Attorney Outlines Ideas for New Partnership Audit Rules

I write concerning the new partnership tax audit rules (Subchapter C, sections 6221 through 6241) enacted by Congress as part of the Bipartisan Budget Act of 2015,¹ I submit these comments and recommendations in response to Notice 2016-23, Request for Comments Regarding Implementation of the New Partnership Audit Regime Enacted as Part of the Bipartisan Budget Act of 2015, issued on March 4, 2016.

I am interested in achieving workable audit rules that will facilitate Internal Revenue Service audits of partnerships and collection of tax on audit adjustments. These should be audit rules that can be reconciled with the substantive rules of Subchapter K. The partnership audit rules should not lead to impossibly complex interpretive regulations. Complexity of rules and regulations already is too much of a problem with taxation of partnerships. I am particularly anxious that new partnership audit rules should not burden small partnerships, small business, and family farms. At the same time, I do not advocate rules that make it practically impossible to audit small partnerships, small business, and family farms.

  1. Personal Background

I am an attorney. I am licensed to practice law before the courts of the State of California.

I am just a simple, obscure South Pasadena tax lawyer writing in hope of advancing the state of the tax system.

I have practiced tax law since 1977. My practice is concentrated in the areas of partnership taxation (Subchapter K) and real estate taxation. I have been involved in issues of partnership taxation and real estate taxation since 1977.

I write from the perspective of a tax practitioner who has spent 39 years working with partnership taxation. Most of my practice works with partnerships with 100 or fewer partners.

I do not represent publicly-traded partnerships and partnerships with hundreds or thousands of partners. I am skeptical that publicly-traded partnerships and many other large partnerships can be accommodated effectively within the current rules of Subchapter K. The pass-through regime of Subchapter K, however, works well for small partnerships, small business, and family farms. I believe that I have some understanding of the audit problems of publicly-traded partnerships and large partnerships, even though I do not work regularly with these partnerships.

I was not at all involved in the creation of the new partnership audit rules. I was not involved in the earlier creation of the TEFRA audit rules.

I submit these comments in the hope that they may help to improve the system of partnership taxation. The new partnership audit rules constitute a clear and present danger to partnership taxation and more particularly to the survival of partnerships as pass-through entities.

I understand that my comments do not reflect the vast experience of large professional organizations. My comments nevertheless may be more independent of the influence of their individual client concerns.

2. Conflicts.

I write this letter on my own behalf. I do not write on behalf of my law firm, any client, any other organization, or anyone else. My comments stand alone. Neither my law firm, nor any client, nor any other organization, nor anyone else joins in or has endorsed my comments. I am not lobbying on behalf of any special interest. My errors and perhaps my naïveté are all my own. Blame me for any errors in my comments. Do not blame anyone else.

I have not been offered, I have not received, and I will not receive any compensation in connection with the preparation or submission of my comments -- or with any result that they may produce.

To the best of my knowledge, neither my law firm nor any of my clients has any matter discussed in this letter currently under audit by the Internal Revenue Service. I do not have, and I do not believe that my firm or any of its clients has, an immediate, direct financial interest in the outcome of the matters discussed in this letter, other than the general interest of all taxpayers in improving the tax system.

3. Terminology.

I use this terminology in this letter:

My comments propose corrective legislation. If these comments are rejected and corrective legislation is not passed, many problems in drafting regulations under the new partnership audit rules will exist. For the most part, these comments do not address those problems.

5. The new partnership audit rules do not work.

The new partnership audit rules do not work, cannot work, and will not work, even with the best regulations.

The new partnership audit rules were sold to Congress as a revenue raiser. The new partnership audit rules may reduce rather than increase tax revenues. The new partnership audit rules also may increase the Internal Revenue Service's expense of conducting partnership audits. The new partnership audit rules, particularly as they may be interpreted by regulations, will increase audit complexity. The new partnership audit rules, to a significant extent, are rules of expediency and convenience. Sound tax theory does not support the new partnership audit rules. Fundamental legislative corrections should be made to the new partnership audit rules.

The new partnership audit rules do not compute the Correct Tax Liability. The tax liability under the new partnership audit rules is not computed under normal income tax principles. Short of the potential for incredible computational complexity, there is no manner for regulations drafted under the new partnership audit rules to calculate the Correct Tax Liability. The proper partners do not bear the economic burden of the tax on partnership audit adjustments under the new partnership audit rules.

A significant risk exists under the new partnership audit rules that partnerships will adjust partner capital accounts in the adjustment year rather than in the reviewed year. Partnership assets then may not be equal to the sum of partnership liabilities and partner capital at the end of the reviewed year. Partner capital accounts in the reviewed year and afterwards (until finally adjusted in the adjustment year) will not be consistent with partnership economics. This suggests that it is inappropriate to use partner capital accounts as determined under the new partnership audit rules to determine either partners' interests in the partnership or substantial economic effect. This overturns basic rules of partnership taxation. The new partnership audit rules override statutory rules concerning at risk and passive losses, both of which rules are applied at the partner level.

The new partnership audit rules similarly create the risk that partnerships will make audit adjustments to bases in partnership interests in the adjustment year rather than in the reviewed year.

Deferring partnership audit adjustments until the adjustment year will seriously damage the theoretical superstructure of Subchapter K. The partners will not compute basis in their partnership interests in accordance with statutory law under Code Section 705. Partner capital accounts will not make sense. Both partnerships and the Internal Revenue Service will not know how to determine partners' interests in the partnership or substantial economic effect between the reviewed year and the adjustment year. A sale of a partnership interest during the period after the reviewed year and prior to the adjustment year may produce inappropriate tax results on account of the failure to adjust the partner's tax basis in his partnership interest on account of partnership audit adjustments.

The new partnership audit rules inappropriately permit many partnerships with 100 or fewer partners to elect out of the consolidated audit scheme. The Internal Revenue Service will have great difficulty auditing these partnerships. Additionally, election out of the new partnership audit rules creates the risk that different partners will appeal audit results to different circuits and produce inconsistent results on appeal.

Even a cursory review of comments that the Internal Revenue Service has received from taxpayers to date demonstrates what a massive regulation project will be necessary in order to implement the new partnership audit rules as currently drafted. These comments also provide some hint of the difficulty that the Internal Revenue Service will have auditing partnerships under the new partnership audit rules and computing imputed underpayments. Simply considering modifications to the imputed underpayment and verifying the information necessary to make these modifications can require a Herculean task.

