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Audit Procedures for Pass-Through Entities (Portfolio 624)

Tax Management Portfolio, Audit Procedures for Pass-Through Entities, No. 624-3rd, analyzes in detail the statutory rules of §6221–§6234 governing the audits of “TEFRA partnerships.” The Portfolio also considers briefly the analogous provisions governing the audit procedures for “subchapter S items” (former §6241–former §6245), before their repeal in 1996, and the provisions governing electing large partnerships (§6240–§6255), enacted in 1997.

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DESCRIPTION

Tax Management Portfolio, Audit Procedures for Pass-Through Entities, No. 624-3rd, analyzes in detail the statutory rules of §6221–§6234 governing the audits of “TEFRA partnerships.” The Portfolio also considers briefly the analogous provisions governing the audit procedures for “subchapter S items” (former §6241–former §6245), before their repeal in 1996, and the provisions governing electing large partnerships (§6240–§6255), enacted in 1997.
Partners are generally required to file their returns consistently with the partnership return or provide notice of any variation to the IRS. Audits are conducted at the entity level and are limited to “partnership items” and related penalties. The IRS deals primarily with the Tax Matters Partner (TMP), who in turn has the duty under §6223(g) to keep the other partners informed of all administrative and judicial proceedings.
After the audit is completed, the IRS notifies the TMP of the proposed adjustments in a notice of final partnership administrative adjustment (FPAA). Certain classes of partners are given the right to participate in both administrative and judicial proceedings. There are special rules which apply to partners with a less than 1% interest in a large partnership, and other rules which apply to indirect partners, that is, the ultimate taxpayers when the partner is itself a pass-through entity. At the conclusion of the partnership proceeding, the IRS applies the partnership determination to each partner's tax liability by means of a computational procedure. The IRS may then also issue an “affected item notice of deficiency” to raise substantive issues on the partner's return related to the partnership determination.
The TMP of a TEFRA partnership also has the ability, in certain circumstances, to file amended partnership returns that will apply to all partners. This amended return, called an Administrative Adjustment Request (AAR), differs in several significant respects from non-TEFRA claims for refund. Specific procedural rules govern the filing, processing, and litigation concerning an AAR.


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AUTHORS

STEVEN R. MATHER
Steven R. Mather, University of Iowa B.B.A., with highest distinction (1978); University of Iowa J.D., with distinction (1982); Member, California and Iowa Bars; Certified Public Accountant, Iowa (1979); Senior Attorney, District Counsel, Internal Revenue Service, Los Angeles (1983–1987); Co-Director, Tax Court Pro Se Program, Los Angeles/Beverly Hills (1988–Present); Lecturer, Federal Tax Procedure, Golden Gate University Masters in Taxation Program; Member, Section of Taxation of California, Los Angeles County and Beverly Hills Bar Associations; Contributor, The Tax Lawyer; Co-author, 637 T.M., Federal Tax Collection Procedure — Liens, Levies, Suits and Third Party Liability, and 638 T.M., Federal Tax Collection Procedure — Defensive Measures.

