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Who Qualifies as a Partner under the New BBA Regulations

This is the first of a series of deeper dives into the newly finalized partnership audit regulations that cover who can elect out of the new centralized partnership audit regime. We have previously blogged about the regulations here.

In order for a partnership to elect out of the new centralized partnership audit regime (the “BBA regime”), there are several hurdles to overcome. The first of which is that the partnership wishing to elect out must be able to satisfy a two part test:  It must have 100 or fewer partners and those partners must be eligible partners

First, the partnership must have 100 or fewer partners. Treasury Regulation 301.6221(b)-1(b)(1)(i) states that a partnership has 100 or fewer partners if, under section 6031(b), it is required to issue 100 or fewer statements.

Who gets a statement?

While these rules seem straight forward, they could become problematic for partnerships with S corporations as partners.   Under new section 6221(b)(2)(A)(ii), the statements required to be furnished by an S Corp under section 6037(b) for its taxable year ending with or within the partnership’s taxable year will count towards the 100 or fewer partner threshold.  This is in addition to the statement that the S Corp partner received from the partnership.  The partnership must also provide the names and taxpayer identification numbers of each person to whom the S Corppartner was required to issue a statement under section 6037(b).  Thus, an S Corp partner and its shareholders will all count towards the 100 or fewer requirement.

A quick example:

A partnership has 50 partners, which are as follows:

  • 49 unmarried individuals
  • 1 S Corp which has 51 shareholders

At first blush, it would seem that this partnership qualifies. It has only 50 partners after all.  However, under the new rules,  the total number of partners for the 100-partner rule is 101 (49 individuals + 1 S Corp + 51 S Corp shareholders) and the partnership cannot elect out of the BBA regime.

So, while you may think you are under the 100 or fewer limit, you will want to make sure you tally and include the number of shareholders your S Corp partner has if you are attempting to elect out of the BBA regime. The presence of a single S Corp partner may defeat the election.

Who is an eligible partner?

Second, each of those partners must be an eligible partner.   Treasury Regulation 301.6221(b)-1(b)(3) describes the types of partners that are “eligible partners” as individuals, C corporations, foreign entities that would be a C corporation if domestic, S Corp, and estates of deceased partners. Partnerships, trusts, disregarded entities, nominees or other similar persons that hold an interest on behalf of another person, and estates other than the estate of a deceased partner are not considered eligible partners under the rules.   Drawing the rules so narrowly promotes the IRS’s goal of pushing as many partnerships as possible into the new regime.

To recap, when weighing the decision to elect out, be careful to ensure that your partnership has 100 or fewer partners (being mindful of the S Corp trap mentioned above), and that each of the partners are eligible partners under the regulations.

Lurking in the wings, however, is the potential for the IRS to use judicial doctrines to recognize constructive or de facto partners or partnerships.  We will discuss this other pitfall in greater detail next week.

IRS Issues Final Regulations on BBA Partnership Audit Regime

The IRS has issued final regulations regarding the new centralized partnership audit regime, referred to as the BBA regime. The regulations are effective as of yesterday, January 2, 2018.. We have blogged about the new rules here and here.

These regulations implement the rules for electing out of the new audit rules. Here, we address how the regulations were updated from the proposed regulations issued over the summer.  While it acknowledged that “the new rules are a significant change in the way partnerships have been traditionally audited,” the IRS rejected most of the suggestions made during the notice and comment period. It noted its inexperience in the operation of these new rules as the reason behind its rejecting most of the suggestions, but consistently left the door open for further rulemaking.  Unfortunately, this does not provide certainty for taxpayers and means in the near future taxpayers must carefully review the rules to ensure they are compliant.

This is especially true for taxpayers who may wish elect out of the BBA regime. A taxpayer wishing to elect out of the BBA regime may do so if 1) it has 100 or fewer partners, and 2) all partners are eligible partners.