6. The New Partnership Audit Rules Particularly Burden Small Partnerships to Solve a Problem of Large Partnerships.

The new partnership audit rules particularly burden small partnerships, small business, and family farms. These partnerships do not have the types of collection and administration problems of publicly-traded and large partnerships that inspired the new partnership audit rules. The new partnership audit rules particularly address problems of publicly-traded and other large partnerships. Nevertheless, under the new partnership audit rules, small partnerships are being subjected to complex audit and collection rules designed to address the problems of publicly-traded and other large partnerships. At the same time, it is appropriate to have partnership-level audit rules for small partnerships. Election out of the new partnership audit rules (marking it almost impossible for the Internal Revenue Service to audit electing out partnerships effectively) is not an effective solution for small partnerships, although many small partnerships will elect out. Small partnerships should not be subject to the new partnership audit rules, but small partnerships still should be subject to consolidated audit rules.

7. Summary of Recommendations.

My principal recommendations are:

This is a simplified summary of how an audit under the existing TEFRA audit rules works:

9. Difficulty Internal Revenue Service has Auditing Partnerships.

The Internal Revenue Service has had a poor record of auditing partnership activities effectively. This poor record may have contributed materially to the use of partnerships as vehicles for tax-shelter investments, as prospects that aggressive positions will escape Internal Revenue Service audit scrutiny encourage taxpayers to take aggressive positions with partnerships.

Various factors contribute to the Internal Revenue Service's inability to audit partnerships, to identify and to make required partnership audit adjustments, and to collect the required tax.

The Internal Revenue Service has audit resources to audit less than 1/2 of 1% of partnerships.² These audits typically are superficial and ineffective and concentrate on easy tax issues for field examiners to understand, such as travel and entertainment and documentation of expenses. As a matter of audit policy, the Internal Revenue Service has substantially ceded interpretation of the partnership tax rules to however taxpayers wish to interpret these rules. Many partnerships are aggressive in interpreting rules that Internal Revenue Service field examiners do not enforce. In the partnership area outside of marketed tax shelter transactions, Internal Revenue Service field examiners are missing tigers and paper tigers.

Some partnership regulations (such as regulations governing partnership allocations under Section 704) are badly worn and ineffective. Notwithstanding frequent taxpayer abuses in these areas, Internal Revenue Service field examiners rarely raise audit issues in these areas. Regulations have not yet addressed some important partnership issues (such as dealing with multiple layers of reverse Section 704(c) adjustments). Taxpayers feel free to advance their own interpretations of the partnership tax law in these areas. These interpretations typically are much more favorable to the taxpayers than to the government. Taxpayers often are happy with lack of guidance in these areas, since taxpayers are left to do what they want.

Internal Revenue Service audits of partnerships outside of the tax shelter area rarely deal with difficult partnership issues, such as partnership allocations, partnership basis adjustments, disguised sales, partnership status, debt-equity, and investment partnership rules. These are sophisticated tax issues that require highly trained and motivated field examiners supported by strong technical support and often supported by substantial computer resources.

Many partnerships succeed with aggressive tax positions because Internal Revenue Service field examiners do not understand the issues or do not feel that they will receive sufficient audit support to undertake audits effectively.

Many Internal Revenue Service field examiners do not feel comfortable auditing partnerships on partnership tax issues. Even attorneys at District Counsel are reluctant to undertake cases involving partnership tax issues. Attorneys at the Internal Revenue Service Chief Counsel's office often do not encounter a broad range of partnership tax issues. These issues are not addressed by Internal Revenue Service audits, by private letter rulings, or by current guidance projects. Even at the office of the Chief Counsel of the Internal Revenue Service, experience in the partnership area usually is limited by demands of formal guidance projects and requests for guidance through private letter rulings.

Internal Revenue Service field examiners typically have poor training in partnership tax issues and consequently do not understand partnership taxation properly. The Internal Revenue Service has limited funds for field examiner training and audit support. The Internal Revenue Service has insufficient staff to devote to partnership audits and audit support. The Internal Revenue Service has failed to develop adequate software and computer support for field examiners to handle difficult partnership audit issues, such as complex rules of Section 704(c) and Section 755 that may require massive numbers of daily calculations.

When partnership audit adjustments are made to large partnerships, the Internal Revenue Service apparently has difficulty matching partnership audit adjustments to partner returns. This reflects a significant failure in Internal Revenue Service computer support.

The Internal Revenue Service fails to recognize partnerships as an audit specialty and to develop teams that specialize in auditing partnerships.

Perhaps most important, in partnership audits, the typical Internal Revenue Service field examiner goes up against accountants who are better staffed, better qualified, better educated, better trained, better supported, better funded, and considerably better compensated than the Internal Revenue Service field examiners are. Partnerships audits often are not a level playing field. Partnership audits too often put the Internal Revenue Service B team or C team against the taxpayer's A team. It should be no surprise that the Internal Revenue Service typically is ineffective on partnership tax issues in partnership audits.

Salaries and support at private accounting firms usually are substantially better than salaries and support at the Internal Revenue Service. Accounting firms compete favorably with the Internal Revenue Service in recruiting young professionals from universities and colleges. Many field examiners and counsel look to the Internal Revenue Service as a training ground from which they can advance to better salaries and support in the private sector with private accounting firms or law firms. Many senior Internal Revenue Service leaders leave the Internal Revenue Service to join large accounting firms or law firms. The national offices of major accounting firms are filled with attorneys and accountants who formerly were Internal Revenue Service leaders.

Specialized counsel or accountants often are involved helping taxpayers at earlier stages of partnership audit disputes than stages at which specialized Internal Revenue Service counsel or accountants are involved.

The Internal Revenue Service has quietly given up auditing some important partnership tax issues altogether. These issues include partnership allocations and partnership basis adjustments when the partnership makes a special basis adjustment election. The Internal Revenue Service has long disregarded issues of collapsible partnerships.

The partnership audit problem was particularly difficult for large partnerships and publicly-traded partnerships. The Internal Revenue Service would institute audits at the individual level. The Internal Revenue Service would seek waivers of statutes of limitations from all direct and indirect partners. The audit situation became especially cumbersome if partners were located in a large number of Internal Revenue Service districts. Different partners might want to take the lead in the audit. Different partners might make different arguments. The Internal Revenue Service could find itself duplicating its work in different audits relating to the same partnership. The Internal Revenue Service would have to enter into a settlement agreement with each partner. If some partners contested the result in court, the Internal Revenue Service could be confronted with prosecuting different cases in different districts. Finally, the Internal Revenue Service would confront the problem of collecting tax on deficiencies from a large number of partners.

Congress recognized in 1982, in passing the TEFRA audit rules, the difficulty or impossibility of auditing partnership activities as part of an individual partner audit.³ The only effective way for the Internal Revenue Service to audit partnerships was to conduct a consolidated audit of the partnership as a whole as a partnership-level audit. TEFRA provided for consolidated audits of the tax treatment of any partnership item. TEFRA unfortunately left a large audit hole under which many partnerships with ten or fewer partners were audited under pre-TEFRA rules that did not permit consolidated partnership audits. These audits would be undertaken, if undertaken at all, as partner audits.

