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:: Partnership - Audit Technique Guide - Chapter 13 - TEFRA (12-2002)   Chapter 13 - Table of Contents Introduction   Identifying the TEFRA Partnership       Tax Matters Partner (TMP) – Designation      Tax Matters Partner – Authority and Responsibilities    Partnership Items/Non-Partnership Items/Affected Items    Partnership Items        Affected Items         Non-partnership Items       Statute Of Limitations         Administrative Adjustment Request       TMP Filed AAR on Behalf of the Entire Partnership    AAR Filed by a Partner      Notice of Inconsistent Treatment       Key TEFRA Dates for Examiner       Supporting Law        Resources        Glossary INTRODUCTION This chapter is designed to give the reader a basic understanding of TEFRA (Tax Equity & Fiscal Responsibility Act of 1982) and certain of its critical aspects.  It is not intended to be a fully comprehensive work.  Certain of the topics are covered by way of reference to the governing statutes, regulations, or IRM rather than by way of a narrative text.  The Resources section lists several published sources which, when viewed together, should present a fully comprehensive and up-to-date picture of TEFRA.  In addition, concurrent with the preparation of this Partnership MSSP Guide, the TEFRA Technical Advisor has prepared a TEFRA Computer Based Training Module (CBT) on CD-ROM. This chapter will address TEFRA only as it applies to TEFRA partnerships and TEFRA related partners.  TEFRA, as it applies to S corporations and REMICs, is not covered.  Neither are non-TEFRA partnership statute considerations or procedures covered.  The differences between TEFRA and non-TEFRA are significant.  In regards to non-TEFRA considerations, examiners should consult IRM 4.29 Partnership Control System (PCS) Multi-Functional Handbook, and IRM 4.31, Flow-Through Entity Multi-Functional Handbook. IRC sections 6221 through 6234 govern audit, administrative, and judicial procedures, as well as certain filing requirements, to be used by entities qualifying as TEFRA partnerships.  These procedures are referred to as, “unified proceedings.”  These Code sections provide that examination, administrative, and judicial actions are conducted at the partnership level. Final Regulations were recently issued and are effective for taxable years beginning on or after October 4, 2001, (66 FR 50541, Treas. Reg. section 301.6221-1 through 301.6233-1.)  For taxable years beginning before October 4, 2001, the Temporary Treasury Regulations continue to govern (Treas. Reg. section 301.6221-1(f)).  The Final Treasury Regulations are substantially similar to the previously proposed and temporary regulations. back to the top IDENTIFYING THE TEFRA PARTNERSHIP It is critical to the examination of a partnership that the examiner recognize whether he or she is dealing with a TEFRA or Non-TEFRA partnership.  The reason for this is that the above Code sections only apply to TEFRA partnerships.  Failure to properly identify a TEFRA partnership from the outset will invariably impact the statute of limitations, proper initiation of the examination and other administrative considerations, both at the partnership and partner level. The identification of a TEFRA entity is essentially governed by IRC section 6231.  While this section of the Code addresses conditions under which the partnership return will be exempted from being considered a TEFRA entity, we will look at the return from the aspect of what may qualify it as a TEFRA partnership. Generally, a partnership with 11 or more partners at any one time during the partnership’s tax year is a TEFRA partnership.  Treas. Reg. section 301.6231(a)(1)-1(a)(1) and Temp. Treas. Reg. section 301.6231(a)(1)-1T(a)(1). CAUTION:  A husband and wife, each having their own partnership interest (separate Schedules K-1) are considered one partner, irrespective of their filing status.  A jointly held interest (one K-1) also qualifies as one partner for purposes of the count.  (Sections 6231(a)(1)(B) & (12) and Reg. 301.6231(a)(1)-1(a)(1) and Temp. Reg. 301.6231(a)(1)-1T(a)(1)). CAUTION:  An individual who has died during the year and his or her estate, each of whom is represented by a separately prepared Schedule K-1, are considered one partner.  This determination is consistent with the “at any one time” rule. A partnership containing less than 11 partners will qualify as a TEFRA partnership if it meets any of the following requisites. It has as a partner any one of the following: Partnership Limited liability Company (LLC) which files a Form 1065 Trust (any type, including Grantor Trusts and grantor type trusts, even if the Schedule K-1 contains the SSN of the grantor ) Nominee Nonresident alien individual S corporation C corporation – except for partnership taxable years ending after August 5, 1997 CAUTION:  The exclusion of a partner, which is a C corporation, as an automatic TEFRA qualifier is a product of TRA ’97 (the Taxpayer Relief Act of 1997).  The problem presented by this change is whether or not other types of Form 1120 such as Form 1120F should be included.  The current position is that all types of Form 1120 (except Form 1120S) are to be treated the same under TRA ’97.  Further, all corporate entities (other than S corporations) are treated as C corporations for the purpose of the small partnership exception regardless of whether they are taxable under subchapter C.  Consult your local TEFRA coordinator or the Foreign Joint Venture Specialist. CAUTION:  If schedule K-1 identifies the entity type of the partner to be a corporation, without specifying that the partner is an S corp., and this determination is critical to qualifying the return as either TEFRA or non-TEFRA, the examining agent should secure an IDRS print to settle the issue.  The year researched for the partner must be the same year as the partnership being examined.  This is also recommended where the partner is identified as a LLC.  Confirm whether the partner has filed a Form 1120 or Form 1065. Prior to enactment of TRA ’97, a partnership of less than 11 partners qualified as a TEFRA entity if it failed the “same share test,” (Temp. Treas. Reg. section  301.6231(a)(1)T-1(a)(3)).  The same share test was repealed by TRA ’97. A partnership which does not otherwise qualify, can elect to be treated as a TEFRA partnership (IRC section 6231(a)(1)(B) and Treas. Reg. section 301.6231(a)(1)-1(b) and Temp. Treas. Reg. section 301.6231(a)(1)-1T(b)). CAUTION:  Checking the “yes” box on page 2 of Form 1065 which asks the question, “Is this partnership subject to the consolidated audit procedures of sections 6221 through 6234?” does not constitute an election.  Nor does the designation of a TMP, in and of itself, constitute a proper election. CAUTION:  The election is only required to be included with the first return for which it is effective, and once made, is effective until revoked with the consent of the Commissioner.  In instances where the partnership would not appear to qualify as a TEFRA entity, but designates a TMP on the tax return or responds positively to the consolidated audit procedures question, inquiry should be made as to whether there is an election in effect.  The examiner should secure the partnership’s file copy of the election and determine if the election is valid under section 301.6231(b)(2) of the Regulations.  