The 100-or-fewer partner rule

Under section 6221, a partnership is eligible to elect out of the BBA rules if it has 100 or fewer partners. Under now-final Treas. Reg. 301.6221(b)-1(b)(1)(i), a partnership has 100 or fewer partners if it is required to furnish 100 or fewer statements under section 6031(b), which generally requires a partnership to furnish a statement to each person that is a partner in the partnership during the partnership’s taxable year. This is a key issue because a partnership that fails to elect out of the regime or a partnership that attempts to elect out of it but cannot will find itself unexpectedly bound by these new rules.

Notice Requirement

Several commentators had suggested that the IRS exclude pass-through entities or disregarded entities in determining whether a partnership meets the 100-partnership threshold. The IRS rejected those suggestions, noting that under section 6031, notice must be provided to each partner, regardless of whether the partner is a disregarded entity or a pass-through.

The IRS also rejected suggestions that it establish a pre-filing procedure to address qualification issues. It did, however, leave open the door to further regulations on this issue, noting that it “may reconsider whether a pre-filing procedure would be helpful after gaining experience with the election out procedures.” It also left open the door for further regulations on the issue of how a partnership may elect out of the regime if it is found to be a constructive partnership or a de facto partnership. Under the regulations, if such a partnership exists and it does not file an election on a timely filed return for that taxable year, it will be bound by the new BBA rules.

Eligible Partner Requirement

Treasury Regulation 301.6221(b)-1(b)(3) describes the types of partners that are “eligible partners” for the 100-or-fewer rule. Partnerships, trusts, disregarded entities, nominees or other similar persons that hold an interest on behalf of another person, and estates other than the estate of a deceased partner are not considered eligible partners under the rules.

Commentators had requested that the IRS expand the definition of eligible partners to include partnerships, disregarded entities, trusts, individual retirement accounts, nominees , qualified pension plans, profit sharing plans , and stock bonus plans. The IRS rejected these suggestions and did not expand the definition of eligible partners because in its view “the interests of efficient tax administration outweigh” any additional administrative burdens created by a narrower definition. It appears the IRS was concerned about allowing more partnerships to elect out of the new regime, because it would require deficiency proceedings for each of the partners in such partnerships and result in substantially more audits.

Making the election

The IRS also addressed comments it had received regarding the timing for making the election and how it may be revoked. It left unchanged, for example, a partnership would be required to obtain the consent of the IRS to revoke an election out. It also did not address whether the election may be timely made on amended returns, stating that other areas of the code address this issue.

Observations

In addressing these comments, the IRS has sent a strong signal that it favors the new BBA regime and may take an aggressive stance against those partnerships that attempt to elect out of it. It also broadcasts to the tax community that it cannot at this stage address all the issues that may arise under the new regime through regulations because it lacks experience with how these rules will work in the real world. This leave taxpayers in a bind because the IRS is uncertain how these rules will work in practice but is likely to favor one particular outcome.

It is important that partnerships plan carefully and particularly if you are thinking of opting out of the BBA regime to ensure you are ready if the IRS decides to challenge that decision.

If you have any questions about this post or how you can prepare for these rule changes, please contact Jeff Erney at (202) 496-7511 or jeffry.erney@dentons.com

Substantial Changes to Partnership Tax Audit Procedures will Severely Impact Partner Liability and Rights Before the IRS

Does your client own an interest in a partnership or an entity treated as a partnership for US tax purposes?  If so, you better take notice because the new partnership tax audit rules are making drastic changes as of January 1, 2018.  The new rules, known as “BBA,” will administer a tax deficiency at  the partnership level, unless certain elections are made.  These rules are a significant departure from the old rules, known as “TEFRA”, which administered a tax deficiency at the individual partner level.  All partnerships will need to amend their respective partnership agreements to take the BBA changes into consideration.  What should a partnership or its partners be concerned about?

Below is a non-exhaustive list of some of the major concerns of these new procedures:

Have you chosen a Partnership Representative (“PR”) under the BBA rules? If so, have you set forth the limitations and obligations of the PR?