In 1982, the Joint Committee on Taxation stated that the rationale for the TEFRA audit procedures was that:

TEFRA provided an imperfect solution. Consolidated audits were useful. The Internal Revenue Service sometimes had difficulty identifying the tax matters partner. There were ambiguities in TEFRA concerning what issues were resolved at the partnership level and what issues were resolved at the partner level. TEFRA posed difficult statute of limitations issues and statute of limitations waiver issues. The Internal Revenue Service also had difficulty determining whether partners were paying the appropriate tax on partnership audit adjustments, particularly when partnerships had tiers of pass-through entities as partners or many partners.

The Joint Committee on Taxation published this comment regarding its analysis of a required large partnership audit proposal made in 2013:

The Internal Revenue Service has been reluctant to admit that the partnership tax rules, particularly the partnership audit rules and some substantive partnership tax rules, simply may not work well for large partnerships, particularly for partnerships that are publicly-traded. Large partnerships create material substantive and audit problems that typically are not encountered by small partnerships. These problems include the ability of the Internal Revenue Service to match partnership audit adjustments and partner returns. Rules for partnership allocations, Section 704(c), and basis adjustment rules may not work well for partnerships with large numbers of partners, particularly publicly-traded partnerships. The Chief Counsel's office devotes disproportionate time to the problems of qualification guidance for publicly-traded partnerships.

A 2012 Administration proposal would have treated required large partnerships with 1,000 or more partners, upon audit, much as corporations.⁸ A General Accounting Office report⁹ questioned large partnership compliance with Internal Revenue Service partnership audit adjustments.

A March 18, 2015, Treasury Inspector General for Tax Administration report¹⁰ identified:

The new partnership audit rules were expanded to include partnerships with fewer than 100 partners, although many partnerships with 100 or fewer partners were permitted to elect out of the new partnership audit rules.

The Internal Revenue Service has been reluctant to admit that the greatest problems of field examiners in the field in auditing partnerships are:

Large partnerships provide an identified problem in matching partnership audit adjustments and amended partner returns reflecting those partnership audit adjustments, particularly when the partnerships have multi-tiered structures.

The principal articulated concerns of the Internal Revenue Service about auditing partnerships under TEFRA apply to large partnerships. Large partnerships create many tax and audit problems.¹³

The new partnership audit rules represent a major departure from traditional rules of how partnerships are taxed. This has major substantive effects and likely will lead to complicated regulations and difficult audit problems as auditors are forced to verify information provided for modification of imputed underpayments.

I understand that considerable political enthusiasm exists in Congress and the Internal Revenue Service for collecting all tax deficiencies from partnership audits at the partnership level. This may well represent a first step toward imposing all tax from partnership income at the partnership level. (Significant Congressional and Internal Revenue Service enthusiasm may exist for taxing partnerships.) This would transform partnerships into a form of corporation. I believe that it would be difficult to justify partnerships as flow-through entities for their regular returns and yet entities subject to regular tax with respect to tax on partnership adjustments.

I nevertheless believe that there is merit in continuing partnerships as pass-through entities, both with respect to regular tax liability and with respect to tax liability for audit adjustments. The Internal Revenue Service has not identified with specificity why it cannot collect tax on partnership adjustments from partners and whether there is a less drastic solution than abandoning partnerships as pass-through entities and collecting tax on partnership audit adjustments under what is essentially a corporate model -- at the entity level. Partnerships remain important for small business and family farms.

The Internal Revenue Service has not implemented basic steps that would enable the Internal Revenue Service to collect tax on partnership audit adjustments from partners. Statute of limitations issues can be dealt with through legislation by adjusting statutes of limitations on direct and indirect partners on tax attributable to partnership audit adjustments. Direct and direct partners can be affirmatively required to file amended partnership returns for the reviewed year to reflect partnership audit adjustments.¹⁴ Special penalties can be provided for failure to amend and to pay the required tax. Special coding can be provided for amended direct and indirect partner returns to permit easier association of those returns with the partnership return. Indirect partners could be identified on lower-tier partnership returns or as part of the partnership audit. Legislation can permit special assessment where partners fail to file amended returns and pay the required tax.

Partnerships can be required to identify both direct and indirect partners and their identification numbers. Indirect partners can be required to identify on their tax returns names and identification numbers of partnerships that are the source of their income. Legislation can require special reporting (to the partnership field examiner) of amended returns filed by direct and indirect partners reflecting partnership audit adjustments.

If collection-at-the-partnership rules are necessary for large partnership audits, Congress could formulate special audit rules that could apply only to large partnerships and publicly-traded partnerships. These rules could address direct and indirect partner statute of limitations, reporting of identity of indirect partners, requirement of partners to file amended tax returns and to pay the required tax, special penalties for failure to amend and to pay the tax, special assessment rules, and the like.¹⁵

Imposing on large partnerships a requirement to pay tax on partnership audit adjustments at the partnership level should be considered only as a last resort after other reasonable alternatives have been attempted and failed.¹⁶

In any event, the new partnership audit rules should not apply to and medium-sized partnerships. These rules contradict partnership theory and will represent an unreasonable burden on small business and family farms.

11. New Partnership Audit Rules.

The Bipartisan Budget Act of 2015, which President Obama signed into law on November 2, 2015, repealed the TEFRA partnership entity-level audit rules, including the electing large partnership rules.¹⁷ On December 18, 2015, Congress passed, and President Obama signed into law, the Protecting Americans From Tax Hikes (PATH) Act of 2015. This act sets forth certain corrections to the new partnership audit rules.

The new consolidated audit regime dramatically revises partnership tax audit rules and may have the effect of materially amending substantive rules of Subchapter K. Existing TEFRA entity-level audit rules apply until partnership taxable years beginning after December 31, 2017.¹⁸ After that, partnership audit rules are dramatically revised.

This briefly summarizes the new partnership audit rules:

Tax on partnership audit adjustments should be paid by the direct and indirect reviewed-year partners. Congress and the Internal Revenue Service can make legislative and regulatory adjustments to solve Internal Revenue Service collection problems.

Partners could be affirmatively required to file amended returns reflecting partnership adjustments and to pay the tax indicated on the return. Special penalties could apply where partners fail to file or to pay.

Taxpayers could be offered the alternative of paying tax on partnership adjustments at the highest individual rate without filing full amended returns. Special rules should apply in the case of tax-exempt and foreign partners. Special rules also should address situations in which partner withholding is required.

