Modifications and Additions to the Unified Partnership Audit Procedures

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 301

[TD 8808]

RIN 1545-AW23

Modifications and Additions to the Unified Partnership Audit

Procedures

AGENCY: Internal Revenue Service, Treasury.

ACTION: Final and temporary regulations.

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SUMMARY: This document contains final and temporary regulations

relating to the unified partnership audit procedures added to the

Internal Revenue Code by the Tax Equity and Fiscal Responsibility Act

of 1982 (TEFRA). The unified partnership audit procedures generally

provide administrative rules for the auditing of partnership items at

the partnership level. These regulations modify the existing unified

partnership audit procedures to comply with the Taxpayer Relief Act of

1997 (1997 Act) and the Internal Revenue Service Restructuring and

Reform Act of 1998 (1998 Act), and add new regulations to administer

the new unified partnership audit provisions added by the 1997 Act. In

general, the text of these temporary regulations also serves as the

text of the proposed regulations set forth in the notice of proposed

rulemaking on this subject in the Proposed Rules section of this issue

of the Federal Register.

DATES: Effective Date: These regulations are effective January 26,

1999.

FOR FURTHER INFORMATION CONTACT: Robert G. Honigman, (202) 622-3050

(not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

This document contains temporary amendments to the Procedure and

Administration Regulations (26 CFR Part 301) relating to the unified

partnership audit procedures found in sections 6221 through 6233 of the

Internal Revenue Code (Code) and final regulations pertaining to the

applicable dates of Sec. 301.6231(a)(7)-1T(p)(2) and

Sec. 301.6231(a)(7)-1T(r)(1). Sections 1231 through 1243 of the

Taxpayer Relief Act of 1997, Public Law 105-34, 111 Stat. 788, modified

some of the existing procedures and added certain new rules. Section

3507 of the Internal Revenue Service Restructuring and Reform Act of

1998, Public Law 105-206, 112 Stat. 685, modified section 6231. This

document modifies existing regulations that, because of the 1997 Act or

the 1998 Act, no longer reflect current law.

Explanation of Provisions

Penalties Determined at the Partnership Level

Before the 1997 Act, the Internal Revenue Service (Service) could

impose penalties on a partner only through the application of the

deficiency procedures after the completion of a partnership level

proceeding. Forcing the Service to open deficiency proceedings against

the individual partners was inconsistent with the efficiency goal of

the unified partnership audit rules. The 1997 Act cured this problem by

providing that, for partnerships under audit for taxable years ending

after August 5, 1997, partnership level proceedings include the

determination of applicable penalties at the partnership level.

Partners now may raise any partner level defenses to the imposition of

penalties only in a subsequent refund action.

Consistent with these statutory changes, the temporary regulations

mandate that the partnership's penalty defenses are to be resolved

during the partnership proceeding. Nevertheless, any individual

defenses that a partner may have to the imposition of a penalty may be

brought by the partner in a refund action subsequent to the partnership

level determination. In order to minimize the burden on individual

partners to defend themselves by bringing their own refund suits, the

temporary regulations incorporate a large number of defenses at the

partnership level. The majority of a partner's defenses to the

imposition of penalties are not specific to a particular partner, but

can be determined by reference to the activities of the partnership.

The applicability of these defenses may be resolved at the partnership

level during the partnership proceeding. In addition, the temporary

regulations modify the computational adjustment rules to allow the

Service to assess penalties under those procedures.

Partial Settlements

The period for assessing tax with respect to partnership items

generally is the longer of the periods provided by section 6229 or

section 6501. For partnership items that convert to nonpartnership

items, section 6229(f) provides that the period for assessing tax shall

not expire before the date which is one year after the date that the

items became nonpartnership items. Section 6231(b)(1)(C) provides that

the partnership items of a partner for a partnership taxable year

become nonpartnership items as of the date the partner enters into a

settlement agreement with the Service with respect to such items. In

some audits, however, the taxpayer and the Service will enter into a

settlement agreement regarding some, but not all, of the taxpayer's

partnership items. The 1997 Act added a special rule for these partial

settlement agreements in section 6229(f)(2), providing that the period

for assessing any tax attributable to the settled items is determined

as if the partial settlement had not been executed. Thus, the

limitations period applicable to the last partnership item to be

resolved for the partnership's taxable year under audit is controlling

with respect to all disputed partnership items (including settled

items) for such partnership taxable year.