If not valid, the partnership is not a TEFRA entity.  If the election is determined to be valid, attach a copy to the examined partnership tax return. For tax years ending after August 5, 1997, partnership information can be relied on for determining if the TEFRA procedures apply.  Internal Revenue Service personnel must be reasonably assured that the information on the return is correct.  To meet the reasonable determination standard, additional information should be secured, if necessary.  The reasonable factor is likely to be a source of litigation in the future.  The examiner’s TEFRA/non-TEFRA determination should be reviewed with the local TEFRA coordinator and clearly documented in the workpapers. CAUTION:  Based on the changing number or type of partners within the partnership, as well as changes in the law, a partnership may qualify as a TEFRA partnership in one year, while being treated as a non-TEFRA partnership in another.  All qualifying tests should be applied to each tax year of the partnership. Electing large partnerships (Form 1065B) and their partners are subject to a special form of unified proceeding.  They are not subject to the regular TEFRA Code sections 6221-6234 (section 6240(b)(1)).  TRA’97 established audit procedures for electing large partnerships with new Code sections 6240-6255 effective for partnership taxable years beginning after December 31, 1997.  Examiners should review the provisions of IRC sections 771-777 and 6240-6255 before commencing an electing large partnership examination. CAUTION: If an electing large partnership is a partner in a TEFRA partnership which is not an electing large partnership, the TEFRA Code sections will apply to items of the electing large partnership which are partnership items with respect to the TEFRA partnership (IRC section 6240(b)(2)). back to the top TAX MATTERS PARTNER (TMP) -- DESIGNATION The proper designation of a qualified tax matters partner is critical.  An improper designation can invalidate a statute extension or the binding effect of agreements on non-notice partners.  In short, an invalid TMP is the equivalent of no TMP. A TMP can be designated by the partnership or selected by the IRS. The process by which a TMP is designated is covered in section 301.6231(a)(7)-1 of the Treasury Regulations. The process by which a TMP is designated for an LLC is covered by section 301.6231(a)(7)-2 of the Treasury Regulations. When the partnership fails to designate a TMP, or the designation has been terminated and the partnership has not made a subsequent designation, IRC section 6231(a)(7)(B) and Treas. Reg. section 301.6231(a)(7)-1(m) provide that the general partner having the largest profits interest be determined to be the TMP.  Paragraph (m)(2) of this section contains instructions for calculating the profits interest of the general partners and provides that when more than one such partner has an identical interest, the TMP will be the partner whose name appears first, alphabetically. (Also, refer to IRM 121.5.1.12.8.11.) When it is impracticable to apply the largest-profits-interest rule, the Commissioner may select as tax matters partner any person who was a general partner at any time during the taxable year and owned a profits interest.  If a general partner cannot be selected, the Commissioner may select any partner who was a partner in the partnership at the close of the taxable year under examination.  The Commissioner’s selection of the TMP is covered by Treas. Reg. sections 301.6231(a)(7)-1(n) through (r) and Temp. Treas. Reg. section 301.6231(a)(7)-1T(p)(2) & (r)(1).   The criteria for selection is contained in Treas. Reg. section 301.6231(a)(7)-1(q)..  The Commissioner is required to notify both the partner selected and the partnership of the selection (Temp. Reg. section 301.6231(a)(7)-1T(r)(1)).  However, 30 days prior to making the selection, the Commissioner must notify the partnership by mail of the intent to select a TMP (Treas. Reg. section 301.6231(a)(7)-1(r)(2)).  This notification is designed to give the partnership a window of opportunity to designate a TMP.  (Also, refer to IRM 121.5.1.12.8.12.) The qualifications required to be designated by the partnership as the TMP are set forth in Treas. Reg. section 301.6231(a)(7)-1(b). Events which serve to terminate the TMP designation are listed in Treas. Reg. sections 301.6231(a)(7)-1(l) and 301.6231(c)-4 through 301.6231(c)-8 and Temp. Treas. Reg. section 301.6231(c)-4T through 8T. CAUTION:  When a terminating event occurs, the partner's status as TMP terminates.  All acts performed by the TMP prior to the occurrence of the terminating event would be considered valid.  Any subsequent actions would not.  The designation of a new TMP will be required, before securing statute extensions or settlements from a new TMP. CAUTION:  The TMP designation entered on Form 1065 should not be accepted, automatically.  Verify that the TMP designated in this manner is qualified and that no terminating event has occurred from the time the partnership return was filed to the present. CAUTION:  In a multiple year exam, do not assume that the TMP for one year is the TMP for another.  Verify the TMP designation for each year. TAX MATTERS PARTNER – AUTHORITY AND RESPONSIBILITIES The IRS deals primarily with the TMP for all administrative and judicial proceedings. The TMP can sign an assortment of documents, such as Form 872-P, however, see Temp. Treas. Reg. section 301.6229(b)-1T. The authority and responsibilities of the TMP are set forth in Treas. Reg. sections 301.6223(g)-1 and 301.6230(e)-1. CAUTION:  Generally, the authority and responsibilities of the TMP should not be delegated to the Power of Attorney.  The execution of a “stock” Form 2848, Power of Attorney and Declaration of Representative, will typically limit the POA’s role in a TEFRA exam to providing and receiving information.  However, Treas. Reg. section 301.6229(b)-1 allows the partnership to authorize any person to extend the period described in IRC section 6229(a) – Period of Limitations for Making Assessment.  The examining agent must verify that the partnership has complied with all of the requirements of Treas. Reg. section 301.6229(b)-1. back to the top PARTNERSHIP ITEMS/NON-PARTNERSHIP ITEMS/AFFECTED ITEMS Partnership items:  A partnership item is an item that is more appropriately determined at the partnership level than at the partner level (IRC section 6231(a)(3)). Affected items:  An affected item is any item that is affected by a partnership item (IRC section 6231(a)(5)). Non-partnership items: A non-partnership item is an item that is not a partnership item or is treated as other than a partnership item (IRC section 6231(a)(4)). Partnership Items Treas. Reg. section 301.6231(a)(3)-1 provides a listing of partnership items.  Partnership items are comprised of: Items which appear on the partnership tax return Other issues which are more appropriately determined through an examination of the partnership’s books and records. Items appearing on the partnership return are more or less obvious and can consist of items other than distributive share items of the partnership such as liabilities, including determinations with respect to the amount of the liabilities, whether the liabilities are recourse or non-recourse and changes from the preceding taxable year.  