Appropriate changes could be made in direct and indirect partner statutes of limitations to ensure that the Internal Revenue Service is not impeded by statute of limitations concerns. For example, it would be possible to provide for suspension of a partner's statute of limitations until the expiration of a specified term after the direct or indirect partner has filed an amended return reporting all adjustments and paying the tax reflected on this amended return (or perhaps until one year after the conclusion of the partnership audit). This extension would apply only to tax on items adjusted in the partnership audit. The direct or indirect partner's statute of limitations on assessing tax related to the partnership adjustments would be unlimited if the partner failed to file an amended return reflecting these adjustments and paying the indicated tax. This should address statute of limitations concerns.

Since the beginning of partnership taxation, partners (rather than the partnership) have paid all taxes on partnership income. The partnership itself did not pay income tax. This included tax on audit adjustments. Partners paid the tax on partnership audit adjustments. The new partnership audit rules reverse this rule and assess tax on partnership audit adjustments against the partnership.

Tax policy requires that a taxpayer's taxes be assessed against and paid by the taxpayer earning the income, based on that taxpayer's tax characteristics, in the year in which the income in paid or accrued. Partnership income is supposed to be taxed to the partners in the year in which earned. Assessing taxes against the partnership may be convenient for the Internal Revenue Service, but this convenience undermines partnership tax theory.

The new partnership audit rules will burden the fabric of the partnership tax regime -- and perhaps will lead to tax abuses. The new partnership audit rules depart from basic principles of partnership tax by assessing taxes relating to partnership audit adjustments against the partnership based at an assumed tax rate and disregarding the partners' personal tax characteristics, such as operating losses. This departs from normal principles of partnership taxation.

The traditional approach and the TEFRA approach produce the tax liability that would result if the partnership had correctly reported its income. The traditional approach and the TEFRA approach produce what we might refer to as the "Correct Tax Liability" based on the partnership audit adjustments. The new partnership audit rules do not produce the Correct Tax Liability nor impose the tax resulting from audit adjustments on the right people -- who should be the reviewed-year partners.

There are better ways to deal with defects of TEFRA than to abandon the pass-through tax principles of Subchapter K and to tax partnership audit adjustments at the partnership level.

The new partnership audit rules can produce a tax liability that differs substantially from the Correct Tax Liability. The new partnership audit rules can result in:

The sensible approach is to make audit adjustments at the partnership level. Those partnership audit adjustments then should flow through to reviewed-year partners to tax the reviewed-year partners in the reviewed year. (This is somewhat similar to the push out method in the new partnership audit rules, except that adjustments are taxed in the reviewed year, which is where they belong.¹⁹) This technique incidentally will preserve proper partner capital accounts and proper partner bases in their partnership interests, effective as of the end of the reviewed year. This is the approach that Congress adopted in enacting TEFRA. Rather than seek to correct flaws in TEFRA, the new partnership audit rules have overturned TEFRA and provided an entirely new regime with a set of its own problems like a porcupine's back.

To the extent that problems in collecting tax on partnership adjustments from partners exist with large partnerships (particularly publicly-traded partnerships), these collection problems may be endemic to large partnerships.²⁰ This may require special partnership audit rules unique to large partnerships. Congress and the Internal Revenue Service also should consider whether the collection mechanism can be made more effective through better Internal Revenue Service computerization of tax return filing information and better computer matching of direct and indirect partners with the underlying partnerships. This may require that additional information be provided on partnership forms K-l and partner tax returns better to associate indirect partners with underlying partnerships. This also may require partner reporting of identifying information for indirect partners to the underlying partnerships.

The problem with partnership audits may relate to statute of limitations issues. Then, it may be appropriate to make legislative changes to the statute of limitations for direct and indirect partners.

13. If recommendation 2 is not accepted, then legislative changes should bifurcate partnership audit rules based on partnership size.

After partnership adjustments are determined, the Internal Revenue Service needs to be able to collect the tax based on audit adjustments. Large partnerships create special collection problems for the Internal Revenue Service.²¹ Congress may determine that the Internal Revenue Service needs to be able to assess tax on partnership adjustments for large partnerships at the partnership level.

I am concerned that, in the new partnership audit rules, small partnerships, small business, and family farms are paying for the sins of publicly-traded partnerships and other large partnerships. This is an unfortunate burden on small partnerships, small business, and family farms.

As an alternative to recommendation 2 if that recommendation is not accepted, Congress might determine to return to partner-level assessment for partnerships with 100 or fewer partners rather than to burden small business with a partnership-level collection mechanism. If collection-at-the-partnership level is necessary for large partnerships, then the partnership audit rules could be bifurcated into audit rules for large partnerships and audit rules for partnerships with 100 or fewer partners.

For large partnerships with 101²² or more partners, under the alternative approach:

This alternative proposal would adopt a model based on the corporate tax model for large partnerships with 101 or more partners (except for professional service partnerships). This model would address the difficulty in collecting tax on audit adjustments from partners of large partnerships.

The proposed model for large partnerships would impose tax at the partnership level on partnership adjustments. This tax would be imposed at a single notional tax rate. The model would not consider individual tax attributes in computing tax on adjustments.

The more administrable form of this model for large partnerships would not consider partnership status in computing tax liability, since determination and confirmation of partnership status can be difficult with large partnerships.²⁹

A compelling need does not exist to collect tax at the partnership level for smaller partnerships. The ideal most consistent with traditional principles of partnership taxation is that audit adjustments should be made in the reviewed year and should flow through to reviewed-year partners in the reviewed year. The reviewed-year partners then can pay adjusted tax for the reviewed year.

Rather than provide for imposing tax on audit adjustments of large partnerships at the partnership level, procedures could be created (such as a requirement for the partnership to provide the field examiner with the tax identification numbers of all direct and indirect reviewed-year partners) that would facilitate verification that reviewed-year partners have paid tax on adjustments. Appropriate changes could be made in partner statutes of limitations.

In any event, partnership adjustments for all partnerships should be determined in a consolidated audit procedure. The current rules for the partnership representative represent a reasonable approach for such a consolidated audit procedure.

To be clear, I do not concede that it is desirable to impose tax on audit adjustments on any partnerships at the partnership level.

14. Legislative changes should eliminate the opportunity to elect out of the partnership audit rules.

All partnership disputes should be resolved in consolidated partnership-level proceedings to the extent that the issues are more appropriately considered and resolved at the partnership level. It is important for the Internal Revenue Service to have a single person representing the partnership with which the Internal Revenue Service can undertake the audit. It is useful for a single person acting on behalf of the partnership to have settlement authority. It is useful to have a single statute of limitations period that the Internal Revenue Service must monitor.

The TEFRA audit rules provide a partnership exception under which certain partnerships can elect out of the TEFRA audit regime.³⁰ Election out under TEFRA is available to many partnerships with 10 or fewer partners that do not have passthroughs entities as partners. When a partnership elects out, effectively all items from partnership operations become nonpartnership items that must be resolved at the individual partnership level.