The temporary regulations state that the one year period for

assessing partnership items that convert to nonpartnership items

applicable to settlement agreements under section 6231(b)(1)(C) does

not apply to partial settlement agreements under section 6229(f)(2).

Moreover, the temporary regulations clarify that the partner remains

subject to the unified audit procedures regarding the nonsettled items.

Tax Matters Partner as a Debtor in Bankruptcy

Section 6229(b)(1)(B) provides that the statute of limitations

under section 6229 is extended with respect to all partners in the

partnership by an agreement entered into between the tax matters

partner (TMP) and the Service. Treas. Reg. Sec. 301.6231(a)(7)-

1(l)(1)(iv) (1996) and Temp. Treas. Reg. Sec. 301.6231(c)-7T(a) (1987),

however, provide that upon the filing of a petition naming a partner as

a debtor in a

[[Page 3838]]

bankruptcy proceeding, the partner/debtor's partnership items convert

to nonpartnership items, and if the partner/debtor was the TMP, that

status terminates. These rules were promulgated to avoid the

complications that the automatic stay provision contained in 11 U.S.C.

362(a)(8) would have on a unified partnership audit. As a result, if a

TMP executed a consent to extend the statute of limitations during a

period when the TMP was a debtor in a bankruptcy proceeding, the

consent would not be binding on the other partners. Under the

regulations, the person signing the agreement was ineligible to act as

the TMP and extend the statute as to all partners.

To resolve the uncertainty under prior law in the situation where a

TMP executes an agreement extending the statute of limitations as to

all partners while, unknown to the Service, the TMP is a debtor in a

bankruptcy proceeding, the 1997 Act provides that the Service may rely

on the executed statute extension agreement unless it is notified of

the TMP's bankruptcy proceeding. If the Service is not notified of the

TMP's bankruptcy proceeding, statute extensions granted by the TMP are

binding on all partners in the partnership.

The temporary regulations provide a mechanism for the TMP, or other

partners, to provide notice to the Service that the TMP is a debtor in

a bankruptcy proceeding and therefore is ineligible to serve as TMP and

extend the statute under section 6229. This mechanism is derived from

existing regulations that provide guidance on how to notify the Service

of information concerning a partnership's partners.

Small Partnership Exception

The 1997 Act amended the small partnership exception to the unified

partnership audit procedures found in section 6231. Formerly, in order

to qualify for the small partnership exception, the partnership had to

have 10 or fewer partners at all times during the tax year, each of

whom was a natural person (other than a nonresident alien) or an

estate, and for which each partner's share of each partnership item was

the same as that partner's share of every other partnership item. The

1997 Act amended the small partnership exception by allowing

partnerships to qualify for the exception even if they have a C

corporation for a partner or specially allocate some partnership items.

The temporary regulations modify the existing regulations interpreting

the small partnership exception to take account of this change in the

law.

Effective Date

These final and temporary regulations are applicable January 26,

1999. In accordance with section 7805(e)(2), the temporary regulations

contained herein shall expire January 25, 2002.

Special Analyses

It has been determined that this Treasury decision is not a

significant regulatory action as defined in EO 12866. Therefore, a

regulatory assessment is not required. It also has been determined that

section 533(b) of the Administrative Procedures Act (5 U.S.C. chapter

5) does not apply to these regulations. For the applicability of the

Regulatory Flexibility Act (5 U.S.C. chapter 6) refer to the Special

Analyses section of the preamble to the cross reference notice of

proposed rulemaking published in the Proposed Rules section in this

issue of the Federal Register. Pursuant to section 7805(f) of the

Internal Revenue Code, these final and temporary regulations will be

submitted to the Chief Counsel for Advocacy of the Small Business

Administration for comment on their impact on small business.

Drafting information. The principal authors of these temporary

regulations are Robert G. Honigman, Office of the Assistant Chief

Counsel (Passthroughs & Special Industries), and William A. Heard,

Office of the Assistant Chief Counsel (Field Service). However, other

personnel from the Service and Treasury Department participated in

their development.

List of Subjects in 26 CFR Part 301

Employment taxes, Estate taxes, Excise taxes, Gift taxes, Income

taxes, Penalties, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

Accordingly, 26 CFR part 301 is amended as follows:

PART 301--PROCEDURE AND ADMINISTRATION

Paragraph 1. The authority citation for part 301 continues to read

in part as follows:

Authority: 26 U.S.C. 7805 * * *

Par. 2. Amend Sec. 301.6221-1T by:

1. Redesignating paragraph (c) as paragraph (e).

2. Adding new paragraphs (c) and (d).

The additions read as follows:

Sec. 301.6221-1T Tax treatment determined at partnership level

(temporary).