  • Once the BBA Rules are effective, all authority over the partnership tax audit lies with the PR
  • The BBA procedures give the PR statutory authority to bind all partners with respect to all actions taken by the partnership in the BBA administrative proceeding and in any judicial proceeding
  • Since the PR is the exclusive party to act on behalf of the partnership, the PR may also, in effect, bind all partners to extensions of the statute of limitations, settlements and available elections

Does your existing partnership agreement require the partnership or the PR to provide notice to all partners of a IRS audit?

  • The BBA procedures abolish all partner-level notices of IRS actions that existed under TEFRA
  • Unlike the TEFRA rules, under BBA there is no affirmative obligation for the Internal Revenue Service, the partnership or the PR to send a notice of an IRS audit to each partner
  • Without revising the partnership agreement, a partnership audit could occur and be resolved without the partners’ knowledge

Does your existing partnership agreement contemplate who will be responsible for tax deficiencies?

  • Under the BBA procedures, unless the PR takes certain actions, tax deficiencies are assessed against the partnership in the year the controversy is resolved (known as the adjustment year) and not in the year which generated the tax deficiency (known as the reviewed year)
  • In effect, the economic burden of a tax deficiency could be borne by partners who had no interest in the partnership when the income/deduction was generated

Does your existing partnership agreement provide for opting-out of the BBA procedures?  If so, does the PR have an affirmative obligation to opt-out?

  • The BBA procedures allow smaller partnerships (with fewer than 100 partners) to elect to opt-out of the BBA rules and have the audit be administered at the partner rather than partnership level
  • Do you desire to have the audit administered at the partner level?  Are you concerned about the IRS expanding the audit to other parts of your business?
  • Are you willing to continue to be responsible for tax deficiencies for the years in which you held an interest in a partnership, even if you later sell such interest.

Does your existing partnership agreement provide for pushing-out tax deficiencies to the reviewed year partners?

  • The push-out election allows the partnership to pass on an adjustment to a former partner without providing them an opportunity to comment, contest, or even receive notice of the adjustment
  • If you exit a partnership are you willing to leave this decision up to the current PR?
  • As a former partner would you desire some control over these decision for which you are ultimately responsible?

The above items address some of the questions partnerships and partners should be thinking about before the BBA procedures go into effect on January 1, 2018.  It is recommended that all partnerships work with their tax counsel to perform a thoughtful and thorough review of their partnership agreements.  The only way to control the results of these new procedures is to be pro-active now before the rules go into effect.

Please contact Jeff Erney at jeffry.erney@dentons.com or Sunny Dhaliwal at sunny.dhaliwal@dentons.com

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IRS Urges Partnerships to Amend Partnership Agreements To Address Expanded Role of Partnership Representatives

The new partnership audit regime, enacted as part of the Bipartisan Budget Act of 2015 (“BBA”), allows the IRS to assess and collect  unpaid tax at the entity level, rather than from individual partners.   The BBA is effective for tax years after 2017 and replaces the Tax Equity and Fiscal Responsibility Act (“TEFRA”).  Under TEFRA, a partnership designates one of its partners as the “tax matters partner” (“TMP”) to act for the entity in proceedings with the IRS.  Instead, in the BBA regime, that person is called the “partnership representative” (“PR”) and has far greater authority than a TMP.  It is imperative that all partnerships understand the changes that are coming and prepare accordingly.

Most significantly, the PR is the exclusive point of contact with the IRS and has the sole responsibility to bind both the partnership and all of the partners to his or her actions.   At a conference on June 16, Brendan O’Dell, an attorney-adviser in the Treasury Department’s Office of Tax Policy, emphasized the significance of understanding the difference between the TMP and PR.

Under TEFRA, the TMP was required to be a partner, and was subject to numerous obligations to other partners with regards to the partnership’s interactions with IRS. Under TEFRA, all partners other than the TMP had significant rights during an audit, including notification rights, the right to participate in proceedings and contradict the actions taken by the TMP.  During the audit and administrative appeals, the TMP did not have the authority to bind the other partners.