The new partnership audit rules dramatically expand the scope of partnerships that can elect out of the new partnership audit rules to include many partnerships with 100 or fewer partners.³¹ Lobbying activity is seeking to expand permitted partners to include partners and trusts. Dramatic expansion of opportunities to elect out of consolidated audits should put the Internal Revenue Service at a serious disadvantage in auditing many partnerships. Most partnerships cannot be audited effectively except as part of a consolidated audit.

The Internal Revenue Service must audit partnership operations as part of an individual partner audit if the partnership elects out of the new partnership audit rules. The Internal Revenue Service has considerable difficulty auditing partnership operations as part of an individual partner audit.

Auditing a partnership through individual partner audits is inefficient and can be ineffective. The TEFRA rules were designed to address this inefficiency and ineffectiveness. The difficulty of the audit can increase as the number of partners increases. Consolidated audits of the partnership are considerably more efficient and more effective. No one truly speaks for the partnership when the partnership is audited as part of a partner audit. The Internal Revenue Service may audit other partners separately on partnership operations. An agreement by one partner will not extend the statute of limitations of other partners. One partner's extension of a statute of limitations does not bind other partners. A statute of limitations may apply with respect to one partner but not with respect to another. One partner's settlement agreement does not bind other partners. Partners may make different arguments or take different positions in their individual audits. Field examiners may make different arguments or take different positions in their individual audits. The partnership may not cooperate with the audit. The Internal Revenue Service may have to use third partner discovery techniques to obtain information from the partnership. Auditing partnership operations at the partner level can lead to inconsistent results and to appeals to different circuits. Partnership-level determinations also can preserve consistent treatment of penalties,

The new partnership audit rules' permissiveness of election out by partnerships with 100 or fewer partners may result in a great increase in audit complexity and potentially a decrease in revenues from partnership audits.

Small business should not be burdened by partnership audit rules that override normal rules of partnership tax and that result in a computation of tax liability that differs from the Correct Tax Liability.

An exception to consolidated audit rules might be made for partnerships solely between spouses. These partnerships appear not to provide the audit challenges requiring consolidated partnership audits.

15. Partnership audits should provide for partnership-level determination of all issues most appropriately determined at the partnership level.

The TEFRA audit rules provide that "the tax treatment of any partnership item (and the applicability of any penalty, addition to tax, or additional amount which relates to an adjustment to a partnership item) shall be determined at the partnership level."³² This statement has created considerable confusion concerning what is "any partnership item" versus an item that is determined at the partner level. There has been substantial litigation to determine whether partnership items were partnership items, affected items (a special type of non-partnership item that is affected by a partnership item), and nonpartnership items.

The new partnership audit rules provide that "[a]ny adjustment to items of income, gain, loss, deduction, or credit of a partnership for a partnership taxable year (and any partner's distributive share thereof) shall be determined, any tax attributable thereto shall be assessed and collected, and the applicability of any penalty, addition to tax, or additional amount which relates to an adjustment to any such item or share shall be determined, at the partnership level . . .,"³³ The relationship between "[a]ny adjustment to items of income, gain, loss, deduction, or credit of a partnership" under new partnership audit rules and partnership items or affected items under the TEFRA rules is uncertain. The language of the new partnership audit rules suggests that only a limited set of issues (income, gain, loss, deduction, or credit) should be determined in partnership audits under the new partnership audit rules.

Congress should consider readdressing the proper scope of what adjustments should be made in partnership audits and more clearly specifying what adjustments should be made at the partnership level.³⁴ A good case can be made for that the partnership audit rules should permit partnership audits to resolve a broad scope of partnership audit issues. The partnership audit should deal with those issues that are more appropriately considered and resolved at the partnership level. These issues might be considerably broader than the natural scope of "[a]ny adjustment to items of income, gain, loss, deduction, or credit of a partnership for a partnership taxable year (and any partner's distributive share thereof)." The concept of "partnership items" under TEFRA would be a good starting point for determining items that should be resolved in a partnership audit; however, this concept could benefit from legislative clarification.

16. Legislative technical corrections should provide that any partnership audit adjustments should be effective in the reviewed year rather than in the adjustment year.

Partnership audit adjustments will result in an imputed underpayment that the partnership is required to pay. The adjustments also will affect a partner's tax basis in his partnership interest and his capital account. The new partnership audit rules do not expressly address when these adjustments are made.

Section 6225(a) states:

A partner's basis in his partnership interest normally is increased by the partner's distributive share of partnership income and decreased by the partner's distributive share of loss in the year in which the partnership recognizes the income or loss.³⁵

Waiting until the adjustment year to allocate adjustments among partners can create bizarre results. We do not altogether know how the partnership will allocate tax items in the years from the year following the reviewed year through the year immediately preceding the adjustment year.

Example 1. Assume that --

• The Internal Revenue Service undertakes a partnership audit under the new partnership audit rules.

• The partnership pays tax on Internal Revenue Service audit adjustments at the partnership level.

• The audit adjustments in the adjustment year reallocate $100,000 in income from partner Jed to partner Sarah.

• The adjustments do not flow through to partners until the adjustment year.

The partner capital accounts problem may be corrected by the automatic operation of a target allocation provision in the year following the reviewed year. The target allocation provision will create an [inappropriate] allocation of income to Sarah in the year following the reviewed year to compensate for the capital account distortion in the reviewed year that otherwise is left uncorrected. Alternatively, the capital accounts problem may be corrected by the operation of partners' interests in the partnership in the year following the reviewed year.

If the partner capital account problem is not solved in the year following the reviewed year, then partnership allocations from the year after the reviewed year through the year preceding the adjustment year become uncertain.

If the partner capital account errors have not been corrected prior to the adjustment year, then the partner capital account errors may still exist at the beginning of the adjustment year. The partnership presumably then will make allocations in the adjustment year to correct the partner capital account errors and to reallocate income in the adjustment year from Jed to Sarah. The income that will be reallocated on account of the audit adjustment should be a cross-section of partnership net income in the adjustment year. In proper circumstances, a significant portion of this reallocated income might have a substantial tax-exempt income component, even though the misallocation of income in the reviewed year involved only ordinary income.

It is not clear how the partnership should account for the partnership's payment of the imputed underpayment. This might be a guaranteed payment, a deemed distribution to a partner, or something else.

The situation becomes more complicated in a situation in which the partnership fails to include an income item in the reviewed year:

Example 2 Assume that --

• A partnership audit is undertaken under the new partnership audit rules.

• The partnership pays tax on Internal Revenue Service audit adjustments at the partnership level.

• The partnership received $100,000 in cash but failed to report the income in the reviewed year.

• Under the economics of the partnership agreement, the income would have been allocated to partner Ritchie.

• The adjustments do not flow through to partners until the end of the adjustment year.