Partnership items also include items which are utilized by the partners for computational purposes only.  Some of these are: Tax preference items used in the computation of alternative minimum tax. Items entering into the partner’s calculation of the current deduction for investment interest. Net earnings from self- employment used in the calculation of the partner’s liability for self-employment tax. Other issues may consist of the identification of the character of a distribution.  Is it a distribution that is the equivalent of a withdrawal or is it a liquidating distribution or debt-financed distribution?  If property has been distributed, does it consist of “hot” and/or “cold” assets?  Without these characterizations being determined at the partnership level, the partner would have no basis for characterizing the tax consequences of the distribution. Partnership items can only be adjusted through a TEFRA proceeding.  The TEFRA assessment statute, IRC section 6229 only applies to partnership items and items directly affected by partnership items (affected items) and items which were once partnership items (converted items).  The statute of limitations under IRC section 6501 need not be considered, although, at times, there can be interplay between the two (see Statute of Limitations on the following pages). Affected Items An affected item is any item that is affected by a partnership item.  Examples are given in Treas. Reg. section 301.6231(a)(5)-1.  Since an affected item is defined as any item which is affected by a partnership item, the path to identifying these items lies in an understanding of how partnership items can affect a partner’s tax return/liability. A computational adjustment is directly assessed where the effect of the partnership item on the partner’s tax liability can be computed mathematically without further determinations at the partner level.  If the adjustment to a partnership results in an increase to the partner’s adjusted gross income, any items on the partner’s tax return, the threshold for deductibility of which is governed by the reported amount of AGI, will be affected.  Directly assessed computational adjustments are also appropriate when items such as tax preference items, investment income, deductions, and interest are used for the calculation of alternative minimum tax and the currently allowable deductions for investment interest expense, respectively.  If an adjustment requires additional partner level determinations before an assessment can be made, that portion of the assessment will be made through an affected item notice of deficiency. Typically, penalties are affected items which require partner level determination.  This type of affected item is subject to deficiency procedures (IRC section 6230(a)(2)). The Revenue Reconciliation Act of 1989 (the 1989 Act) consolidated penalties for negligence (IRC section 6653), overvaluation (IRC section 6659) and substantial understatement (IRC section 6661) into IRC section 6662 referred to as the “accuracy related” penalty.  Under TRA ’97, for partnership years ending after August 5, 1997, the applicability of penalties relating to adjustments to partnership items are determined at the partnership level.  The penalty is assessed in the same manner as partnership items. Treas. Reg. section 301.6221-1(c) & (d).  Partner level defenses can only be raised through refund claims. Innocent spouse relief is an affected item.  Currently, IRM 104.5, Relief from Joint & Several Liability Handbook, has a section “reserved” for TEFRA.  As of the preparation of this MSSP Guide  the Service will consider innocent spouse requests for relief from TEFRA proceedings only after there is a final determination concerning the treatment of partnership items (for example, a settlement is entered into, or the decision of the court becomes final).  An as yet unnumbered letter has been drafted, which should serve to apprise taxpayers with a request for innocent spouse relief on file of the Service’s current policy. The following are some items that are affected items requiring partnership level determinations under the TEFRA provisions, followed by partner level affected item notices of deficiency along with some (but not all) of the issues to be given consideration at each level: back to the top Outside basis Partnership level: Cash contributions Distributive items of income, losses and deductions Distributions Partner’s basis in contributed property (that is, IRC sections 704(c) and 722) Partner level: Price paid if interest purchased from another partner and no section 754 election At-risk Partnership level: Partner’s share of liabilities Nature of liabilities (recourse and non-recourse) Partner level: Partner’s obligation in respect of borrowed funds used in acquiring the partnership interest Outside basis determined at partner level Passive losses: Partnership level: Activity engaged in by the partnership (whether it is a rental activity) Portfolio income Partner level: Material participation Real estate professional Cancellation of indebtedness (COD): Partnership level: Income from COD Partner level: Exclusion under IRC section 108 -- For example, a determination of the extent to which the partner is insolvent, bankrupt or elects to reduce basis can only be made at the partner level. An affected item may require a determination and adjudication at the partnership level for its partnership item components, and a determination and adjudication at the partner level for its partner level components.  In Roberts v. Commissioner, 94 T.C. 853 (1990), the issue was at-risk.  The Service had failed to examine the partnerships involved and the statute of limitations under IRC section 6229(a) had expired.  An examination at the partner level revealed that the partner had entered into a series of side agreements, which limited the exposure to debt/loss.  The partner took the position that the determination of amount at-risk under IRC section 465 was exclusively a partnership item (Treas. Reg. section 301.6231(a)(3)-1(a)(1)(vi)(C)).  The partner further stated that, as a consequence, the issue should have been raised in a partnership proceeding.  The Service conceded the partnership level components since the period for correcting a partnership proceeding had expired.  Never-the-less, it argued that it could still adjust the partner level components through a notice of deficiency.  The Service argued that “the existence of a partner-level, third party side agreement and its effect on a partner’s amount at-risk may be adjudicated as a partner level determination in an affected item deficiency proceeding.”  (See Temp. Treas. Reg. section 301.6231(a)(5)-1T(c)).  The Court held that “the partner’s amount at-risk under IRC section 465 was not an item required to be determined by the partnership and, therefore, is not a “partnership item” within the meaning of IRC section 6231(a)(3).”  The Court also held that the government’s “notice of deficiency making the at-risk disallowance at the partner level was appropriate.” Non-partnership Items Partnership items become non-partnership items for any partner as a result of the occurrence of a conversion event (IRC section 6231(b) & (c)).  Non-partnership items resulting from a conversion event (except settlement agreements) are assessed under normal deficiency procedures applied at the partner level.  The partner is no longer part of the TEFRA proceeding.  