TABLE OF CONTENTS

Detailed Analysis

I. Overview

Introductory Material

A. TEFRA Statutory Framework

B. Comparison to Non-TEFRA Audit Procedures

C. Electing Large Partnerships

II. Partnerships Covered

Introductory Material

A. General Rule

B. Small Partnership Exception

1. Ten or Fewer Partners

2. All Individuals, Estates, or C Corporations

C. Election to Be Covered

D. Remedies After Incorrect Classification

1. Common Classification Problems

2. Relief for Reasonable IRS Mistake

3. Procedural Remedies

4. Recovering Attorney's Fees

III. Key Definitions

Introductory Material

A. Types of Partners

1. Tax Matters Partner (TMP)

a. Persons Eligible to Be TMP

b. Designation of the TMP by the Partnership

(1) Eligibility

(2) Designation

(3) Termination of the TMP and Replacement by the Partnership

c. The "Automatic Designation" Rule

d. Designation of the TMP by the IRS

e. Recognition and Selection of the TMP by the Tax Court

f. Powers and Duties of the TMP

(1) Distribution of Information

(2) Extension of Statute of Limitations

(3) Settlement Powers

(4) Conducting Audit and Litigation

(5) Using a Power of Attorney

g. Practical and Ethical Problems for the TMP

h. Action by Incorrect TMP

2. Notice and Non-Notice Partners

3. Five Percent Notice Group

4. Five-Percent Litigation Group

5. Pass-thru Partner

6. Indirect Partner

7. Participating Partner

B. Types of Items

1. Partnership Items

2. Affected Items

a. General Definition

b. Computational Affected Items

c. Substantive Affected Items

(1) "Outside" Basis, At-Risk and Passive Losses

(2) Determination of Beneficial Ownership

(3) Income from the Discharge of Indebtedness

3. Nonpartnership Items

4. Converted Items

a. Converted Items from Settlement

b. Deficiency Converted Items

c. Special Enforcement Area Converted Items

5. Penalties

C. Types of Forms and Notices

1. Notification of Inconsistent Treatment

2. Notice of Beginning of Administrative Proceeding (NBAP)

3. 60-Day Letter

4. Notice of Final Partnership Administrative Adjustment (FPAA)

5. Notice of Computational Adjustment

6. Affected Item Notice of Deficiency

7. Administrative Adjustment Request (AAR)

D. Types of Assessments

1. Computational Adjustments

2. Consistency Assessment

3. Math Error Assessment

IV. Consistency Requirement

Introductory Material

A. Consistent Return Requirement

1. Consistency with Partnership Return

2. Unfiled Partnership Return as Inconsistency

3. Exceptions

a. Notice of Inconsistent Treatment

b. Reliance on Erroneous K-1

4. Consistency Assessment

B. Consistent Settlement Requirement

V. Statute of Limitations

Introductory Material

A. Steps for Statute of Limitations Analysis

B. Importance of Correct Classification

C. Partnership Items

1. General Rule for Partnership Proceeding

a. TEFRA Partnership Statute of Limitation as a Minimum Period

b. Timeliness of the FPAA

c. Suspension from Issuing the FPAA

2. Exceptions to General Rule

a. Six-Year Statute for Omitted Income

b. Extended Statute for Fraud

c. Extended Statute for Unidentified Partners

d. No Partnership Return

e. Extensions by Agreement

(1) Authority of TMP to Extend TEFRA Partnership Statute of Limitations

(2) Authority of Other Partners to Extend TEFRA Partnership Statute of Limitations

(3) Extension of TEFRA Partner Statute of Limitations

f. Suspensions from IRS Summons

g. Notable "Nonexceptions"