Conversely, under the BBA regime, the PR is not required to be a partner with “skin in the game” but rather can be any person, including a non-partner, provided they have a substantial presence in the U.S. Moreover, the PR has sole authority to bind the partnership, and all partners and the partnership are bound by the actions of the PR and any final decision during all stages of the proceeding (audit, appeals and litigation).  This includes the power to bind the partnership and all partners to extensions of the statute of limitations and available elections.  Other partners no longer have a statutory right to notice of, or to participate in, the partnership-level audit proceeding.  Moreover, the decisions of the PR can economically impact the partnership, current partners, and former partners.  For example, a PR has the ability to unilaterally decide whether an audit adjustment must be borne by the partnership or by the partners.

Thus, this expanded authority granted to the PR is likely to lead to disputes, and potentially litigation, between partners and the PR. According to Mr. O’Dell, in the event of such a dispute, the IRS will not get involved and “will still treat the actions of the partnership representative as binding on the partnership and to those partners.”  In order to alleviate such issues, the IRS emphasized addressing the authority of the PR in the partnership agreement before the BBA regime becomes effective, as many, but not all, of the powers granted to the PR under BBA may be circumscribed by the partnership agreement.  These issues, thus, “put a lot of pressure on the front end for drafting agreements” and adding in adequate protections, O’Dell said.

The IRS has made clear that once the new partnership audit rules are effective, it will exclusively communicate with and seek consent from the PR. Thus, any protection or notice afforded to partners, former partners, and the partnership must come from the partnership agreement.

We highly recommend that all partnerships review and revise their partnership agreements before the BBA takes effect (years after December 31, 2017) in order to address the changes of the new law.  Contact Jeff Erney for questions about this post or how a partnership can best structure its partnership agreement now before the BBA takes effect.  Jeffry.Erney@dentons.com

Partnership Proposed Regulations Re-Released

Today, the prior January 2017 partnership audit proposed regulations were re-released.  A pubic hearing is scheduled for September 18th with comments due by August 14th.  We will monitor the commentaries as they are filed and post them HERE.

Partnership Proposed Regulations Issued – New Audit Rules For Partnerships

The IRS has issued Proposed Regulations addressing the Centralized Partnership Audit Regime.  Back in November of 2015, statutory changes were enacted to replace the traditional audit rules for partnerships and replacing them with a new centralized partnership audit which, in most instances, places the tax liability at the partnership level rather than at the partner level.

Partnerships are pass through entities for US tax purposes and items of income, expense and credits are taken on the personal income tax returns of the individual partners.  Under the new statute, an audit of the partnership could result in additional taxes being owed at the partnership level rather than flowing through to the individual partners.

“It has taken over a year for the proposed regulations to be issued,” said James N. Mastracchio, Co-Chair of Denton’s Tax Controversy Practice, “and that is a good thing.”  The proposed regulations are “extensive” and “cover a number of issues that we face as advisors to our clients.” added Mastracchio.

There will be a long comment period with the ultimate effective date of the regulations to take place in early 2018.

IRS on Alert of Partners Attempting to Slip Through the Cracks Before New Partnership Audit Regime Takes Effect

Despite the significant uncertainty surrounding the new partnership audit regime implemented under the 2015 Bipartisan Budget Act (Pub. L. No. 114-74) (“BBA”), the IRS expressed its intention to watch for partners exiting partnerships to avoid tax, during a District of Columbia Bar event on June 23, 2016.

The new rules, effective in 2018, require partnership-level audits of large partnerships, and make it simpler for IRS examiners to undertake an audit because the system will be able to calculate and collect adjustments at the partnership level.   Since there can be several years between when a return is filed and when an audit adjustment is levied, however, it leads to the possibility that partners could sell their interest before the commencement of an audit and avoid adjustments that may have been attributable to them.

Although the panel suggested amending partnership agreements so that partners who sell their interests would still be on the hook for any tax due later, it is unclear whether partners intending on exiting partnerships in light of the new rules would agree to such an amendment. Further, because of the vast uncertainty regarding various areas of the partnership audit rules, most partnerships are not amending their agreements at this time.