* * * * *

(c) Penalties determined at partnership level (partnership taxable

years ending after August 5, 1997). Any penalty, addition to tax, or

additional amount that relates to an adjustment to a partnership item,

shall be determined at the partnership level. Partner level defenses to

such items can only be asserted through refund actions following

assessment and payment. Assessment of any penalty, addition to tax, or

additional amount that relates to an adjustment to a partnership item

shall be made based on partnership level determinations. Partnership

level determinations include all the legal and factual determinations

that underlie the determination of any penalty, addition to tax, or

additional amount, other than partner level defenses specified in

paragraph (d) of this section.

(d) Partner level defenses. Partner level defenses to any penalty,

addition to tax, or additional amount that relates to an adjustment to

a partnership item, may not be asserted in the partnership level

proceeding, but may be asserted through separate refund actions

following assessment and payment. See section 6230(c)(4). Partner level

defenses are limited to those that are personal to the partner or are

dependant upon the partner's separate return, and cannot be determined

at the partnership level. Examples of these determinations are: whether

any applicable threshold underpayment of tax has been met with respect

to the partner or whether the partner has met the criteria of section

6664(b)(penalties applicable only where return is filed), or section

6664(c)(1)(reasonable cause exception) subject to partnership level

determinations as to the applicability of section 6664(c)(2).

* * * * *

Par. 3. Amend Sec. 301.6223(c)-1T by adding a sentence to the end

of paragraph (c) to read as follows:

Sec. 301.6223(c)-1T Additional information regarding partners

furnished to the Service (temporary).

* * * * *

(c) * * * Furthermore, reference to a prior general notification to

the Service that a partner who would otherwise be the tax matters

partner is a debtor in a bankruptcy proceeding or has had a receiver

appointed for him in a receivership proceeding is not sufficient unless

a copy of the notification document referred to is attached to the

statement.

* * * * *

Par. 4. Amend Sec. 301.6224(c)-3T by:

1. Revising the section heading.

2. Revising paragraphs (b), (c)(3)(ii), and (d), Example (1).

[[Page 3839]]

The revisions read as follows:

Sec. 301.6224(c)-3T Consistent settlement terms (temporary).

* * * * *

(b) Requirements for consistent settlement terms--(1) In general.

Consistent settlement terms are those based on the same determinations

with respect to partnership items. However, consistent settlement terms

also may include partnership level determinations of any penalty,

addition to tax, or additional amount that relates to partnership

items. Settlements with respect to partnership items shall be self-

contained; thus, a concession by one party with respect to a

partnership item may not be based upon a concession by another party

with respect to any item that is not a partnership item other than any

penalty, addition to tax, or additional amount that relates to an

adjustment to a partnership item. Consistent agreements, whether

comprehensive or partial, must be identical to the original settlement

(that is, the settlement upon which the offered settlement terms are

based). A consistent agreement must mirror the original settlement and

may not be limited to selected items from the original settlement. Once

a partner has settled a partnership item, or penalty, addition to tax,

or additional amount that relates to an adjustment to a partnership

item, that partner may not subsequently request settlement terms

consistent with a settlement that contains the previously settled item.

The requirement for consistent settlement terms applies only if--

(i) The items were partnership items (and any related penalty,

addition to tax, or additional amount) for the partner entering into

the original settlement immediately before the original settlement; and

(ii) The items are partnership items (and any related penalty,

addition to tax, or additional amount) for the partner requesting the

consistent settlement at the time the partner files the request.

(2) Effect of consistent agreement. Consistent settlement terms are

reflected in a consistent agreement. A consistent agreement is not a

settlement agreement which gives rise to further consistent settlement

rights because it is required to be given without volitional agreement

of the Secretary. Therefore, a consistent agreement required to be

offered to a requesting taxpayer is not a settlement agreement under

section 6224(c)(2) of the Internal Revenue Code, or paragraph (c)(3) of

this section which starts a new period for requesting consistent

settlement terms. For all other purposes of the Internal Revenue Code,

however, (e.g., binding effect under section 6224(c)(1), and conversion

to nonpartnership items under section 6231(b)(1)(C)) a consistent

agreement is treated as a settlement agreement.

(c) * * *

(3) * * *

(ii) The 60th day after the day on which the settlement agreement

was entered into.

