications” to the imputed underpayment that were not approved by the Commissioner.  Prior to the Tax Technical Corrections Act of 2018, Public Law 115-141 (TTCA), the issue of jurisdiction over imputed underpayments and modifications was unsettled.  By amending the definition of partnership-related item to specifically include an imputed underpayment while also amending section 6234(c) to provide the court with jurisdiction “to determine all partnership-related items” for the taxable year to which the FPA relates, the TTCA amendments make clear that the court has jurisdiction to determine an imputed underpayment.  Therefore, the Code provides the court with jurisdiction to determine an imputed underpayment, including any modifications to that imputed underpayment that were denied by the Commissioner.  This is reflected in Rule 255.2(b).   

Binding Effect of Tax Court’s Decision

Rule 255.7 provides that any decision that the Tax Court enters in a partnership action under BBA is binding on the partnership and all of its partners.  The term “partner” is not defined under New Title XXIV.A.  However, under Rule 240 “partner” is defined for purposes of a TEFRA action to mean “a person who was a partner as defined in Code section 6231(a)(2)” at any time during the taxable year before the Court.  Section 6231(a)(2), prior to amendment by the BBA, defined partner for TEFRA purposes to mean a partner in the partnership and “any other person whose income tax liability under subtitle A is determined in whole or in part by taking into account directly or indirectly partnership items of the partnership.” 

Unlike TEFRA, the BBA does not define the term “partner”.  However, the BBA does define a partnership-related item broadly to include items or amounts “relevant in determining the tax liability of any person” under chapter 1 (emphasis added).  See section 6241(2)(B)(i).  In addition, the Joint Committee on Taxation explanation accompanying TTCA explicitly states that the scope of BBA is not narrower than TEFRA, “but rather, [is] intended to have a scope sufficient to address those items described as partnership items, affected items, and computational items in the TEFRA context…, as well as any other items meeting the statutory definition of a partnership-related item.” See Technical Explanation of the Revenue Provisions of the House Amendment to the Senate Amendment to H.R. 1625 (Rules Committee Print 115-66), p.37, JCX-6-19 (March 22, 2018). 

Consistent with the broad scope of partnership-related item under BBA, when describing the binding nature of final decisions in proceedings under the BBA, Treas. Reg. §301.6223-2(a) provides that such decisions are binding on the partnership, its partners, and “any other person whose tax liability is determined in whole or in part by taking into account directly or indirectly adjustments determined under the [BBA]”.   Whether the Tax Court follows this regulation in extending the binding effect of its own decisions in BBA partnership actions remains to be seen.

Filed Under: BBA Partnership Regime, Tax Court Tagged With: ,
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