The IRS intends to issue regulations with an effective date of January 1, 2018, which would address the scope of the rules and how statute of limitations are applied in this context.   Many areas of uncertainty with the new rules, however, have not yet been addressed by the IRS.

One major area of uncertainty revolves around the “partnership representative,” which is an expanded version of the “tax matters partner” role under prior law. The partnership representative, which is not required to be a partner, will have sole authority to act on behalf of the partnership in an audit proceeding, and will bind both the partnership and the partners by its actions in the audit. The IRS no longer will be required to notify partners of partnership audit proceedings or adjustments, and partners will be bound by determinations made at the partnership level.

It appears that partners neither will have rights to participate in partnership audits or related judicial proceedings, nor standing to bring a judicial action if the partnership representative does not challenge an assessment. Accordingly, the partnership representative is vested with significant responsibility and power under the BBA, and would likely need to devote the majority of his or her time addressing these issues. This raises the possibility that certain individuals might be compensated for this role, and the role might be limited by the provisions of the partnership agreement. At the very least, there should be provisions in place to have a degree of control over elections made at the entity level, or final determinations at the entity level.

Another noteworthy area of concern is how the new rules would impact State tax filings. States have not yet reacted to the new rules, and thus, partners may be reluctant to make amendments until they are aware of both the state and federal implications of the audit rules. The IRS expects to issue guidance in stages to alleviate some of the concerns expressed by practitioners and allow them to move forward with amendments to partnership agreements.

Notwithstanding the uncertainty, it is clear that the IRS is watching for those seeking to take advantage of the new regime to avoid tax.

SCOTUS Struggles with TEFRA Jurisdiction: Oral Arguments in United States v. Woods

On October 9, 2013, the U.S. Supreme Court heard oral arguments in United States v. Woods, 471 Fed. Appx. 320 (5th Cir. 2012), cert. granted, 133 S. Ct. 1632 (Mar. 25, 2013) (No. 12-562).  The original question presented to the Court by petitioner was whether the 40% gross valuation misstatement penalty applies to transactions that lack economic substance.  When the Court granted the certiorari petition, however, it expressly asked the parties to brief and argue the additional question of whether the district court had jurisdiction in the case under I.R.C. section 6226 to consider the substantial valuation misstatement penalty at issue.  And it was this jurisdictional question that dominated oral argument before the Court.

Both the parties and the Court focused on the statutory language granting a court jurisdiction at the partnership level.  Specifically, I.R.C. section 6226(f) grants a court jurisdiction to determine “all partnership items . . . and the applicability of any penalty . . . which relates to an adjustment to a partnership item.”  Justice Kagan attempted to narrow the issue to whether the penalty was directly or indirectly “related to” a partnership item, and accused both parties of adding something to the statute: the taxpayer requiring the penalty “directly” relate, and the government asking the Court to read the statute to include any penalties “indirectly” relating to a partnership item.  Counsel for the taxpayer-Respondent explained that Congress separately defined an “affected item”, which includes outside basis, and could have explicitly expanded the statute to include penalties related to the partnership item and affected items, but it did not.  Respondent later reminded the Court that tax penalties are strictly construed in favor of the taxpayer and that any ambiguity must be resolved in the taxpayer’s favor.

On the merits, Respondent’s counsel focused on Congress’ intent and the context of the statute, arguing that the statute deals with a different situation than the one before the Court: the statute addresses a misstatement of value, not an entirely disallowed transaction.  Respondent explained the distinction by analogy, “if I donate a painting that I say that is worth $1 million to a church and I put that on my return, but, in fact, it turns out that I didn’t donate the painting, I may have committed a fraud . . . but I haven’t made a valuation misstatement, nor have I misstated my basis.”  As multiple Justices recognized, Congress enacted a new statute in 2010 to directly address that problem, in a noneconomic substance penalty.  See I.R.C. § 7701(o).  Both parties before the Court agreed that the noneconomic substance penalty would apply to the current case had that penalty been on the books at the time of the transaction.

