Amending a partnership return.

Many partnerships are not eligible to file an amended Form 1065, U.S. Return of Partnership Income, to correct an error on a previously filed partnership return. The Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) and subsequent regulations issued thereunder on the unified partnership audit procedures, provide a set of procedures for partnerships, their partners and the IRS to follow to adjust partnership items. Although the procedures are commonly referred to as the TEFRA unified audit rules, they also cover how a partnership amends a previously filed return.

Who Can File?

The TEFRA unified audit rules apply to entities treated as a partnership for Federal tax purposes, except for small partnerships (as defined in Sec. 6231 (a)(1)(B), see below) and electing large partnerships specifically excluded under See. 6240(b).

How to File

A partnership subject to the TEFRA unified audit rules may not simply file an "amended" Form 1065 to correct a partnership item reported on a previously filed partnership return. Under these rules, the tax matters partner (TMP) must file Form 8082, Notice of Inconsistent Treatment or Administrative Adjustment Request (AAR), on the partnership's behalf and request the Service to treat the AAR as a substituted return.

The request must include a revised schedule of distributive shares, an explanation of the changes and other information required by Regs. Sec. 301.6227(c)-1(a). To fall within the statute of limitations (SOL), the TMP has to file the AAP, within the three-year period beginning on the later of the filing of the partnership return for the year or the last day for filing the return (without extensions). Additionally, the TMP would have to file the AAR before the Service issues a final partnership administrative adjustment (FPAA), if a partnership audit is under way.

As provided in Sec. 6227(c), the IKS may respond in one of the following ways in the AAR:

* Treat the request as a correction of mathematical or clerical errors;

* Allow credits or make refunds on some or all items contained in the request (other than items no longer partnership items);

* Conduct a partnership-level proceeding; or

* Take no action.

If the IRS agrees to the request, it substitutes the treatment of the partnership items on the AAR for the treatment of such items on the original partnership return. It treats the substituted return as a correction of a mathematical or clerical error and mails a Notice of Clerical or Mathematical Error Correction to each partner.

A partnership qualifying as a small partnership, under Sec. 6231 (a)(1)(B), is exempted from the TEFRA unified audit rules. A small partnership may file an amended Form 1065 and issue amended Schedules K-1 to its partners within the SOL, to correct a previously filed partnership return.

Small Partnerships

A small partnership is a partnership with 10 or fewer partners (who are natural persons, C corporations or estates) at any one time during the partnership tax year. For these purposes, a husband and wife and their estates are one partner. Even though a partnership may have 10 or fewer partners, the presence of certain types of partners (e.g., nonresident aliens and flowthrough entities (such as partnerships, S corporations and trusts)) will automatically disqualify small-partnership status.

Transfers of partnership interests generating more than 10 partners throughout the year will not disqualify a partnership, as long as there were no more than 10 partners at any given time. For example, in a 10-partner partnership, one partner may transfer his or her interest to an entering partner, thereby creating 11 partners during the tax year, without losing small-partnership status, as long as the two partners do not own partnership interests at the same time.

A partnership's status as a small partnership is an annual determination. Thus, a partnership not qualifying in one year might qualify in a subsequent year, on rectification of the disqualifying event. Moreover, a small partnership may elect to be subject to the TEFRA unified audit rules, by attaching a statement to the partnership return for the first tax year for which the election is to be effective. The statement must be identified as an election under Sec. 6231(a)(1)(B)(ii) and must be signed by all partners during such tax year. Once the election is made, the partnership is subject to the TEFRA unified audit rules until the election is revoked (with IRS consent).

The act of responding "yes" to the question on Schedule B of Form 1065, which asks if the partnership is subject to the Secs. 6221-6233 consolidated audit procedures, does not qualify as an election. A partnership that has mistakenly checked the box "yes" and is not otherwise subject in the TEFRA unified audit rules should be able to respond "no" to the same question on subsequent returns. However, care should be taken to properly answer the questions on Schedule B, as Sec. 6231(g) allows the Service to determine if the partnership is a TEFRA or non-TEFRA partnership or an electing large partnership, based on the face of the partnership return. If the IRS reasonably, but erroneously, determines a partnership is subject to the TEFRA unified audit rules, based on information contained in the partnership return for a tax year, the rules will nonetheless apply for such tax year. It is not clear what qualifies as "reasonable" but erring on the conservative side would be appropriate.

Penalties

Disregard for the TEFRA unified audit procedures can subject a taxpayer to the accuracy-related penalty under Sec. 6662 or the fraud penalty under Sec. 6663, as web as put the preparer at risk for preparer penalties.

FROM KRISTY L. REMPALSKI, CPA, GRAND RAPIDS, MI