Special care needed in dealing with statute of limitation issues for TEFRA partnerships.

• Author: McCall, Matt
• Position: Tax Equity and Fiscal Responsibility Act of 1982

Audits of flowthrough entities such as partnerships cause administrative complexity for the IRS and taxpayers because the audit sometimes drags on longer than the statute-of-limitation period for the IRS to make an adjustment. For individual or C corporation audits, this is easily handled by having the taxpayer agree to extend the statute-of-limitation period. However, the situation is more complicated for flowthrough entities.

Sec. 6501(a)

It is well-settled that the limitation period for partnerships is the Sec. 6501(a) period of the partner. Sec. 6501(a) provides that taxes shall be assessed by the later of three years from the time the tax return is filed or the original due date for the tax return. In most cases the filing date of the flowthrough entity's return is not relevant in determining the limitation period for the IRS to make an adjustment.

Example 1: A partnership has two individual partners, Partner A and Partner B, and files its 2010 partnership tax return on July 15,2011. Partner A files his 2010 individual return on April 15, 2011, and Partner B files her 2010 individual return on Oct. 15, 2011.

On May 1, 2014, the IRS audits the partnership and makes an adjustment to increase the income on the partnership return. Because Partner A 's Sec. 6501 limitation period expired on April 15, 2014, the IRS is precluded from adjusting his individual return for the change in the partnership unless the IRS obtained Partner A 's consent to extend the statute of limitation before April 15, 2014. The IRS can adjust Partner B's individual return because her Sec. 6501 statute-of-limitation period does not expire until Oct. 15, 2014. Interestingly, under Sec. 6501(a), the IRS could have made the partnership adjustment for Partner B after July 15, 2014 (three years from the filing of the partnership return), which is beyond what most people would think is the limitation period for the partnership.

Dealing with small partnerships under the Sec. 6501(a) rules was not excessively burdensome for the IRS. However, the rules presented great administrative challenges for the IRS when dealing with partnerships with a large number of partners. The IRS needed to track the Sec. 6501 limitation period for each partner and, if necessary, obtain a consent to extend the statute of limitation from each individual partner.

The challenge to the IRS was even more cumbersome when dealing with multitiered partnerships that have large numbers of partners, some of...