The statute of limitations for converted items is under IRC section 6229(f). STATUTE OF LIMITATIONS Briefly, the statute of limitations for the key case TEFRA partnership becomes the statute of limitations for all of its partners.  This concept extends to the investors in tier flow-through entities.  However, the statute of limitations established at the key case level does not extend to issues raised on the tier’s own tax return.  For this, separate statute consideration must be given to the tier return as a key case.  If the tier partnership is not itself a TEFRA partnership, separate statute extension will be required from the partners under IRC section 6501.  IRC section 6229 contains the rules for the TEFRA assessment statute as well as deviations which apply to a variety of circumstances.  In the case of a false or fraudulent return, IRC section 6229(c)(1)(B) provides for an unlimited statute of limitations for any partner who signed, or participated directly or indirectly in the preparation of the return and a 6-year statute for all other partners.  In the case of a substantial omission of income, IRC section 6229(c)(2), and in the case of a false return for non-culpable partners, IRC section 6229(c)(1)(B), provide for a 6-year statute in place of the normal 3-year statute for all partners.  IRC sections 6229(c)(1)(A) & 6229(c)(3) & (4) provide for no limitation on the TEFRA assessment statute for certain partners responsible for the filing of a false return and all partners when the partnership fails to file a return.  The examination of a TEFRA partnership should include total familiarity with IRC section 6229. IRC sections 6229 and 6501 are not always mutually exclusive.  The application of IRC section 6229(b)(3) is one such example.  Here, a statute extension secured under IRC section 6501(c)(4), if properly worded, will keep open that particular partner’s statute of limitations for partnership items. NOTE:  Chief Counsel has advised that, in certain circumstances, their office would be willing to defend the position that IRC section 6229 merely sets forth a minimum period during which the partner’s period for assessment under IRC section 6501 shall not expire for partnership items.  Chief Counsel suggests that if the IRC section 6229(a) statute has expired with respect to partnership items, but the IRC section 6501 statute remains open for one or more partners, consult with local Counsel for a determination as to whether the case should be conceded or not.  Neither the agent nor his manager can make the determination to rely on the IRC section 6501 statute.  Only Chief Counsel can make this determination.  The same approach is suggested for an expiration of the IRC section 6229(f) statute for converted items.  See TEFRA UPDATE 1998, Tax Equity and Fiscal Responsibility Act, Document 10808 (4-98). back to the top ADMINISTRATIVE ADJUSTMENT REQUEST An Administrative Adjustment Request (AAR) is an amended return for partnership items. IRC section 6227 contains the authority and procedures for AARs.  IRC section 6228 provides for judicial review where the AAR is not allowed in full. The period within which an AAR must be filed is governed by IRC section 6227(a), (b) & (e). Aside from calendar parameters, the AAR cannot be filed after the mailing to the TMP of an FPAA with respect to the year in question (IRC section 6227(a)(2)). A superseding return is an amended return received on or before the due date of the original return.  An AAR cannot be treated as a superseding return. TMP Filed AAR on Behalf of the Entire Partnership An AAR can be filed by the TMP for the entire partnership.  The AAR must be filed by the TMP on behalf of the partnership on the form prescribed by the Service for that purpose in accordance with the instructions accompanying that form (Treas. Reg. section 301.6227(b)-1(a)).  The form so prescribed is Form 8082.  This section of the Regulations provides additional filing instructions and requires that the AAR be accompanied by revised schedules showing the effects of the proposed changes on each partner and an explanation of the changes (Treas. Reg. section 301.6227(b)-(1)(a)(3)).  An AAR package must also include the amended return and revised schedules K-1 for the affected partners. The TMP may request that the AAR receive substituted return treatment (IRC section 6227(c)(1)(A)).  When the AAR is filed in this manner, the Service may treat the changes shown on the AAR as corrections of mathematical or clerical errors appearing on the partnership return (IRC section 6227(c)(1)(B)).  The IRS may credit or refund any overpayment of tax to the partner(s) based on the AAR, or assess any resulting tax without a deficiency or partnership level proceeding, if no partner objects. When an AAR is filed requesting substituted return treatment and a partnership proceeding under IRC section 6223 is not initiated, partner tax assessments can only be made after the affected partners are mailed a notice of the correction of the error and no partners, within the allotted 60-day period, request that the correction not be made (IRC section 6230(b)).  The receipt of an objection from one or more of the partners may be resolved through initiation of a TEFRA proceeding. When an AAR is filed with tax assessment consequences for at least one partner, failure to request substituted return treatment will mean that the Service cannot assess tax without a partnership level proceeding. If the AAR does not have tax assessment consequences for any of the partners, requesting substituted return treatment will not be necessary.  If the AAR is accepted as filed, refunds can be made to partners without a partnership level proceeding. When the AAR is not treated as a substituted return, the Service has three options under IRC section 6227(c)(2): Accept the AAR as filed and allow any refunds or credits due to the affected partners arising from the adjustments shown on the AAR.  See IRC section 6227(c)(2)(B) for partners with converted items. Conduct a partnership proceeding wherein normal TEFRA procedures will apply. Take no action on the AAR. If an AAR filed by a TMP is not allowed in full, or alternately, the Service takes no action on the AAR, IRC section 6228(a) provides for the filing of a petition by the TMP for an adjustment with respect to the partnership items to which such part of the request (AAR) relates. IRC section 6228(a)(2) provides a time frame for filing the petition and can be extended for the partnership by execution of Form 9248 (Form 9247 for a partner level AAR).  Under IRC section 6228(a)(2)(B), a petition cannot be filed once a Notice of Beginning of Administrative Proceeding (NBAP) has been mailed to the partnership with respect to the year covered by the AAR.  The petition would then be filed under the provisions of IRC section 6226 once an FPAA is issued. The partnership’s failure to keep the period for filing a petition open under IRC section 6228 will jeopardize the partners’ right to receive refunds or credits (IRC section 6230(d)). The right to petition under IRC section 6228(a) is also available for AARs requesting substituted return treatment wherein the Service has either not granted the request for such treatment or has failed to take timely action on the request (Treas. Reg. section 301.6227(b)-1(b)). CAUTION: A partnership level AAR which the Service concludes should be accepted as filed must have a PCS package submitted to link the affected partners.  