Current developments in partners and partnerships.

• Author: Burton, Hughlene A.

This article reviews and analyzes recent law changes as well as rulings and decisions involving partnerships. The discussion covers developments in the determination of partners and partnerships, gain on disposal of partnership interests, partnership audits, and basis adjustments.

During the period of this update (Nov. 1, 2021, through Oct. 31, 2022), the IRS issued guidance for taxpayers regarding changes made to Subchapter K over the past few years. Also, the Service issued guidance related to foreign partners. In addition, the courts and the IRS issued various rulings that addressed partnership operations and allocations.

Audit issues

In 1982, the Tax Equity and Fiscal Responsibility Act (TEFRA) (1) enacted "unified audit rules" to simplify IRS audits of large partnerships by determining partnership tax items at the partnership level. Any adjustments would then flow through to the partners, against whom the IRS would assess deficiencies. Two issues that arose frequently under TEFRA concerned partnership-level items of income and the statute of limitation for the partners and the partnership.

In an effort to streamline the audit process for large partnerships, Congress enacted Section 1101 of the Bipartisan Budget Act of 2015 (BBA), (2) which amended in its entirety Sec. 6221 et seq. The revised sections instituted new procedures for auditing partnerships, affecting issues including determining and assessing deficiencies, who pays the assessed deficiency, and how much tax must be paid. The BBA procedures replaced the unified audit rules as well as the electing large partnership regime of TEFRA. In 2018, Congress enacted the Tax Technical Corrections Act (TTCA), (3) which made a number of technical corrections to the rules under the centralized partnership audit regime. The amendments under the TTCA are effective as if included in Section 1101 of the BBA and, therefore, are subject to the effective dates in Section 1101(g) of the BBA.

Court decisions under TEFRA

Even with the adoption of the BBA audit rules, cases are still being litigated involving TEFRA issues. Most of these TEFRA cases involve either of two issues: the statute of limitation or whether income or a deduction is a partnership item. During the update period, several cases dealt with a statute-of-limitation issue, two dealt with a partnership item issue, and one dealt with penalties assessed during the TEFRA audit.

Statute-of-limitation issues

During the audit of Rocky Branch Timberlands LLC's (4) partnership return for 2017, the IRS determined that it would need an extension of time to complete the audit beyond the three-year statute of limitation. As such, the IRS asked the LLC to extend the statutory period for an additional 15 months and sent the LLC a Form 872-P, Consent to Extend the Time to Assess Tax Attributable to Items of a Partnership, to consent to the extension. The LLC signed the consent but did not return it to the IRS. Later, the LLC told the IRS that it had decided not to extend the statutory period. Before the original statute of limitation lapsed, the

IRS sent the LLC a notice of proposed adjustment proposing to disallow a charitable deduction for a conservation easement.

The LLC disagreed with the disallowance and asked for a review from the IRS's Independent Office of Appeals before the IRS issued its Final Partnership Administrative Adjustment (FPAA). The LLC attached a signed Form 872-P and asked the IRS to execute the form and extend the statutory period so that the LLC could obtain a review by the Independent Office of Appeals before issuance of the FPAA. The IRS refused to extend the statutory period and did not allow an Independent Office of Appeals review before it filed the FPAA. The LLC sued the IRS, seeking relief to stop the IRS's process.

Before the suit was heard, the IRS issued the FPAA. The LLC amended its complaint, seeking to have everything undone so it could go back and have the review. The court dismissed the case, holding that it did not have subject matter jurisdiction because the FPAA had already been issued. The court explained that it could not order the IRS to rescind an FPAA because it would violate the Anti-Injunction Act. It is interesting to note that if the LLC had agreed to the original request for an extension, it would have been able to have the case reviewed by the Independent Office of Appeals.

Another case, Baxter, dealt with an American Agri-Corp (AMCOR) partnership strucrure consisting of three partnerships that the IRS determined was an impermissible tax shelter. (5) The IRS issued FPAAs for all three partnerships to the tax matters partner. The IRS had determined that the partnerships engaged in a series of sham transactions rather than farming activities and proposed adjustments disallowing a number of deductions taken by the partnership. The taxpayers had deducted the losses allocated to them from the partnership.