(d) * * *

Example (1). The Service seeks to disallow a $100,000 loss

reported by Partnership P. The Service agrees to a settlement with

X, a partner in P, in which the Service allows 60 percent of the

loss, accepts the treatment of all other partnership items on the

partnership return, and imposes a penalty for negligence related to

the loss disallowance. Partner Y, which owns a 10 percent interest

in the partnership, requests settlement terms which are consistent

with the settlement made between X and the Service. The items are

partnership items (and a related penalty) for X immediately before X

enters into the settlement agreement and are partnership items (and

a related penalty) for Y at the time of the request. The Service

must offer Y settlement terms allowing a $6,000 loss, a negligence

penalty on the $4,000 disallowance, and otherwise reflecting the

treatment of partnership items on the partnership return.

* * * * *

Par. 5. Add Sec. 301.6229(b)-2T to read as follows:

Sec. 301.6229(b)-2T Special rule with respect to debtors in Title 11

cases (temporary).

(a) In general. Notwithstanding any other law or rule of law, if an

agreement is entered into under section 6229(b)(1)(B), and the

agreement is signed by a person who would be the tax matters partner

but for the fact that, at the time that the agreement is executed, the

person is a debtor in a bankruptcy proceeding under Title 11 of the

United States Code, such agreement shall be binding on all partners in

the partnership unless the Service has been notified of the bankruptcy

proceeding in accordance with paragraph (b) of this section.

(b) Procedures for notifying the Service of a partner's bankruptcy

proceeding. (1) The Service shall be notified of the bankruptcy

proceeding of the tax matters partner in accordance with the procedures

set forth in Sec. 301.6223(c)-1T.

(2) In addition to the information specified in Sec. 301.6223(c)-

1T, notification that a person is (or was) a debtor in a bankruptcy

proceeding shall include the date the bankruptcy proceeding was filed,

the name and address of the court in which the bankruptcy proceeding

exists (or took place), the caption of the bankruptcy proceeding

(including the docket number or other identification number used by the

court), and the status of the proceeding as of the date of

notification.

Par. 6. Add Sec. 301.6229(f)-1T to read as follows:

Sec. 301.6229(f)-1T Special rule for partial settlement agreements

(temporary).

(a) In general. If a partner enters into a settlement agreement

with the Service with respect to the treatment of some of the

partnership items in dispute for a partnership taxable year, but other

partnership items for such year remain in dispute, the period of

limitations for assessing any tax attributable to the settled items

shall be determined as if such agreement had not been entered into.

(b) Other items remaining in dispute. Pursuant to section 6226(c),

a partner is a party to a partnership level judicial proceeding with

respect to partnership items. When a partner settles partnership items,

the settled partnership items convert to nonpartnership items under

section 6231(b)(1)(C) and will not be subject to any future or pending

partnership level proceeding pursuant to section 6226(d)(1). The

remaining unsettled partnership items, however, will remain subject to

determination under partnership level administrative and judicial

procedures. Consequently, any remaining unsettled items will be deemed

to remain in dispute. Thus, the period for assessing settled items will

be governed by the period for assessing the remaining unsettled items.

Par. 7. Amend Sec. 301.6231(a)(1)-1T by:

1. Revising the first two sentences of paragraph (a)(1).

2. Removing paragraph (a)(3).

3. Redesignating paragraph (a)(4) as paragraph (a)(3).

The revision reads as follows:

Sec. 301.6231(a)(1)-1T Exception for small partnerships (temporary).

(a) * * *

(1) ``10 or fewer.'' The ``10 or fewer'' limitation described in

section 6231(a)(1)(B)(i) is applied to the number of natural persons

(other than nonresident aliens), C corporations, and estates of

deceased partners that were partners at any one time during the

partnership taxable year. Thus, for example, a partnership that at no

time during the taxable year had more than 10 partners may be treated

as a small partnership even if, because of transfers of interests in

the partnership, 11 or more natural persons, C corporations, or estates

of deceased partners owned interests in the partnership for some

portion of the taxable year. * * *

* * * * *

[[Page 3840]]

Par. 8. Amend Sec. 301.6231(a)(6)-1T by:

1. Revising paragraph (a).

2. Removing paragraph (c).

The revision reads as follows:

Sec. 301.6231(a)(6)-1T Computational adjustments (temporary).