Neither advocate had much time to argue the merits of the case, and, interestingly, the Justices asked few questions during those parts of the arguments.  On the other hand, questions from the bench commanded the jurisdictional arguments.  While tax practitioners may be hoping for a decisive answer to the question on the merits, it is possible the Court will issue a more narrow ruling that it lacks jurisdiction in this case to answer that question.  Of course, predictions based on oral arguments alone are like writing in the wind and the running water.  It is difficult to predict whether the Justices will rule on the merits of the case, much less what that ruling may be.

Adam Pierson, a member of Dentons’ Litigation practice, co-authored this article.

Jurisdiction to Dispute Penalties: Partner v. Partnership-Level Proceedings

The U.S. Supreme Court recently heard oral arguments in United States v. Woods, 471 Fed. Appx. 320 (5th Cir. 2012), cert. granted, 133 S. Ct. 1632 (Mar. 25, 2013) (No. 12-562).  In addition to the heavily-disputed circuit split regarding the gross misstatement penalties, the Court may rule on a complicated jurisdictional question implicated in TEFRA partnership proceedings.  Although neither party nor the lower courts raised the issue, the Court directed the parties, without further detail, to brief and argue whether the district court had jurisdiction under I.R.C. § 6226 to consider the substantial misstatement penalty for an underpayment “attributable to” an overstatement of basis.  Accordingly, the Court may address the issue of whether penalties related to the overstatement of outside basis must be resolved in a partnership proceeding or must be raised in a subsequent partner-level claim.  It is possible that the Supreme Court may resolve the Woods case on jurisdictional grounds, without addressing the substantive circuit split on whether the 40% gross valuation misstatement penalty applies to transactions that lack economic substance, though most believe that it will also address the circuit split on the gross valuation misstatement penalty.

In either event, the fact that the Supreme Court directed the parties to brief and argue the jurisdictional issue is a pointed reminder that the TEFRA partnership audit procedures are outdated and in desperate need of a fix.  In fact, TEFRA jurisdictional issues have generated huge amounts of litigation about partnership tax procedure, often without addressing the underlying merits of a tax dispute.  So the Supreme Court’s guidance in Woods on TEFRA jurisdiction may have far reaching impact and either confirm or cast doubt on a whole series of ad hoc TEFRA procedural decisions over the past ten years.

In Woods, the particular TEFRA partnership procedures at issue involves penalties.  When TEFRA was originally enacted, penalties were not partnership items and had to be resolved in individual partner-level proceedings after the completion of the partnership audit and any resulting tax litigation.  In 1997, congress amended TEFRA to provide that penalties are determined at the partnership level without reclassifying penalties as partnership items.  As a result, significant confusion arose as to whether all or only a portion of the penalty issues (e.g., everything except the reasonable cause defense to penalties as this is specific to an individual partner’s state of mind) can be determined in a partnership proceeding.  Also, significant issues arose as to whether a court has jurisdiction in a partnership  proceeding over penalties if the underlying adjustment resulting in a partner-level underpayment of tax is itself not a partnership item.

Many courts have found that the reasonable cause defense to penalties is jurisdictionally appropriate at the partnership level when the defense involves the conduct and state of mind of the partnership’s managing member or when the defense is not personal to the partners or dependent on their separate returns.  Where the penalties imposed require a determination of non-partnership items, however, courts have found the defense properly raised at the partner level.  Thus, several courts have found no jurisdiction in a partnership-level proceeding when the penalties related to the outside bases of the individual partners because outside bases are generally not partnership items and must determined at the partner level.  It is this last point that the Supreme Court in Woods has focused its jurisdictional analysis on, even though the parties to the case did not raise jurisdictional questions.