If there will be no partnership proceeding, use Form 8341 instead of Form 8340 as NBAPs should not be mailed.  Failure to link the affected partners will result in inactivity at the partner level.  No assessments, refunds or credits will be made.  This will give the appearance of “no action taken” on the AAR. An in-house report should be prepared.  The RAR takes the partnership from the original return presentation to the amended return amounts, as expressed in the AAR.  The RAR will become the basis for the closing package submitted to the service center.  Your service center may allow you to attach the amended Schedules K-1 to the RAR, in lieu of completing Form 886-Z. Note, however, that IRM 121.5.2.3.1(5)(a) appears to require only that a Form 886-Z(C) be prepared. CAUTION: The processing of an AAR, in accordance with the IRM, cannot be avoided with the expectation that any refunds or credits due the partners will be allowed upon receipt of the partner’s amended return.  Prior to TEFRA, each partner was required to file an amended return to reflect changes made by the partnership in its amended return.  IRC section 6227 provides for a direct change to the tax liability of the partners by the filing of an AAR at the partnership level. The partners are not required, nor encouraged, to file their own amended returns. (See IRC section 6230(d)(5)).  Partnership level AARs with tax assessment consequences for the partners are of special concern.  Do not rely on the partners filing amended tax increase returns.  IRC section 6227 allows for assessments against the partners either through a partnership proceeding or substituted return treatment.  Again, the partners are not required to file an amended return under the unified partnership rules. CAUTION: Allowance of an AAR that merely reallocates partnership items between the partners should not be treated as a “no-change,” especially in a partnership proceeding.  Partnership items include the partnership's aggregate and each partner’s share of items of income, gain, loss, deductions, or credits of the partnership, etc. (Treas. Reg. section 301.6231(a)(3)-1(a)). AAR Filed by a Partner A partner can also file an AAR.  If the partner’s AAR is predicated on the partnership having filed an AAR of its own, the partner’s AAR should be suspensed and the issue addressed at the partnership level.  If the partner AAR is not predicated on the partnership having filed an AAR, Form 8082 should serve as a Notice of Inconsistent Treatment.  The issue(s) raised in a Notice of Inconsistent Treatment or an AAR of this type can be addressed through a partnership level proceeding.  Optionally, the Service may mail to the partner a notice that all partnership items of the partner for the year to which such AAR relates shall be treated as non-partnership items (IRC section 6231(b)(1)(A)) only if no TEFRA proceeding is initiated.  Subsequent to the notice of conversion being mailed, the AAR is treated as a claim for credit or refund of an overpayment attributable to non-partnership items (IRC section 6228(b)(1)(A)).  The request to have partnership items converted to non-partnership items should be routed to local Counsel through the local TEFRA coordinator.  The authority for granting the conversion has not been delegated beyond the Commissioner. Refer to IRM 121.5.2.3.2 for options regarding the processing of partner level AARs and Form 8150 procedures for situations in which the partner’s AAR and an AAR filed on behalf of the TEFRA partnership are filed at different service centers. NOTICE OF INCONSISTENT TREATMENT IRC section 6222(a) requires that the partner’s treatment of partnership items be consistent with the treatment of that item by the partnership in all respects including the amount, timing and characterization of the item (Treas. Reg. section 301.6222(a)-1(a)).  If a partner does file a return which is not consistent with the partnership, the partner must inform the Service of the inconsistency (IRC section 6222(b)).  The notice is given on Form 8082.  The form must identify all partnership items that are treated inconsistently.  If any item is omitted from the form it will be subject to the treatment for non-notification (Treas. Reg. section 301.6222(b)-2(b)).  Form 8082 must be attached to the partner’s tax return.  If the inconsistency is the subject of the partner’s amended return, Form 8082 must be attached to that. When the partner has given the Service proper notification, an assessment of tax can only be made as a result of a partnership proceeding, or by notifying the partner that all partnership items arising from that partnership will be treated as non-partnership items (Treas. Reg. section 301.6222(b)-2(a)) followed by the issuance of a notice of deficiency.  The IRS has the option to convert partnership items to non-partnership items (IRC section 6231(b)(2)(A)).  See the discussion of the Service’s notice to convert partnership items to non-partnership items under “AARs Filed by a Partner.” If the partner has treated a partnership item inconsistently with the partnership’s treatment and fails to notify the Service of the inconsistent treatment, the tax attributable to the inconsistent treatment can be directly assessed by computational adjustment.  The partner may also be subject to a negligence penalty (IRC section 6222(d)).  An indirect partner can be inconsistent with the pass-through partner as long as he is consistent with the source/key case partnership (Treas. Reg. section 301.6222(a)-2)). Form 8150 procedures, similar to that of partner filed AARs, may be necessary for the Notice of Inconsistent Treatment. CAUTION:  IRC section 6222(b)(1)(A)(ii) allows the partner to file a Notice of Inconsistent Treatment when the partnership has not filed a return (the partner has not received a Schedule K-1).  In most instances the partner will report zero distributive items pending receipt of the Schedule K-1. KEY TEFRA DATES FOR EXAMINER The examination cannot be started with less than 12 months remaining on the statute of limitations, unless approval of the LMSB, Director of Field Operations, or the SB/SE or W & I equivalent is secured (IRM 121.5.12.10.1). If the case is closed no-change within 45 calendar days of the issuance of an NBAP to the TMP (the first NBAP), certain procedural requirements can be avoided (IRM 1212.5.12.10.4(7)). An FPAA should not be mailed less than 120 days from the date the last NBAP is mailed to a notice partner (IRC section 6223(d)(1)).  See the Hillcrest Letter, Exhibit 121.5.1-3 of IRM 121.5. An FPAA must be mailed to each notice partner no later than 60 days from the date the FPAA is mailed to the TMP (IRC section 6223(d)(2)). Supporting Law IRC sections 6221 through 6234 IRC section 6501 Supporting regulations TRA’97 RRA’98 Historic litigation cited in “resources” below Current litigation (LEXIS) Resources Mather, BNA, Tax Management Portfolio No. 467, Audit Procedures for Pass-Through Entities Hesch, BNA, Tax Management Portfolio No. 710, Partnerships: Overview, Conceptual Aspects, and Formation Office of Chief Counsel, TEFRA UPDATE 1998, Tax Equity and Fiscal Responsibility Act, Document 10808 (4-98) Kelly, Dennis M., as updated by Ransick, Mark, An Overview of TEFRA Partnership Proceedings, Including the Taxpayer Relief Act of 1997, and Restructuring and Reform Act of 1998 (October 1998) IRM 4.29, Partnership Control System (PCS) Multi-Functional Handbook IRM 4.31, Flow-Through Entity Multi-Function Handbook Instructions to Form 8082. For further information, contact the TEFRA Technical Advisor in LMSB. back to the top GLOSSARY AAR (Administrative Adjustment Request) - A request by the Tax Matters Partner on behalf of all partners or a request by a partner in his own behalf to have the Service adjust partnership items, usually for the purpose of seeking a refund. Abandonment - The surrender of all legal rights to a partnership interest by some overt action on the part of a partner with the expectation of receiving nothing in return. Affected item - Any item affected by a partnership item.  