Unified partnership audit procedures revisited.

In the late 1970s and early 1980s, the IRS was required to devote substantial resources to fighting tax shelters. Generally, these were structured as partnerships, passing "aggressive" deductions and tax credits to the investors for use on their personal returns. Once the Service identified a shelter to be examined, it needed to identify all partners (including those deriving their interests via other flowthrough entities) and deal with each on an individual basis. This meant procuring waivers of the statute of limitations (SOL), issuing 30-day letters and ultimately statutory notices of deficiencies to numerous individuals, often in different parts of the country, for identical issues. The strain on the IRS and the Tax Court was staggering, and many taxpayers fell through the cracks.

In an effort to combat these problems, Congress enacted new Secs. 6221-6233 as part of the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA). These provisions created procedural mechanisms to allow the Service to audit and adjust all matters relating to a partnership at the entity level, with the ultimate determinations binding on the partners. Central to this scheme is the Tax Matters Partner (TMP), who has a great deal of authority to affect the tax liability of all the partners. These unified audit proceedings allow the IRS to issue a Notice of Beginning of Administrative Procedure (NBAP) to the TMP to start the unified audit procedures. From that point on, the TMP has substantial authority in its dealings with the Service, including the ability to extend the SOL, settle matters at the administrative level and even petition the Tax Court and litigate issues relating to the partnership's reported income and deductions. The provisions contain many detailed rules on notices to the partners as to the status of any such partnership proceedings, the ability of partners to elect out of these rules in certain circumstances and the methods by which partners can contest partnership-level adjustments outside of the unified rules.

A recent case underscores how powerful a tool the unified audit rules are for the IRS and involve the application of Sec. 6229, Period of Limitations for Making Assessments. This section mirrors both the three-year "normal" statute and the six-year statute for "fraud." Sec. 6229(c) provides that "if any partner has, with the intent to evade taxes, signed or participated directly or indirectly in the preparation of a partnership return which includes a false or fraudulent item," the SOL is extended to six years for all other partners.

Transpac Drilling Venture, Fed. Cir., 1996, involved a situation in which the general partner pled guilty to tax evasion relating to 1983 and 1984 partnership returns. The Service ultimately disallowed substantially all of the claimed deductions by issuing a Notice of Final Partnership Administrative Adjustments within six years of the returns being filed, which a limited partner challenged as time barred. The Court of Appeals upheld the deficiencies, relying on the plain language of the statute that the intent to evade taxes did not have to be the taxes of the partner preparing or signing the return.

The unified partnership audit procedures were made applicable to S corporations in 1982 with the addition of Secs. 6241 6245. The proliferation of S corporations over recent years, as well as the growth in the use of limited liability companies over the past few years, makes it important for practitioners to review these rules to protect their clients.

From Elliot Glass, CPA, J.D., Feldman Radin & Co., P.C., New York, N.Y.