Field Service Addresses Procedural Partnership Issues

2. Is a "no change" FPAA valid?

3. Is a net operating loss ("NOL") of a TEFRA partnership a partnership item, affected item or nonpartnership item? is the carryforward or carryback of the loss to other years a partnership item, affected item or nonpartnership item?

4. Are Forms 870-L(AD) and 870-S(AD) "determinations" for purposes of mitigation under I.R.C. section 1313?

5. Do the taxpayers in this case meet the "related party" requirement under I.R.C. section 1313?

6. Do certain statements made by an Appeals officer in a Form 870-S(AD) and 870-L(AD) constitute oral agreements that should be considered binding on the Service under the doctrine of equitable estoppel?

2. Yes, it is valid. The issuance of a no change FPAA is a determination that the Commissioner accepts the return as filed and such an FPAA meets the requirements of I.R.C. section 6223(a).

3. NOLs of a TEFRA partnership are partnership items under Temp. Treas. Reg. section 301.6231(a)(2)-1T since they are an item of partnership loss that the partnership is required to take into account for the partnership's taxable year. The carryforward and carryback amounts of the NOLs are affected items which must be adjusted pursuant to the TEFRA provisions. Assessment of tax attributable to the NOLs is subject to the I.R.C. section 6229 period of limitations.

4. No, Forms 870-L(AD) and 870-S(AD) are not "determinations" for purposes of I.R.C. S 1313 since they are not a decision of the court, a closing agreement, or a disposition of a claim for refund.

5. Yes, the taxpayers will meet the definition of "related party" for purposes of I.R.C. section 1313(c) because the taxpayers (who are suffering from a disallowance) are partners with the taxpayers who suffered the initial disallowance.

6. No, the doctrine of equitable estoppel would not apply under the facts presented since there was no detrimental reliance by the taxpayers.

[5] The claim for mitigation arises out of the Service's disallowance of worthless debt deductions to a related partnership and two related S corporations of * * * arising out of the same transaction. These related entities are * * * a TEFRA partnership, * * * a TEFRA S corporation, and * * * a TEFRA S corporation. Based on the disallowance to these related entities, * * * should have obtained a tax benefit because the deduction was properly attributable to * * * in a barred year. This resulted is a double disallowance of a deduction. It is in response to this double disallowance that the taxpayers filed the amended return. Further, a potential claim of equitable estoppel may be present based on statements made by an Appeals Officer concerning the Form 870-L(AD) and the Form 870-S(AD). In these forms, there was no discussion of the disallowance of the expense to the related partnership and S corporations. However, in the Officer's supporting statement, which was not part of the 870's, the Officer made reference to the worthless notes. The taxpayers have stated that they only agreed to adjustments to these related entities because the Officer agreed to allow the deduction to * * * No written correspondence has been located which indicate that the Service agreed to this proposal.

[6] The taxpayers have filed suit in district court, presumably under I.R.C. section 6228, from the disallowance of the AAR. Currently, Exam needs to issue a deficiency notice * * * by * * * in order to deny the increased loss claimed by the taxpayer in a carryover year.

[7] I.R.C. section 6227 establishes a procedure to allow a refund claim for partnership items by the filing of an AAR at the partnership level. Under this provision, a TMP may file an AAR for the entire partnership. Also, a partner may file an AAR on his own behalf. I.R.C. section 6228 provides rules for judicial review where AARs are not allowed in full by the Service.

[8] There are time limits on when any partner may file an AAR. Under I.R.C. section 6227(a)(1), a partner must file an AAR within 3 years after the partnership return was filed or the last day for filing such return, whichever is later. The date for filing the return is determined without regard to extensions. Further, under I.R.C. section 6227(a)(2), a partner may not file an AAR after a notice of FPAA is mailed to the TMP for the same taxable year to which the AAR relates. There is no provision for extending the period for filing an AAR, by agreement or otherwise.

[9] The partnership's * * * calendar year is at issue. The partnership filed the partnership return for this year, on * * * The return was due to be filed, without regard to extensions, on * * * Therefore, any AAR filed on behalf of the partnership by the TMP must have been filed prior to * * * The AAR in this case was not filed until * * * well after the expiration of the I.R.C. section 6227 filing period. Furthermore, an FPAA was issued to the TMP of the partnership by the Service for the * * * year on * * * Accordingly, the AAR is also untimely since it was not filed prior to the issuance of the FPAA to the TMP for the * * * year.

[10] As was stated in the incoming memorandum, the extension of the I.R.C. section 6229 statute of limitations for assessment does not extend the period for filing an AAR. Also, there is no TEFRA equivalent of I.R.C. section 6511(c) where extension of the I.R.C. section 6501 statute accordingly extends the refund statue.

[11] The taxpayer attempts to read I.R.C. section 6227(a) in a manner that concludes that the AAR must be filed before the later of: (1) three years after the return is filed or due to be filed or (2) the issuance of the FPAA to the TMP. The taxpayer would then contend that since the FPAA in this case was invalid./1/ the AAR was timely since it was filed prior to the issuance of any FPAA by the Service for the year to which the AAR relates.