After being directed to brief the issue, the taxpayers in Woods rely heavily on Tax Court decisions Jade Trading and Petaluma to argue that the district court lacked jurisdiction to impose the penalty because it relates to a nonpartnership item, i.e., the partner-by-partner determination of the partners’ outside (or tax) bases in the partnership interests.  See Petaluma FX Partners LLC v. Comm’r, 591 F.3d 649, 655-56 (D.C. Cir. 2010), on remand 135 T.C. 366; Jade Trading v. United States, 80 Fed. Cl. 11, 60 (2007), aff’d in part and vacated in part, 598 F.3d 1372 (Fed. Cir. 2010).  In contrast, the government argued that the district court had jurisdiction to impose the penalty because the issue was a partnership item.  Interestingly, the government previously conceded that its argument was wrong.  See Brief for Respondents, United States v. Woods, 133 S. Ct. 1632, 2013 WL 3816999, *21-24 (July 19, 2013) (citing Logan Trust v. Comm’r, No. 12-1148 (D.C. Cir. Oct. 25, 2012) (“We agree that outside basis is an affected item, not a partnership item . . .”)).

Hopefully, the Supreme Court’s jurisdictional decision in Woods clarifies—instead of further confuses—TEFRA jurisdictional rules.  Given the current political environment in Washington, D.C., it is unlikely that congress would take up a statutory fix to TEFRA, much less agree on what that fix should look like.  The current case-by-case, and often conflicting, judicial resolution of TEFRA issues is maddening to lawyers, judges, and especially taxpayers who simply want the merits of their tax cases decided.

The Eighth Circuit Weighs in on Whether Outside Basis is an Affected Item at the Partner Level

As a part of the continuing TEFRA partnership audit proceeding litigation saga, the Eighth Circuit in Thompson v. Comm’r, (No. 12-1725) (Sept. 9, 2013), weighed in on the question of whether outside basis can be decided at the partnership level, or whether it is an affected item that must be determined subsequently at the partner level.  In Thompson, after partnership-level proceedings involving a SON-of-BOSS transaction were decided in favor of the government, the IRS issued a notice of deficiency to the partners explaining several adjustments made to their individual returns and imposing a 40% accuracy-related penalty.  When the taxpayers filed a petition in Tax Court to challenge the notice of deficiency, the IRS moved to dismiss for lack of jurisdiction and argued that the notice was issued in error and that the deficiency procedures of I.R.C. § 6230(a)(1) were inapplicable.  The Tax Court agreed with the IRS and dismissed the partners’ petition.  Writing for the majority, Judge Wherry held that computing the partners’ deficiency arising from the adjustments finalized in the partnership-proceeding did not require any partner-level determinations since the partnership activities “constituted an economic sham” that “foreclosed [the partners] from claiming any loss on liquidating a partnership interest in a disregarded partnership.”  On appeal, the Eighth Circuit reversed, holding that the Tax Court erred in determining that it lacked jurisdiction over the petition.

The Eighth Circuit’s focus, interestingly, was on whether the Tax Court actually made a determination of the partners’ outside basis in the partnership-level proceeding.  The Eighth Circuit held that because the Tax Court did not determine the partners’ outside basis in the partnership, the notice deficiency procedures were applicable and the Tax Court had jurisdiction to consider the taxpayers’ petition.  But, as Judge Gruender noted in his concurring opinion, the question is not whether the Tax Court made the determination; Judge Gruender argued that the Tax Court did in fact make a determination that the partners’ outside basis in the partnership was zero, but that this determination must be “determined at the partner level.”

In holding the Tax Court had jurisdiction, the Eighth Circuit agreed with other circuits to have addressed the question, citing Jade Trading, LLC v. United States, 598 F.3d 1372 (Fed. Cir. 2010) and Petaluma FX Partners, LLC v. Comm’r, 591 F.3d 649 (D.C. Cir. 2010).

The United States Supreme Court may rule on this issue in United States v. Woods, 471 Fed. Appx. 320 (5th Cir. 2012), cert. granted, 133 S. Ct. 1632 (Mar. 25, 2013) (No. 12-562), where, on its own initiative, the Court directed the parties to brief and argue whether the district court had jurisdiction to consider the substantial misstatement penalty for an underpayment “attributable to” an overstatement of basis.