(a) In general. A change in the tax liability of a partner to

properly reflect the treatment of a partnership item under subchapter C

of chapter 63 of the Internal Revenue Code is made through a

computational adjustment. A computational adjustment includes a change

in tax liability that reflects a change in an affected item where that

change is necessary to properly reflect the treatment of a partnership

item, or any penalty, addition to tax, or additional amount that

relates to an adjustment to a partnership item. However, if a change in

a partner's tax liability cannot be made without making one or more

partner level determinations, that portion of the change in tax

liability attributable to the partner level determinations shall be

made under the provisions of subchapter B of chapter 63 of the Internal

Revenue Code (relating to deficiency procedures), except for any

penalty, addition to tax, or additional amount which relates to an

adjustment to a partnership item.

(1) Changes in a partner's tax liability with respect to affected

items that do not require partner level determinations (such as the

threshold amount of medical deductions under section 213 that changes

as the result of determinations made at the partnership level) are

computational adjustments that are directly assessed. When making

computational adjustments, the Service may assume that amounts the

partner reported on the partner's individual return include all amounts

reported to the partner by the partnership, absent contrary notice to

the Service (for example, a ``Notice of Inconsistent Treatment''). Such

an assumption by the Service does not constitute a partner level

determination. Moreover, substituting redetermined partnership items

for the partner's previously reported partnership items (including

partnership items included in carryover amounts) does not constitute a

partner level determination where the Service otherwise accepts all

nonpartnership items (including, for example, nonpartnership item

components of carryover amounts) as reported.

(2) Changes in a partner's tax liability with respect to affected

items that require partner level determinations (such as a partner's

at-risk amount to the extent it depends upon the source from which the

partner obtained the funds that the partner contributed to the

partnership) are computational adjustments subject to deficiency

procedures. Nevertheless, any penalty, addition to tax, or additional

amount that relates to an adjustment to a partnership item may be

directly assessed following a partnership proceeding, based on

determinations in that proceeding, regardless of whether partner level

determinations are required.

* * * * *

Par. 9. Amend Sec. 301.6231(a)(7)-1 by adding a sentence at the end

of paragraphs (p)(2) and (r)(1) to read as follows:

Sec. 301.6231(a)(7)-1 Designation or selection of tax matters partner.

* * * * *

(p) * * *

(2) * * * For regulations applicable on or after January 26, 1999

(reflecting statutory changes made effective July 22, 1998) and before

January 25, 2002, see Sec. 301.6231(a)(7)-1T(p)(2).

* * * * *

(r) * * * (1) * * * For regulations applicable on or after January

26, 1999 (reflecting statutory changes made effective July 22, 1998)

and before January 25, 2002, see Sec. 301.6231(a)(7)-1T(r)(1).

* * * * *

Par. 10. Add Sec. 301.6231(a)(7)-1T to read as follows:

Sec. 301.6231(a)(7)-1T Designation or selection of tax matters partner

(temporary).

(a) through (p)(1) [Reserved]. For further guidance, see

Sec. 301.6231(a)(7)-1(a) through (p)(1).

(p)(2) When each general partner is deemed to have no profits

interest in the partnership. If it is impracticable under

Sec. 301.6231(a)(7)-1(o)(2) to apply the largest-profits-interest rule

of Sec. 301.6231(a)(7)-1(m)(2), the Commissioner will select a partner

(including a general or limited partner) as the tax matters partner in

accordance with the criteria set forth in Sec. 301.6231(a)(7)-1(q). The

Commissioner will notify, within 30 days of the selection, the partner

selected, the partnership, and all partners required to receive notice

under section 6223(a), effective as of the date specified in the

notice. For regulations applicable before July 22, 1998, see

Sec. 301.6231(a)(7)-1(p)(2).

(p)(3) through (q) [Reserved]. For further guidance, see

Sec. 301.6231(a)(7)-1(p)(3) through (q).

(r) Notification of partnership--(1) In general. If the

Commissioner selects a tax matters partner under the provisions of

Sec. 301.6231(a)(7)-1(p)(1) or (3)(i), the Commissioner will notify,

within 30 days of the selection, the partner selected, the partnership,

and all partners required to receive notice under section 6223(a),

effective as of the date specified in the notice. For regulations

applicable before July 22, 1998, see Sec. 301.6231(a)(7)-1(r)(1).

(r)(2) [Reserved]. For further guidance, see Sec. 301.6231(a)(7)-

1(r)(2).

Approved: December 30, 1998.

Robert E. Wenzel,

Deputy Commissioner of Internal Revenue Service.

Donald C. Lubick,

Assistant Secretary of the Treasury.

[FR Doc. 99-885 Filed 1-25-99; 8:45 am]

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