[12] The taxpayer's contention lacks merit for three reasons. First, the statute should not be read disjunctively as the taxpayer asserts. In other words, I.R.C. section 6227(a)(1) and (a)(2) conjunctively establishes two separate time requirements on filing AARs by a partner or TMP.

[13] Second, under the logical extreme of the taxpayers argument, I.R.C. section 6227(a)(1) would be written out of the Code since a partner could file an AAR at any time so long as the Service had not yet issued an FPAA to the partnership.

[14] Third, we believe that I.R.C. section 6227(a) is reasonably read to provide for administrative remedies to partners generally where the Service is not conducting a proceeding. See I.R.C. section 6227(a)(2) (no AAR after FPAA mailed to TMP); I.R.C. section 6227(a)(2)(B) (no suit with respect to disallowed AAR may be filed after NBAP sent to partnership for year at issue). In any event, I.R.C. section 6227(a), as a time limitation on refund claims against the government, should not be construed in a manner that would extend the period beyond that which Congress intended. See United States v. Dalm, 110 S. Ct. 1361, 1366 (1990). (strictly interprets time limitations I.R.C. sections 7422 and 6511.)

Issue 2

[15] The taxpayer contends that the no change FPAA that was issued to the partnership for * * * was invalid since it made no final determination of an adjustment. Therefore, the taxpayer would use this fact to add to his argument above that an AAR may be filed at any time before the issuance of an FPAA to the TMP. We have already stated that we disagree with the taxpayer's interpretation of I.R.C. section 6227(a). Although it is true that an FPAA must make a determination, Clovis I v. Commissioner, 88 T.C. 980 (1987), the issuance of a no change FPAA is a determination that the Commissioner accepts the partnership return as filed and such an FPAA meets the requirements of I.R.C. section 6223(a). University Heights at Hamilton v. Commissioner, 97 T.C. 278, 282 (1991). In fact, the Tax Court has specifically held that "respondent may choose to issue a 'no change' [FPAA] to prevent a [partner] from later filing an administrative adjustment request with respect to the [partnership] items in question." Id. at 282. Therefore, we disagree with the taxpayers contention that the FPAA is invalid.

Issue 3

[16] Under TEFRA, a partnership item is defined as any item required to be taken into account for the partnership's taxable year under any provision of subtitle A to the extent regulations prescribed by the Secretary provide that such item is more appropriately determined at the partnership level than at the partner level. I.R.C. section 6231(a)(3). Losses incurred by a partnership are clearly partnership items. An affected item is any item affected by a partnership item. I.R.C. section 6231(a)(5). Because the existence and amount of a NOL carryback or carryforward are affected by the existence and amount of a partnership item, i.e., a partnership loss, a NOL carryback or carryforward is an affected item.

[17] This characterization is supported by the Tax Court's analysis of an investment tax credit loss carryback in Maxwell v. Commissioner, 87 T.C. 783 (1986): ". . . the amount of credit to be carried back is not a 'partnership' item because a partnership does not take into account any carryback for any taxable year. Rather, the carryback is peculiar to each partner's own tax posture. The carryback is, however, an 'affected item' since its existence or amount is 'affected by' the investment tax credit that is a partnership item. Sec. 6231(a)(5)." Maxwell at 790. Similarly, a carryforward is not taken into account by the partnership but is instead an item unique to each partner and an item that is linked to a partnership item, a partnership loss.

[18] It is important to note that the statutory definition of an affected item is not limited to an affected item that arises in the same year as the partnership item to which it is connected. Instead, the definition extends to any item that is affected by a partnership item, regardless of the year in which the affected item is reported. Accordingly, the period for assessment of tax resulting from an affected item is generally governed by the period of assessment for the partnership item to which it is attributable. I.R.C. section 6229(a). In this instance, the portion of the net operating loss carryback or carryforward attributable to the partnership loss is properly classified as affected items with respect to the partnership's tax year, the year in which the loss giving rise to the carryback or carryforward arose. Under section 6229(a), the Service has three years from the date of filing the partnership return to assess any tax attributable to partnership items or affected items, unless the statute is extended under I.R.C. section 6229(b).

[19] In this case, the I.R.C. section 6229(a) period of limitations expired on * * * one year after the default of the FPAA. Under I.R.C. section 6230(d)(1), no credit or refund of any overpayment attributable to these affected items in carryback or carryforward years is allowed if the I.R.C. section 6229(a) period has expired. Therefore, credit or refund of these affected items may not occur even if the carryforward or carryback year is otherwise open with respect to the partners individual tax liability under I.R.C. section 6501.

