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economic substance. For a transaction to arguments that the Tax Court erred in basis method in its books and records,
have economic substance, it must have a post-trial rulings by accepting IRS com- the partnership may determine its part-
reasonable possibility of a profit, and the putations that contained errors or by not ners’ beginning capital accounts for the
transaction should have an independent considering new substantive issues that 2020 tax year using any one of the fol-
business purpose beyond reducing taxes. the taxpayer waited to raise until after lowing methods: the tax basis method,
The IRS has been diligent in examin- the trial. the modified outside basis method,
ing transactions that it considers to lack In addition, the appellate court found the modified previously taxed capital
economic substance or to be a sham that the Tax Court properly rejected the method, or the Sec. 704(b) method.
transaction and generally has prevailed taxpayer’s deficiency notice challenge In Notice 2021-13, the IRS deter-
on the issue. To help clarify the rules, that the IRS did not issue prerequisite mined that a partnership that includes
Congress codified the economic sub- final partnership administrative adjust- incorrect information in reporting its
stance doctrine in the Health Care and ments to the partnership in accordance partners’ beginning capital account bal-
Education Reconciliation Act of 2010.13 with TEFRA procedures. The partner- ances on the 2020 Schedules K-1 (Form
There were several cases this past year ship in this case was a small partnership; 1065), Partner’s Share of Income, Deduc-
that considered whether a partnership however, the partnership did not make tions, Credits, etc., will not be subject to a
had economic substance. a valid TEFRA election to be treated as penalty under Sec. 6698 if the partner-
such. The taxpayer also argued unsuc- ship can show that it took ordinary and
Sham partnerships cessfully that the deficiency notices were prudent business care in calculating
In several deficiency cases consolidated mailed after the statute of limitation beginning basis. Sec. 6698 imposes a
into a single proceeding, Greenberg,14 a expired in one year under review. With penalty for failing to file a return or re-
taxpayer/CPA and a colleague/attorney respect to another year, the taxpayer port at the time prescribed, or for filing
allegedly used a purported investment claimed that the deficiency notice was a return or a report that fails to show the
partnership and other entities to effect untimely because the deficiency was for information required under Sec. 6031.
son-of-boss/short option strategy tax “converted items.” In 2021, Treasury and the IRS re-
shelter transactions. The Tax Court re- The Tax Court ruled that all of the leased final versions of Schedules K-2,
jected the taxpayer’s loss deduction claim deficiency notices were timely filed. The Partners’ Distributive Share Items — In-
for one partnership’s abandonment of its appellate court agreed and ruled that ternational, and K-3, Partner’s Share of
purported interest in another entity. The the Tax Court properly rejected the tax- Income, Deductions, Credits, etc. — In-
court concluded that the taxpayer failed payer’s arguments because the taxpayer ternational, for Forms 1065 for tax year
to show that the partnership ever owned had no proof that the IRS failed to fol- 2021.16 The schedules are designed to
any interest in the stated entity, or if low “established procedures” for mailing help guide partners and shareholders on
it did, that it intended to abandon the notices for the first year, and the record how to compute their U.S. income tax
interest and/or took steps to do so. The showed that the assessment period was liability with respect to items of interna-
taxpayer appealed. suspended for the deficiency notice re- tional tax relevance, including claiming
Affirming the Tax Court’s ruling,15 lated to the converted items. deductions and credits. The IRS has also
the appellate court found that the Tax issued draft instructions that explain
Court properly upheld the IRS’s adjust- Partnership reporting how to complete the forms.
ments, including those disregarding Beginning in the 2020 tax year, partner- The new forms and instructions will
certain partnerships as shams and treat- ships are required to calculate and report also provide greater clarity to partner-
ing the transactions that the partnership their partners’ capital accounts using the ships, S corporations, and U.S. persons
engaged in as engaged in by the taxpayer transactional approach for the tax basis who are required to file Form 8865,
directly. The appellate court also rejected method. The instructions to the 2020 Return of U.S. Persons With Respect to
the taxpayer’s arguments that the IRS Form 1065, U.S. Return of Partnership Certain Foreign Partnerships, with respect
failed to make a considered determina- Income, explained that if a partnership to controlled foreign partnerships on
tion regarding these transactions or that did not report its partners’ capital ac- how to provide international tax infor-
the Tax Court erred by not putting the counts using the tax basis method in the mation. The updated forms will apply to
burden of proof on the IRS. Further, the 2019 tax year and did not maintain its any persons required to file Form 1065;
appellate court rejected the taxpayer’s partners’ capital accounts under the tax Form 1120-S, U.S. Income Tax Return

13. Health Care and Education Reconciliation Act of 2010, P.L. 111-152. 15. Greenberg, 10 F.4th 1136 (11th Cir. 2021).
14. Greenberg, T.C. Memo. 2018-74. 16. IR-2021-140.

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