This situation similarly creates doubt concerning how to apply target allocation provisions from the year following the reviewed year through the year immediately proceeding the allocation year. This problem will continue until the situation is presumably corrected in the adjustment year. Similarly, Ritchie's tax basis in his partnership interest will be $100,000 lower than it should be.

Partner capital accounts should be consistent with partnership economics. This suggests that the premise that partner capital accounts are not adjusted until the adjustment year is false. This matter, however, should be clarified by legislation.

17. Legislative changes should address the statute of limitations problems currently identified under TEFRA.

Partnership audits often take more time than permitted by the statute of limitations. During a tax audit, taxpayers typically waive the statute of limitations before the statute expires. The situation of waiving partner statutes of limitation is considerably more complicated for a partnership under audit, particularly when the partnership under audit is a lower-tier partnership in a tiered partnership structure. The complexity for the Internal Revenue Service is increased by uncertainty over whether items are partnership items (to which the automatic extension of partner statutes under TEFRA apply), affected items, or nonpartnership items (dependent solely on the partner statute of limitations).

The basic statute of limitation under Section 6501(a) is normally a three year statute of limitations that applies to assessing a deficiency against a partner. More technically, the tax deficiency must be assessed no later than three years from (i) the date on which the partner's individual files his tax return or (ii) the original due date for the partner's tax return. The expiration of the partner's statute of limitations can preclude the Internal Revenue Service from assessing a tax deficiency due to partnership adjustments unless the partner has voluntarily extended his statute of limitations. The basic statute of limitations applies to all nonpartnership items and, subject to extension by Section 6229(a), to partnership items.

TEFRA enacted a special statute of limitations that extends the partner statute of limitations for items adjusted in TEFRA partnership audits. The Section 6229(a) statute provides:

The resolution was that the Internal Revenue Service can assess a deficiency based on the adjustment of a partnership item for a partnership taxable year within the period ending on the later of these two events: (i) three years after the date on which the partnership filed its tax return for the taxable year under audit, and (ii) three years from the due date of the partnership's tax return. Section 6229(a) extends (but never shortens) the statute of limitations for a deficiency attributable to partnership items determined in a TEFRA audit of a partnership.³⁶

The Internal Revenue Service has been plagued by statute of limitations issues under TEFRA. This has resulted in case after case in the courts dealing with TEFRA statute of limitations issues. The issue often is whether an item is a partnership item, an affected item, or a nonpartnership item.

The new partnership audit rules solve the TEFRA statute of limitations issue imperfectly by moving partnership adjustments from the reviewed year to the adjustment year or to the notice year (depending on whether the partnership pushes out adjustments to partners). This time-shift of adjustments can materially alter the tax effects of partnership adjustments. The new partnership audit rules may result in adjustments being taxed at an inappropriate tax rate. The new partnership audit rules also can change the interaction of partnership adjustments with other items in the partner's personal tax return. Finally, the new partnership audit rules do not clearly solve the issue of clearly determining what issues are resolved in a partnership audit and what issues must be resolved in a partner audit.

The new partnership audit rules do not help the Internal Revenue Service with statute of limitations issues if the audit determines that an item should be determined at the partner level rather than the partnership level. In this regard, the new partnership audit rules may exacerbate rather than ameliorate the Internal Revenue Service's statute of limitations problems. It appears that more issues are resolved at the partner level under the new partnership audit rules than was the case under the TEFRA audit rules.

The statute of limitations under the new partnership audit rules provides that any assessment for a partnership adjustment must be made no later than the later of:

The Internal Revenue Service apparently is concerned about assessment of deficiencies on partnership adjustments against reviewed-year partners and indirect partners. This concern arises particularly with partnerships that have many partners and apparently with publicly traded partnership. This concern grounds the approach of new partnership audit rules that taxes audit adjustments to the partnership rather than the partners and that moves these adjustments from the reviewed year to the adjustment year.

The Internal Revenue Service appears to believe that it cannot effectively collect tax on partnership adjustments from the partners of large and publicly-traded partnerships. The Internal Revenue Service has not adequately explored alternatives to collection of tax on partnership adjustments at the partnership level for large partnerships. This might include:

• revised statute of limitations for direct and indirect partners on tax attributable to partnership audit adjustments,

• affirmative requirements for to file amended returns reporting partnership audit adjustments,

• a possible certification requirement under which direct and indirect partners certify that they have filed amended returns including partnership audit adjustments and paid the tax reflected on these returns,

• better information reporting to the Internal Revenue Service that will permit the Internal Revenue Service to match partner amended returns with the partnership return,

• simplified assessment of partner tax attributable to partnership audit adjustments, and

• enhanced partner penalties for failure to pay tax on partnership audit adjustments.

If Congress does believe that the collection problem for large partnerships is sufficiently intractable, then special collection rules might be limited to large partnerships. Also, Congress might reconsider the desirability of taxing these large partnerships as tax partnerships if collecting tax from their partners is quite so difficult.

Smaller partnerships with more reasonable numbers of partners should not be burdened with rules designed to address large partnerships with many partners and publicly-traded partnerships. Most importantly, partnership audit rules for partnerships should not interfere with the substantive rules of Subchapter K, such as those concerning partnership allocations and a partner's basis in his partnership interest. Congress nevertheless should consider a statute of limitations for small partnerships that protects the Internal Revenue Service from statute of limitations bars in situations in which the Internal Revenue Service has exercised reasonable audit due diligence. Such a statute might extend partner limitation periods until the first anniversary of the reviewed-year partner having filed an amended return and paying the required tax on partnership audit adjustments.

Congress could bifurcate partnership audit rules, if necessary. Special audit rules could apply exclusively to large partnerships. Another audit regime would apply to small partnerships. This approach is similar to the special current audit rules for electing large partnerships, except that large partnership audit rules presumably would be made mandatory.

Another possibility is altogether to create a new tax regime for large partnerships and publicly-traded partnerships or to deny these entities partnership treatment altogether.

18. The authority of the partnership representative under the new partnership audit rules should be retained.

The new partnership audit rules concerning the partnership representative represent a reasonable accommodation with the Internal Revenue Service's legitimate concerns of needing a single person to represent the partnership. These provisions provide for a consolidated proceeding in which the field examiner needs to deal only with the partnership representative. The partnership representative has full authority to make all audit-related agreements with the Internal Revenue Service on behalf of the partnership. This provides a procedure that is reasonably administrable and efficient. These provisions concerning the partnership representative should be continued in any revisions to the new partnership audit rules. Adjustments, however, should be made in the reviewed year. Adjustments should flow through to partners in the reviewed year.

19. In addition to changing partnership audit rules; the Internal Revenue Service needs substantially to increase its partnership audit efforts.