Issue 4

[20] The meaning of "determination" for the purposes of mitigation is spelled out in I.R.C. section 1313(a). Clearly, Forms 870-L(AD) and 870-S(AD) are neither decisions of a court, closing agreements nor dispositions of a claim for refund. The only possible ambiguity arises from section 1313(a)(4) which provides that an agreement for purposes of the mitigation statutes, under regulations to be prescribed by the Secretary, will constitute a determination. The form customarily used for this is Form 2259, Agreement as Determination Pursuant to Section 1313(a)(4) of the Internal Revenue Code, not a Form 870 (or any variant). To constitute such an agreement, a Form 870-L(AD) or 870-S(AD) would have to meet the requirements of Treas. Reg. section 1.1313(a)-4. Among other things, this regulation requires that the heading of the agreement state that it is an agreement pursuant to section 1313(a)(4), and we doubt that anyone would have altered the Forms at issue in such a manner. Accordingly, we conclude that the Forms 870-L(AD) and 870-S(AD) are almost certainly not "determinations" within the meaning of section 1313(a)(4) and therefore "mitigation" relief is unavailable.

ISSUE 5

[21] The definition of "related party" for the purposes of mitigation is contained in section 1313(c). We believe that the taxpayers here would meet the definition of related party. Despite the fact that the adjustments here are made at the partnership level, they do flow through to the individual partners. Thus, the denial of an expense to * * * on the basis that it is properly attributable to * * * becomes the denial of a deduction to * * * individual partners. When that same expense is denied to * * * and thus to * * * partners, who are the same individuals as * * * partners, it seems to us that a double disallowance of a deduction has occurred. The taxpayers who are suffering this second disallowance are either the same, or partners (because of differing partnership shares) of, the taxpayers who suffered the initial disallowance. Section 1313(c)(6) includes partners as "related taxpayers." Accordingly, we conclude that the "related party" rule does not prevent the applicability of mitigation to this situation.

[22] We also note that the mitigation statutes are applicable to correct any error "prevented by the operation of any law, or any rule of law," other than the mitigation statutes themselves, and compromises. I.R.C. section 1311(a). Thus, the fact that we are dealing with TEFRA procedures rather than ordinary statutes of limitations does not restrict the applicability of mitigation.

[23] Finally, I.R.C. section 1314(b) requires that the taxpayer file its claim within one year of the determination in order to take advantage of mitigation. While, as we have observed above, the Forms 870-L(AD) and 870-S(AD) are not determinations, even if they were, a "claim for refund," or in this case, the AAR, would have had to have been filed within one year of the determination. It is not clear from the facts provided whether this was done, but you may wish to consider this as an alternative basis for rejecting the assertion that mitigation applies.

ISSUE 6

[24] In regard to the issue of whether the doctrine of equitable estoppel could apply against the government in this case, we believe based on the facts available to us that it would not apply. The Tax Court in Estate of Emerson v. Commissioner, 67 T.C. 612 (1977), stated that estoppel should be applied against the government only with utmost caution. The court then listed the elements necessary to establish equitable estoppel: (1) There must be a false statement or wrongful misleading silence; (2) the error must be one of fact; (3) the person asserting estoppel must be ignorant of the true facts; and (4) that person must be adversely affected by the false statement (also known as detrimental reliance). Id. at 617-18.

[25] Under this test, the taxpayers will have a very difficult time meeting the fourth standard, detrimental reliance. For one thing, * * * apparently did not follow the agreement suggested in the supporting statement either. Based on the facts given us, it appears that * * * deducted the losses in * * * as ordinary rather than as capital, although the suggested agreement in the supporting statement called for the losses to be treated as capital. In addition, there can be no detrimental reliance if the government agent making the alleged false statement did not have authority to act in that context or manner. See, e.g., Bay Sound Transportation Co. v. United States, 410 F.2d 505 (5th Cir. 1969). An Appeals Officer has the authority to make settlements with taxpayers, but they must be in writing and in certain formats (closing agreements and, by administrative policy, forms 870-AD). Oral statements by Appeals officers do not constitute legally binding agreements with the government. (It is our understanding that the supporting statement was not sent to the taxpayers.) The Supreme Court has stated that citizens are presumed to know the law and cannot rely on the conduct of officials which is contrary. Federal Crop Insurance Corp. v. Merrill, 332 U.S. 380 (1947). Applying that rationale to this case, the taxpayers may not rely on any oral representations by the Appeals Officer since legally he could only bind the government by the use of a closing agreement or a Form 870-AD. One other fact to consider in this context is that this alleged agreement occurred while settling the tax liability of * * * a separate entity from * * *. It would be difficult for the taxpayers to state that they relied on representations in regard to one taxpayer in the midst of settlement discussions for a separate taxpayer.

[26] This document may include confidential information subject to the attorney-client and deliberative process privileges, and may also have been prepared in anticipation of litigation. This document should not be disclosed to anyone outside the IRS, including the taxpayer(s) involved, and its use within the IRS should be limited to those with a need to review the document in relation to the subject matter or case discussed herein. This document is also tax information of the instant taxpayer which is subject to section 6103.

[27] If you should have any questions, please contact Keith Troxell at FTS 202-566-3233.