IRC section 6231(a)(5). Aggregation of activities - The grouping together of certain activities to which the at-risk rules apply. Alternate economic effect test - An alternative mechanical test for determining whether the allocation of a tax item of the partnership has economic effect that is used when a partner does not have an unconditional obligation to restore a negative capital account balance when the partnership is liquidated and that relies on the existence of a qualified income offset (QIO) provision. Anti abuse rules - Rules, such as Treas. Reg. section 1.701-2 or more specific rules in other regulations, that allow the Service to implement the intent of all or part of Subchapter K. Assumption - The act of taking over the obligation of another, such as the obligation to repay a loan. At risk - The amount of money or property for which a partner bears the risk of loss and the amount of borrowing for which the partner is personally liable for repayment. At risk recapture - Any amount of previously allowed losses that is treated as income from the activity when, and to the extent that, the taxpayer’s amount at risk in an activity is reduced below zero. Automatic Stay - An order issued by bankruptcy court which prevents any creditor from collecting a liability against a person for which a bankruptcy petition has been filed. Avoiding Powers - The trustee may avoid a transfer of an interest of the debtor in property. Bankrupt - A taxpayer who has received a discharge under Title 11 of the United States Code.  A taxpayer who has been adjudicated as bankrupt by a United States Bankruptcy Court. Bar Date - The date by which all creditor’s claims must be filed with the bankruptcy court. Bargain sale - The amount of debt relief to a partner who contributes his partnership interest to a charitable organization. Basis/adjusted basis - The cost of an asset, later adjusted by specific events (for example., allocation of income or loss in the case of the basis of a partnership interest). Book capital accounts - Accounts included in a partnership’s balance sheet that reflects the partners’ economic interests in the partnership. Built in gain - The excess of the fair market value of property contributed to a partnership over its adjusted basis.   Built-in-Gain or Loss - The difference between a property’s fair market value and its basis at the time of contribution. Built in loss - The excess of the adjusted basis of property contributed to a partnership over its fair market value. Capital account - An account included in a partnership’s balance sheet that reflects the partners’ economic interest in the partnership. Character of gain or loss - Capital or ordinary, determined by looking at the source of the gain or loss.  Charitable organization - IRC section 170(c) defines a domestic charitable organization  as U.S.-based, organized and operated exclusively for a qualified charitable purpose, with no earnings that inure to the benefit of any private shareholder or individual. COD -  Cancellation of Indebtedness income. Cold asset/capital asset - An asset that would produce capital gain or loss.  Collapsible partnership - A partnership to which IRC section 751 applies. Compliance period - With respect to any building, the period of 15 taxable years beginning with the 1st taxable year of its credit period. Computational adjustment - The change in the tax liability of a partner reflecting the proper treatment of partnership items under the TEFRA provisions.  IRC section 6231(a)(6).  This is the amount that is assessed following a TEFRA proceeding.  Contingency -  An event that may occur. Contribution - A transfer of cash or property to a partnership in exchange for a partnership interest. Contributing partner - Any partner who contributes a particular asset with a built-in gain or a built-in loss to the partnership. Constructive ownership - A taxpayer’s ownership through attribution of a capital interest or a profits interest in a partnership resulting from the taxpayer’s relationship with other persons that own interests directly or indirectly in the partnership. Converted item - A partnership item which has converted to a non-partnership item pursuant to IRC section 6231(b) or (c). Credit period -  The period of 10 taxable years beginning with either the taxable year in which the building is placed in service, or, at the election of the taxpayer, the succeeding taxable year, but only if the building is a qualified low-income building as of the close of the 1st year of such period. Current distribution/Non-liquidating distribution - A distribution to a partner not in liquidation of the partner’s entire interest.  Includes a distribution in partial liquidation of a partner’s interest as well as a distribution of the partner’s distributive share of current partnership income. Current distributions - Distributions that do not retire completely the partnership interest of the distributee partner. Dealer - Someone who buys and sells securities for others. Deemed cash contribution - The method IRC section 752 uses to increase a partner’s outside basis for that partner’s share of the partnership’s liabilities. Deemed contribution - The tax treatment associated with an increase in a partner’s share of partnership liabilities. Deemed distribution - The tax treatment associated with a reduction in a partner’s share of partnership liabilities. Deemed Exchange - The result of an increase in a distributee partner’s interest in the value of one class of property while his interest in the value of the other class of property is decreased. Depreciation recapture - Gain, upon the disposition of depreciable property, that is attributable to depreciation deductions and recharacterized as ordinary income.  A type of IRC section 751(a) property. Discharge - Relief from certain liabilities. Disguised sale - A  transaction that is in form a contribution to a partnership and a distribution, but is in substance a sale or exchange. Disguised sales - Transactions that use contributions to partnerships and related distributions to disguise what is, in substance, a sale or exchange of property. Disproportionate Distribution - A distribution which changes the value of a partner’s interest in the partnership’s hot and cold assets. Disproportionate Distribution - A distribution that changes the value of the distributee partner’s interest in hot or cold assets. Distribution - A transfer of cash or property by a partnership to a partner.   