The Internal Revenue Service needs more than improved audit rules to address partnership issues. The partnership audit rules perhaps have been a convenient excuse for the failure of Internal Revenue Service efforts to audit partnerships and to collect tax on account of partnership audit adjustments. This excuse may have concealed more extensive Internal Revenue Service failures in the partnership area. These are a series of Internal Revenue Service problems that negatively impact on the quality of Internal Revenue Service partnership audits:

• The Internal Revenue Service audits only a small percentage of partnerships.⁴⁰

• Internal Revenue Service audit efforts will not be effective unless the Internal Revenue Service audits more partnerships -- both large partnerships and small partnerships.

• Internal Revenue Service audit efforts will not be effective unless the Internal Revenue Service develops the understanding and ability to deal with more difficult partnership tax issues -- partnership allocations, collapsible partnership rules, basis adjustment rules, disguised sales, fee waivers, investment partnerships, etc.

• The conventional wisdom is that Internal Revenue Service audits of partnerships outside of the tax shelter area generally are superficial and inadequate.

• The Internal Revenue Service audit resources are substantially stressed by personnel cutbacks and resignations of experienced senior personnel.

• Partnership audits are not properly staffed and funded.

• The Internal Revenue Service does not provide field examiners with adequate computer support.

• The Internal Revenue Service does not permit sufficient specialization of field examiners in partnership audit issues.

• The Internal Revenue Service does not provide field examiners with proper training in substantive tax issues under Subchapter K. Training in partnership tax issues is dramatically inadequate.

• The Internal Revenue Service may find that field examiners in the partnership area require substantially more training and skill than field examiners in other areas. This also may require higher qualifications and special compensation consideration for field examiners in the partnership area.⁴¹ Field examiner compensation is low.

• The Internal Revenue Service also has important regulations projects, such as how to deal with tiers of reverse Section 704(c) adjustments and how to deal with service partners, substantially in arrears.

I shall respond to any inquiries or shall provide supplementary comments on request. I also am available by telephone at 626.441.5404.

² See Government Accounting Office, Trends in Compliance Activities Through Fiscal Year 2015, reference: 2016-30-073 (September 8, 2016). This table shows the Internal Revenue Service's rate of audit of partnership tax returns:

                                              Percentage of Partnership

⁴ See Joint Committee on Taxation, JCS-38-82, GENERAL EXPLANATION OF THE REVENUE PROVISIONS OF THE TAX EQUITY AND FISCAL RESPONSIBILITY ACT OF 1982 at 268 (Dec. 31, 1982).

⁵ Joint Committee on Taxation, JCS-2-12, DESCRIPTION OF REVENUE PROVISIONS CONTAINED IN THE PRESIDENT'S FISCAL YEAR 2013 BUDGET PROPOSAL at 624 (June 2012).

⁶ See Government Accounting Office, Large Partnerships: Characteristic of Population and IRS Audits, GAO-14-379R (Mar. 19, 2014).

⁷ Treasury Inspector General for Tax Administration, Additional Improvements Are Needed to Measure the Success and Productivity of the Partnership Audit Process, 2015-30-004, (Mar. 18, 2015).

⁸ Joint Committee on Taxation, JCS-2-12, DESCRIPTION OE REVENUE PROVISIONS CONTAINED IN THE PRESIDENT'S FISCAL YEAR 2013 BUDGET PROPOSAL at 624 (June 2012); Department of the Treasury, GENERAL EXPLANATIONS OF THE ADMINISTRATION'S FISCAL YEAR 2013 REVENUE PROPOSALS 254 (Feb. 2012).

⁹ See Government Accounting Office, Large Partnerships: Characteristic of Population and IRS Audits, GAO-14-379R (Mar. 19, 2014).

¹⁰ Treasury Inspector General for Tax Administration, Additional Improvements Are Needed to Measure the Success and Productivity of the Partnership Audit Process, 2015-30-004, (Mar. 18, 2015).

¹¹ An example is the failure of the Internal Revenue Service to propose regulations governing tiers of reverse I.R.C. § 704(c) adjustments.

¹² Two examples are I.R.C. § 704 regulations concerning substantiality and partners' interests in the partnership.

¹³ Some of these problems may reflect the weakness of Internal Revenue Service resources in keeping track of filed returns and matching partnership and partner returns. The best solution to this problem is to increase the strength of Internal Revenue Service computer resources and to require provision of necessary information to the Internal Revenue Service in order to permit the Internal Revenue Service to associate indirect partner returns and the audited partnership return. Many provisions of Subchapter K are difficult to apply to large partnerships and publicly-traded partnerships. These partnerships typically make up their own rules for applying these provisions. Those rules often are not rules that the Internal Revenue Code approves.

¹⁴ Appropriate exceptions should be made for taxpayers not taxable in the adjustments in the United States. Appropriate adjustments should be made where income is subject to withholding tax obligations.

¹⁵ If Congress is unable to prescribe rules for large partnership audits consistent with the pass-through regime of Subchapter K, then Congress should consider the appropriateness of taxing these entities as tax partnerships. There already are many other reasons to consider the appropriateness of treating large partnerships with hundreds or thousands of partners as tax partnerships. Large entities with many partners, particularly publicly-traded entities are not easily governed by rules of Subchapter K.

¹⁶ One of these alternatives is treating all publicly-traded partnerships and partnerships with more than a specified number of direct and indirect partners as corporations for tax purposes or subject to a new tax regime.

¹⁷ Section 1101, Pub. L. No. 114-74, the Bipartisan Budget Act of 2015. Section 1101 repeals the current rules governing partnership audits with a new centralized partnership audit regime that, in general, assesses and collects tax at the partnership level.

¹⁸ Bipartisan Budget Act of 2015 § 1101(g)(4) generally provides that a partnership may elect (in the time and manner prescribed by the Treasury or its delegate) for parts of the new rules to apply to partnership taxable years beginning after November 2, 2015 and before January 1, 2018.

¹⁹ Partners could be affirmatively required to file amended returns reflecting partnership adjustments and to pay the tax indicated on the return. Special penalties could apply where partners fail to file or to pay. These returns could be required within a specified period after notice of partnership adjustments.

Special rules should apply in the case of tax-exempt and foreign partners. Special rules also should address situations in which partner withholding is required.

Appropriate changes could be made in direct and indirect partner statute of limitations to ensure that the Internal Revenue Service is not impeded by statute of limitations concerns. For example, it would be possible to provide for suspension of a partner's statute of limitations until the expiration of a specified term after the direct or indirect partner has filed an amended return reporting all adjustments and paying the tax reflected on this amended return (or perhaps until one year after the conclusion of the partnership audit). This extension would apply only to tax on items adjusted in the partnership audit. The direct or indirect partner's statute of limitations on assessing tax related to the partnership adjustments would be unlimited if the partner failed to file an amended return reflecting these adjustments and paying the indicated tax.