On audit of the taxpayers' return, the IRS assessed additional taxes attributable to the limited partnership interests. The taxpayers paid the tax and sued for a refund, arguing that the assessment was untimely under Sec. 6501 because the FPAAs were issued more than three years after the filing dates of their joint individual tax returns that reflected the partnerships' losses. In addition, they contended that the assessment was invalid because it was not preceded by the issuance of a notice of deficiency, as required under Sec. 6213. The district court ruled in favor of the taxpayers.

The IRS appealed the ruling to the Fifth Circuit. (6) That court in 2022 reversed the district court's ruling on both of the issues and remanded the case to the district court, instructing it to dismiss the taxpayer's case for lack of jurisdiction. Regarding the timeliness of the assessment, the Fifth Circuit observed that in previous cases where taxpayers had made the same argument regarding limitation periods, the court had repeatedly found such claims effectively sought refunds attributable to partnership items that thus were barred under former Sec. 7422(h). Therefore, the Fifth Circuit held that the district court did not have jurisdiction to hear the claim.

Regarding the taxpayers' claim that the assessment was improper because it was not preceded by a deficiency notice, the Fifth Circuit held that the district court did not have jurisdiction to consider that claim because it impermissibly varied from the taxpayers' administrative claim. Even if the district court had jurisdiction, the taxpayers' argument would fail, the Fifth Circuit said, because it involved a misunderstanding of the meaning of the term "deficiency" as defined by Sec. 6211(a).

In another case, (7) the IRS issued two FPAAs to a partnership that made adjustments to its tax returns for two years. The only material difference between the FPAAs was that the second FPAA corrected the name of the partnership on the attached schedules.

The taxpayers petitioned the Tax Court for a redetermination of federal income tax deficiencies for those years. The Tax Court dismissed the petition as untimely because the taxpayers failed to file the petition within 150 days of when the IRS issued the first FPAA. (8)

The taxpayers argued that their petition was timely because Sec. 6223(f) barred the IRS from issuing more than one FPAA pertaining to a partnership's tax year. They also argued that the second FPAA was the only valid one and that their petition was filed within 150 days of that FPAA. The Tax Court concluded that the first FPAA was the only valid FPAA and, therefore, the taxpayers' petition was untimely. The taxpayers appealed the decision to the Fifth Circuit, which found that the Tax Court had properly dismissed the petition as untimely filed.

Partnership item issues

Several court cases decided during the period turned on whether the treatment of an item was properly reported or determined at the partnership level or at the partner level.

In Gluck, the taxpayers sold a condominium and then attempted to complete a like-kind exchange within the meaning of Sec. 1031 by purchasing a partnership interest in an apartment building. (9) Under Sec. 1031, taxpayers can defer the tax on the gain from a sale of real property held for productive use in a trade or business or for investment if they exchange it for property of a like kind within a certain period. However, a partnership interest is not considered of like kind to real property and thus does not qualify for Sec. 1031 exchange treatment. In this case, the taxpayers filed their tax return and claimed like-kind exchange treatment for their interest in the property purchased to replace their condominium.

The IRS audited the taxpayers' return and found that they had purchased an interest in a partnership that owned the property, not a direct interest in the property itself. Thus, the IRS determined, the transaction did not qualify as a like-kind exchange, and the gain on the sale was taxable. The IRS based this determination on the tax return that was filed for a partnership that represented that it owned the property and included the taxpayers as a partner. The taxpayers received notice of the partnership tax return having been filed and did not file Form 8082, Notice of Inconsistent Treatment or Administrative Adjustment Request (AAR), which would have notified the IRS they were taking a position on their tax return that was inconsistent with items on the partnership tax return or that they wanted to challenge the partnership's characterization of those items.

Since the taxpayers had not alleged any inconsistencies with the partnership tax return, the IRS followed the information provided on the Form 1065, U. S. Return of Partnership Income.

The Tax Court rejected the taxpayers' filing on the grounds that it lacked jurisdiction to hear the petition because the adjustment the IRS made on their tax return was treated as a computational adjustment of an affected...