Page 3 - Partnership Audit Rules - Drafting Partnership Agreements: The New Partnership Representative And The Outgoing Tax Matters Partner

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come tax audits of the partnership under TEFRA. Where a small part- nership is not “eligible,” it again will be subject to the entity-level audit rules and the governing agree- ment should make provision for the appointment, duties, limitations, etc. of the tax matters partner. Qualifica- tion is determined on an annual ba- sis and it is possible for a partner- ship to be covered by the entity- level rules in one year and not be covered in another year.
Electing Large Partnerships Under TEFRA
Large partnerships having 100 or more partners in the preceding year may elect to be treated for tax pro- cedure purposes as “electing large partnerships” and are outside of the entity-level audit rules under TEFRA. Once the election is filed, it applies for all subsequent years unless a revocation of election is consented to by the Service. An electing large partnership under TEFRA is subject to a separate set of procedural rules pertaining to the audit and litigation of partnership items relating to such entity. A modified entity form of reporting is required with fewer partnership items passing through to the part- ners and a separate set of rules for audit and litigation. Partners in an electing large partnership are re- quired to report all items consist- ently with how the items are re- ported on the partnership’ s return. Under the large (electing) partner- ship rules, the current-year partners’ share of current-year partnership items of income, gains, losses, de- ductions, or credits are adjusted to reflect partnership adjustments relat- ing to a prior-year audit that take effect in the current year. The ad- justments generally do not affect the prior-year returns of any partners (except in the case of changes to any partner’s distributive share).
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Under the current electing large partnership rules, the Service is not required to provide notice to indi- vidual partners that it has initiated a partnership-level audit or that it has made a final partnership administra- tive adjustment (“FP AA”). Section 6223(a) provides that a copy of the FPAA must be mailed to each part- ner. The Service is only required to give notice to the partnership of a partnership adjustment to the part- nership’ s last known address, even if the partnership has terminated. The procedural rules are in Sections 6240 through 6255. Within 90 days of the mailing of the FPAA to the tax matters partner, that partner, and only that partner, may file a petition for readjustment of the partnership items. Where the tax matters partner does not file within the prescribed 90-day period, any “notice” partner may file a petition within the next 60 days under Section 6226(b).
Summary of TEFRA Audit Rules
The basic characteristics of the TEFRA entity-level audit rules (other than the small partnership and electing large partnership ex- ceptions) may be summarized as follows:
1. Partners are required to re- port on their tax returns in a manner that is consistent with positions taken and reported on Form K-1unless the partners provide no- tice of any inconsistent treatment.
2. Partnership items or issues are addressed at the partnership level in a unified partnership-level proceeding for audit, appeal, and administrative purposes, as well as in judicial proceedings.
3. The tax matters partner des- ignated by the entity taxed as a partnership, i.e., a general partner of the partnership, generally represents the partnership and its partners.
4. The Service makes its pro- posed audit adjustments in an FPAA, which starts the time for the partnership to file for judicial re- view of one or more contested items, including an affirmative de- fense, such as the running of the statute of limitations.
5. Each “notice partner” is re- quired to receive notice of important actions to be taken by the IRS, such as the commencement of an audit or the issuance of an FPAA.
6. In general, a “notice part- ner” has the right to participate in the audit, administrative appeal, or judicial proceeding involving a TEFRA partnership audit.
7. Each partner has the right to a settlement that is consistent with any settlement agreement the Ser- vice enters into with another part- ner.
8. On completion of the audit and administrative proceedings, each partner has the right to contest the recommended adjustments made by the IRS before a court of appli- cable jurisdiction, i.e., the Tax Court, federal district court in which venue lies, or the Court of Federal Claims.
9. After a final partnership- level determination (on one or more partnership items) has been made, through either a final court decision or settlement, the Service makes its computational adjustments and is- sues assessments. At such time, a partner can challenge the assessment only with respect to the computation itself and not as to the merits of any partnership-level adjustment.
10. The statute of limitations for all partners’ partnership items generally (but not exclusively) is determined based on the filing date of the partnership return. The tax matters partner may extend the stat- ute of limitations with respect to partnership items and certain “af-
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