The Internal Revenue Service also could institute new reporting rules that would permit the Internal Revenue Service to identify direct and indirect partners of the audited partnership and to associate the amended returns of these partners with the partnership.

²⁰ Congress perhaps should consider whether the current rules of Subchapter K are appropriate for large partnerships if the Internal Revenue Service cannot effectively audit large partnerships and collect the tax from the partners.

²¹ Large partnerships incidentally create special problems under a number of partnership provisions, including Section 704(b), Section 704(b), Section 706, and Section 743. Congress might consider whether it is appropriate to have different substantive rules for large partnerships with many partners and partnerships. This principle already is reflected in the rules under I.R.C. § 7704 that treat some publicly-traded partnerships as corporations. A special simplified tax regime outside of Subchapter K might be provided for partnerships with 100 or more partners.

²² The 101 number is not magical. The number could be set higher than 101.

²³ A regime could be designed to treat this tax as a creditable withholding tax on partners.

²⁴ The current push out rules under the new partnership audit rules push out adjustments to the partners (the correct partners) in the wrong taxable year (the adjustment year rather than the reviewed year). This will result in a tax liability that may differ substantially from the Correct Tax Liability. It should be reasonable to ask partners to file amended returns in the reviewed year to reflect reviewed-year partnership adjustments. If the problem with large partnerships is that the Internal Revenue Service cannot collect tax on partnership adjustments at the partner level, then permitting push out elections is not a good solution. If the Internal Revenue Service needs to collect tax on audit adjustments from large partnerships at the partnership level, then the Internal Revenue Service should collect tax on audit adjustments from large partnerships at the partnership level. If push out of adjustments is a reasonable solution, then adjustments should be pushed out to reviewed-year partners in the reviewed year. This push out may require appropriate modification of the statute of limitations for those reviewed-year partners. The statute of limitations for direct and indirect reviewed-year partners could be extended to expire no later than a defined period after the partner has filed an amended return reporting all partnership adjustments and has paid the tax stated on the return. Tax liability should not be elective, which is the case under the push out rules.

²⁵ Some partnerships might prefer the new partnership audit rules if the imputed underpayment were computed more reasonably. I believe, however, that few partnerships would elect consolidated audit procedures if they had the choice to avoid consolidated audits. The prospect of the inability of the Internal Revenue Service effectively to audit partnerships outside of consolidated partnership audit procedures likely will convince most of those partnerships that are permitted to elect out of the new partnership audit rules to do so. Small partnerships will look to electing out of the new partnership audit rules as providing practical immunity to effective Internal Revenue Service audit.

The scope of partnerships electing out of new partnership audit rules will depend to a significant extent on the outcome of regulations under the new partnership audit rules. The vital question is what partners are qualified partners that do not disqualify the partnership from electing out of the new partnership audit rules. I understand that various comments have been submitted advocating that both partnerships (including tiered partnerships) and trusts (both tax-regarded trusts and grantor trusts) should be permitted as qualifying partners. If these groups are approved as qualifying partners of a partnership that elects out of the new partnership audit rules, I believe that most partnerships with 100 or fewer partners will elect out of the new audit regime. Many partnerships will not be permitted to elect out of the new partnership audit rules if partnerships and trusts are not permitted partners.

²⁶ A two-person partnership the only partners of which are married spouses would not seem to present the problems requiring a consolidated audit regime.

²⁷ This would operate in the same manner as partnership adjustments under TEFRA.

²⁸ The direct or indirect partner of the audited partnership would have an unlimited statute of limitations if he failed to amend his return to reflect partnership adjustments and to pay the tax indicated on the return. This should eliminate statute of limitations concerns. The extended statute of limitations would apply only to tax on partnership audit adjustments.

²⁹ Some who have commented on the current new partnership audit rules have suggested procedures for informing the Internal Revenue Service of partner tax status. These proposals often suggest reliance on partner affidavits of partner tax status without further inquiry by the Internal Revenue Service. I am not familiar with any proposals that have dealt adequately with positive confirmation of partner tax status. Additionally, determining notional tax based on partner tax status can be complicated when partnership interests are held through tiers of partnerships. I believe that it will prove difficult to determine and to verify partner status for many large partnerships if partner status is considered in determining partnership tax liability.

³⁰ I.R.C. § 6231(a)(1)(B).

³¹ I.R.C. § 6221(b).

³² I.R.C. § 6221.

³³ I.R.C. § 6221(a).

³⁴See, e.g., United States v. Woods, 571 U.S. 11 (2013); Greenwald v. Commissioner, 142 T.C. 308, 315 (2014); Domulewcz v. Commissioner, 129 T.C. 11 (2007), aff'd in part, remanded in part sub nom. Desmet v. Commissioner, 581 F.3d 297 (6th Cir. 2009); Thompson v. Commissioner, 729 F.3d 869 (8th Cir. 2013); Thompson v. Commissioner, 821 F.3d 1008 (8th Cir. 2016); McNeill v. United States, No. 15-8095 (10th Cir. 2016); RJT Investments X v. Commissioner, 491 F.3d 732 (8th Cir. 2007); Tigers Eye Trading LLC v. Commissioner, 138 T.C. 67 (2012); Alpha I LP v. United States, 84 Fed. CI. 209 (2008), rev'd, 682 F.3d 1009 (Fed. Cir. 2012); Grigoraci v. Commissioner, T.C. Memo. 2002-202; Petaluma FX Partners LLC v. Commissioner, 591 F3d 649 (DC Cir. 2010), aff'g in part, rev'g in part and remanding on penalty issues, 131 TC 84 (2008), on remand, 135 TC 581 (2010); 591 F.3d 649, 653 (D.C. Cir. 2010); Bemont Investments., LLC v. United States, 679 F.3d 339 (5th Cir. 2012); Blonien v. Commissioner, 118 T.C. 541 (2002); Estate of Quick v. Commissioner, 110 T.C. 172 (1998).

³⁵ I.R.C. § 705.

³⁶See, e.g., AD Global Fund, LLC v. United States, 481 F.3d 1351 (Fed. Cir. 2007); Rhone-Poulenc Surfactants & Specialties LP v. Commissioner, 114T.C. 533 (2000).

³⁷ I.R.C. § 6235(a)(1).

³⁸ I.R.C. § 6235(a)(2).

³⁹ I.R.C. § 6235(a)(3).

⁴⁰ See Treasury Inspector General for Tax Administration, "Trends in Compliance Activities Through Fiscal Year 2015," Reference Number: 2016-30-073 (September 8, 2015). One in every 196 partnership returns was examined in fiscal year 2015.

⁴¹ Many of the current problems of the Internal Revenue Service audits of partnerships perhaps can be traced to inadequate compensation of field examiners and inadequate funding of audits, training, and support.