Distribution in complete liquidation - The termination of a partner’s entire interest in a partnership by means of a distribution or a series of distributions. Donee - The person receiving the gratuitous transfer; the gift recipient. Donor - The person who makes a gratuitous transfer; the person making the gift. Economic equivalence test - Even if an allocation fails the primary and alternate economic effect test, the allocation will be respected under the economic effect equivalence test if a liquidation of the partnership occurring at the end of the year in which the allocation takes place would produce the same economic results to the partners as if the primary economic effect test had been met. Economic substance - Judicial doctrine used to determine whether a transaction or entity serves an economic purpose other than tax savings when determining the proper tax treatment of a transaction. Encumbered property - Property that is subject to a liability. Entity theory of partnership taxation - Theory which supports the determination of the tax consequences of partnership operations at the partnership level rather than at the partner level. Excess distribution - The amount by which the fair market value of the distributed property (other than money) exceeds the distributee partner’s adjusted tax basis in his partnership interest. Exempt Assets -  Assets which do not become a part of the bankruptcy estate and which the debtor is permitted to keep while still receiving a discharge in bankruptcy.  The kind and amount of exempt assets vary from state to state, but do not included secured assets. Extended Use Agreement - An agreement recorded under state law between the taxpayer and the appropriate housing credit agency under IRC section 42(h)(6) that requires, among other things, that a certain percentage of the units in the qualified low-income building will continue to be rented to low-income tenants for at least fifteen years beyond the end of the compliance period. Fair market value - The value of an asset or property as determined by a willing seller and a willing buyer on the open market. Family member - IRC section 704(e) defines the “family” of an individual as including only his spouse, ancestors and lineal descendants, and any trusts for the primary benefit of such persons.  See chapter 11 of this Guide. Family partnership -  See chapter 11 of this Guide. FPAA (Notice of Final Partnership Administrative Adjustment) -  The notice that constitutes the Service’s final determination of adjustments to partnership items and initiates the 150-day period for filing a petition in court challenging the Service’s final determinations. “Fruit of the Tree” -  Income is attributable to the taxpayer who earned it regardless of his attempt to escape it by anticipatory arrangements and contracts however skillfully devised to prevent the income when paid from vesting even for a second in the taxpayer who earned it. Gift tax -  A tax imposed on a gratuitous transfer.  If the tax is paid by the donee there will be income to the donor. Goodwill - The value of a trade or business attributable to the expectancy of continued customer patronage. This expectancy may be due to the name or reputation of a trade or business or any other factor."  See Treas. Reg. section 1.197-2(b)(1). Gratuitous transfer -  A transfer for no consideration; a gift. Guaranteed loan - A loan the payment of which is guaranteed by a partner. Guaranteed payments - Payments made to a partner which are not determined with regard to the income of the partnership.  See IRC section 707(c). Holding period - The time that an asset is held, used for determining whether a gain or loss is long-term or short-term. Hot asset/IRC section. 751 asset - An asset that would produce ordinary gain or loss (unrealized receivables and inventory items).  Depreciation recapture is treated as an unrealized receivable. Income in respect of a decedent (IRD) - Income rights that are not properly included on the decedent’s final income tax return. Indemnification agreement - An agreement whereby a partner agrees to reimburse another partner or the partnership for payments the other party makes, such as the repayment of a loan. Innocent spouse relief - Relief granted under IRC sections 6015 or 6230(c)(5). Inside basis - The tax basis that the partnership has in its assets. Insolvent - A taxpayer whose liabilities exceed the fair market value of his assets. IRC section 754 election - An election that allows a partnership to adjust its basis under IRC sections 743 (upon transfers of partnership interests) and IRC section 734 (upon distributions to a partner). IRC section 754 revocation - The revocation of an election under IRC section 754. Intent of Subchapter K -  The intent of Subchapter K is to permit taxpayers to conduct joint business (including investment) activities through a flexible economic arrangement without incurring an entity-level tax.  Implicit within the intent of Subchapter K are the following: the partnership must be bona fide, each partnership transaction or series of transactions must be entered into for a substantial business purpose, the form of each transaction must be respected under substance over form principles, and the tax consequences must accurately reflect the partners’ economic arrangement and clearly reflect the partners’ income. Like-kind exchange - A transaction under IRC section 1031 in which a taxpayer transfers an asset in exchange for another asset of like kind.  Exchanges of partnerships interests do not qualify for like kind exchange treatment. Liquidating distributions - The termination of a partner’s entire interest in the partnership by means of a distribution, or a series of distributions. Loss carryforwards - Suspended losses that are carried forward to a subsequent year and allowed in the first year in which the loss limitations do not limit the allowance of the loss. Loss limitations - Limits on the allowance of a partner’s share of partnership loss based on the partner’s outside basis in the partnership, the partner’s amount at risk, and the partner’s passive participation in the partnership activity. Low income housing credit - The credit given under section 42 of the Internal Revenue Code to owners of certain low-income housing projects.  The amount of the credit is equal to the applicable percentage of the qualified basis of each qualified low-income building. Mark-to-Market - A method applied to any regulated futures contract, foreign currency contract, nonequity option, dealer equity option, and dealer securities futures contract held by the taxpayer at the close of the taxable year which treats such property as sold for its fair market value on the last business day of such taxable year and any gain or loss is taken into account for the taxable year. Minimum gain chargeback - A provision that must be included in the partnership agreement in order for the partnership’s allocations of non-recourse deductions to be respected, requiring that a partner who receives the tax advantage of a deduction must later be allocated offsetting income in an equal amount. Mixing bowl transactions - Transactions in which partners arrange to pool their assets in a partnership, and then make related allocations or distributions in order to shift the benefits and burdens of ownership.  