3. Partner-Level Proceeding

a. Computational Adjustment

b. Converted Items from Settlement

c. Affected Items

D. Converted Items

E. Nonpartnership Items

F. Refund Statutes

VI. Administrative Stages of TEFRA Proceeding

Introductory Material

A. Role of the TMP

B. Right of Other Partners to Participate or Waive Rights

1. Right to Information

2. Right to Attendance

3. Waiver of Rights

C. IRS Case Handling

1. Case Processing

2. Information Base

D. Notice of Beginning of Administrative Proceeding (NBAP)

1. NBAP to TMP

2. NBAP to Notice Partners and Notice Groups

3. NBAP to Pass-thru and Indirect Partners

4. Effect of Failure to Provide NBAP

E. Audit and Area-Level Conference

F. 60-day Letter

G. Appeals Conference

H. Administrative Settlement

1. Consistency Requirement

2. Authority of the TMP to Bind Other Partners

3. Authority of the Pass-thru Partner and TMP to Bind Indirect Partners

4. Forms and Procedures Used to Implement the Settlement

5. Alternative Events Constituting a Settlement Agreement

6. Coordination with Non-TEFRA Years

7. Advance Payments

I. Notice of Final Partnership Administrative Adjustment (FPAA)

1. Persons Entitled to Receive the FPAA

2. Last-Known-Address Issue

3. Contents of the FPAA

4. Restriction on Assessment

5. No Second FPAA

VII. Judicial Stages of TEFRA Proceeding

Introductory Material

A. Filing the Petition to Contest the FPAA

1. Jurisdictional Issues

a. Valid FPAA

b. Which Partners May File and When

(1) Petition Filed by the TMP

(2) Petition Filed by Other Parties

c. District Court and Court of Federal Claims Petitions

2. Priority of Multiple Petitions

3. Relative Merits of Alternative Forums

4. Contents of the Petition

B. Effect of No Contest

C. Role of the TMP

D. Right of Other Partners to Conduct or Join Litigation

E. Procedures for Conducting the Case

F. Settlement of Litigation

1. Consistency Requirement

2. Authority of the TMP to Bind Other Partners

3. Authority of the Pass-thru Partner to Bind Indirect Partners

4. Forms and Procedures Used to Implement the Settlement

a. TMP Settlements for All Parties

b. IRS-Proposed Settlements with No Objection

c. Partner-by-Partner Settlements

d. "Piggyback" Agreements

5. Alternative Events Constituting a Settlement Agreement

6. Coordination with Non-TEFRA Years

7. Advance Payments

G. Affected Item Procedures

H. Appeal and Final Decision

I. Assessment Procedures

VIII. Administrative Adjustment Request (AAR)

Introductory Material

A. Time for Filing AAR

B. AAR Filed by the TMP on Behalf of the Partnership

1. Substituted Return AAR

a. Manner of Filing

b. IRS Response

2. Claim for Refund AAR

a. Manner of Filing

b. IRS Response

3. Filing the Refund Suit

a. Time and Manner of Filing

b. Coordination with an FPAA Proceeding

c. Conduct of the Litigation

4. Appeal

C. Partner AAR

1. Manner of Filing

2. IRS Response

3. Filing the Refund Suit

IX. Special Issues

Introductory Material

A. Foreign Partnerships

B. Tiered Partnerships

C. Coordination of Partnership Item and Nonpartnership Item Adjustments

1. General Deficiency and Refund Rules

2. Nonpartnership Item Adjustments for "Oversheltered" Partners-the Munro Situation

a. Background Leading to Decision in Munro

b. Legislation Overruling Decision in Munro

3. Penalty Issues

a. Determination at Partnership Level

b. Prior Treatment as Affected Items

c. Former § 6621(c) Tax-Motivated Interest

D. Special Enforcement Areas

1. Bankruptcy

2. Other Special Enforcement Areas

E. Innocent Spouse Relief

X. S Corporations (Prior Law)

A. General Applicability of Partnership Rules

1. Termination of Applicability for Tax Years Beginning After December 31, 1996

2. Applicability for Tax Years Beginning Before January 1, 1997

B. Special Rules

1. Small S Corporation Exception

2. Tax Matters Person (TMP)

3. Subchapter S Items

4. Statute of Limitations

a. Non-TEFRA Statute of Limitations

b. Corporate Level Tax

XI. REMICs

XII. Electing Large Partnerships

Introductory Material

A. Mandatory Consistency

B. Flow-Through of Prior-Year Partnership Adjustments to Current Partners

1. General

2. Definition of "Takes Effect"

3. Partnership Liability for Tax; Tax Election to Pay

4. Offsetting Adjustments in Subsequent Years

5. Partnership Liability for Interest and Penalties

C. Administrative Proceedings

D. Designated Representative

E. Notice Requirements

F. Adjudication of Disputes Concerning Partnership Items

G. Statute of Limitations

H. Regulatory Authority

I. Due Date for Information Returns


WORKING PAPERS

Working Papers

Table of Worksheets

Worksheet 1 Comparison of Non-TEFRA and TEFRA Partnerships - Statutes of Limitations Under § § 6229 and 6501; Conduct of Audit

Worksheet 2 Inconsistency Notification Discrepancies Between Taxpayer's Return and Schedules K-1 Under TEFRA Partnership's Form 1065 That Must Be Explained to Meet Consistent Return Requirement of § 6222

Worksheet 3 Audit Timeline: TEFRA Flow-Through Examination Time Chart

Worksheet 4 Notice of Beginning of Administrative Proceeding (NBAP) Under § 6223 with Respect to Partnership Item

Worksheet 5 60-Day Letter and Form 870-L: Proposed Partnership Adjustments and Penalties; Settlement Agreement Under § 6224(c) and Waiver of Restrictions on Assessment and Collection

Worksheet 6 Notice of Final Partnership Administrative Adjustment (FPAA) Under § 6223 and Form 870-P, Settlement Agreement Under § 6224(c) for Assessment and Collection of Tax Deficiency for Partnership Adjustments

Worksheet 7 Cover Letter and Form 4549A-CG, Income Tax Examination Changes

Worksheet 8 Motion for Entry of Decision, Certificate of Filing of Motion for Entry of Decision, and Decision per Settlement of Adjustments to Partnership Items Pursuant to Tax Court Rule 248(b)

Worksheet 9 Decision per Settlement of Adjustments to Partnership Items Pursuant to Tax Court Rule 248(a)

Worksheet 10 Notice of Settlement Agreement Under § 6224(c) of Partnership Items by Participating Partners Pursuant to Tax Court Rule 248(c)

Worksheet 11 Notice of Consistent Agreement Under § 6224(c)(2) with Respect to Partnership Items by Participating Partners Pursuant to Tax Court Rule 248(c)

Worksheet 12 Decision per Opinion: Statement of Adjustments to Partnership Items; No Allocation Issues

Worksheet 13 IRS Motion to Appoint a Tax Matters Partner

Worksheet 14 Affected Item Notice of Deficiency

Worksheet 15 Notice of Computational Adjustment: Notice of How the IRS Applied a Partnership Item Adjustment to the Partner's Tax Liability

Worksheet 16 Sample Petition for Readjustment of Partnership Items Filed by Tax Matters Partner (TMP) Under § 6226 in Tax Court

Worksheet 17 Sample Designation of Tax Matters Partner (TMP) by General Partners Having a Majority of the Profits Interest Under Regs. § 301.6231(a)(7)-1(e)

Worksheet 18 Sample Election by Small Partnership Under § 6231(a)(1)(B)(ii) to Have the TEFRA Unified Audit Rules Apply

Worksheet 19 Sample Election with Regard to Filing Consistent with an Inconsistent Schedule K-1 Under § 6222(b)

Bibliography

OFFICIAL

Statutes:

Treasury Regulations:

Committee Reports:

Court of Federal Claims Rules:

Internal Revenue Manual:

Miscellaneous:

Tax Court Rules:

Treasury Rulings:

Cases:

UNOFFICIAL

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