IRC sections 704(c) and 737 have curtailed these transactions. NBAP (Notice of Beginning of Administrative Proceeding) -  The notice sent to the Tax Matters Partner (with copies to all notice partners) which signals the beginning of a partnership audit. Net Precontribution Gain - For property contributed to a partnership after June 8, 1997, this is the amount of net gain (that is, gain reduced by any loss) that the distributee partner would be required to recognize under IRC section 704(c)(1)(B) if all property owned by the partnership immediately before the distribution that had been contributed by the distributee within 7 years of the distribution were distributed to a partner other than the contributing partner. Noncontributing partner - Any partner who does not contribute a particular asset with a built-in gain or a built-in loss to the partnership. Non-exempt assets - Assets of the debtor which must become a part of the bankruptcy estate. Non-recourse -Debt for which no taxpayer is personally liable. Nonpartnership item - Any item that is (or is treated as) not a partnership item.  IRC section 6231(a)(4). Non-recourse debt - A liability for which no partner bears the economic risk of loss. Non-recourse liability - A liability for which no partner bears the economic risk of loss.  Non-TEFRA partnership - A partnership not governed by the above statutory provisions and accompanying regulations. Normal distribution - Periodic distributions to partners that are presumed not to be disguised sales, including distributions of normal operating cash flow, reasonable guaranteed payments, and preferred returns, intended to compensate partners for the use of their capital. Notice of Inconsistent Treatment - A notice by a partner indicating that the partner is claiming partnership items inconsistently with how the items are reported on the partner’s Form K-1 or the partnership return. Optional basis adjustments - Adjustments to the basis of partnership property under IRC sections 743 and 734, which are only made if there is an IRC section 754 election in effect. Organization costs - Organization costs include the legal and accounting costs necessary to organize the partnership, facilitate the filings of the necessary legal documents, and other regulatory paperwork. Outside Basis - The basis that the partner has in his/her partnership interest. Partial liquidations - Distributions which result in a reduction, but not entirely, of a partner’s interest in the partnership. Partner non-recourse debt - A non-recourse loan that a partner or a related person makes to a partnership, where the economic risk of loss for the liability is not borne by another partner. Partnership agreement - Any agreement that has an impact on the economic sharing arrangement among the partners or between one or more partners and the partnership. Partnership debt - A liability of the partnership rather than of any individual partner. Partnership item - Any item required to be taken into account for the partnership’s taxable year under subtitle A of the Internal Revenue Code to the extent regulations provide that the item is more appropriately determined at the partnership level than at the partner level.  IRC section 6231(a)(3). Partnership minimum gain - The total amount of gain that the partnership would realize if it disposed of each property subject to a non-recourse liability for no consideration other than full satisfaction of the liability. Partnership proceeding - A proceeding conducted under the unified partnership audit and litigation procedures contained in IRC sections 6221 through 6234. Pre contribution built in gain or loss - Any gain or loss contained in property when the property is contributed to the partnership. Primary economic effect test - A mechanical test for determining whether the allocation of a tax item of the partnership has economic effect that requires the partnership to maintain capital accounts in accordance with the rules of Treas. Reg. section 1.704-1(b)(2)(iv), and to use such accounts in determining the partners’ rights and responsibilities when the partnership is liquidated.  This test requires all partners to have an unconditional deficit restoration obligation. Private foundation -  An organization defined in IRC section 509. Prompt Assessment - A request by the trustee under Bankruptcy Code section 505 (b). Proportionate Distributions - A prorata distribution of the partnership’s assets, that is, each partner’s share of hot and cold assets remain unchanged by the distribution. QRPBI -(Qualified Real Property Business Indebtedness) - Indebtedness which was incurred or assumed by the taxpayer in connection with real property used in a trade or business and is secured by such real property, was incurred or assumed before January 1, 1993, or if incurred or assumed on or after such date, is qualified acquisition indebtedness, and with respect to which the taxpayer makes an election. Qualified acquisition indebtedness -  Indebtedness incurred or assumed to acquire, construct, reconstruct, or substantially improve such property. Qualified income offset - A provision in a partnership agreement that requires that a partner who receives an unexpected adjustment, allocation, or distribution must be allocated items of income and gain in order to eliminate a deficit balance in the partner’s capital account. Qualified low-income building -  Any building which is part of a qualified low-income housing project at all times during the compliance period. Qualified/nonqualified liability -  A non-qualified liability is a liability incurred within 2 years of a transfer and the proceeds of which were neither used to acquire or improve the contributed property, nor incurred in the ordinary course of a business and substantially all of the business assets are transferred.  Qualified liabilities are all liabilities that are not nonqualified. Qualified non-recourse financing -  Certain non-recourse, nonconvertible debt borrowed in connection with the holding of real property, from certain persons regularly engaged in the lending business and secured by the property. Reaffirmation - An agreement to continue paying a debt, generally a secured debt, even though you could receive a discharge of the debt in bankruptcy.  Generally a debtor will reaffirm a debt in order to keep the asset which secures it. Recourse liability - A liability for which a partner bears the economic risk of loss. Remedial allocation method - A method of allocating tax items in order to take into account the built-in gain or built-in loss in contributed assets that requires tax allocations of “fictional” or “notional” income, gain, loss, or deduction in order to correct distortions created by the ceiling rule. Revaluations - A recomputation of the partnership’s book value of assets to reflect the fair market value.  A partnership is permitted to do this in certain instances under Treas. Reg. section 1.704-1(b)(2)(iv)(f). Sale or exchange of a partnership interest -A transaction in which a partner transfers all or a portion of his interest in a partnership in exchange for something of value. Security agreement -An agreement whereby a person pledges assets as security for a loan.  In general, a partner is treated as bearing the economic risk of loss for a partnership liability that is secured by the partner’s pledge of assets to the extent of the fair market value of the security. Security Trader - Someone who buys and sells securities with reasonable frequency in the hopes of catching the swings in the daily market and profits on a short-term basis.