[Federal Register Volume 64, Number 16 (Tuesday, January 26, 1999)]
[Rules and Regulations]
[Pages 3837-3840]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-885]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 301

[TD 8808]
RIN 1545-AW23


Modifications and Additions to the Unified Partnership Audit 
Procedures

AGENCY: Internal Revenue Service, Treasury.

ACTION: Final and temporary regulations.

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SUMMARY: This document contains final and temporary regulations 
relating to the unified partnership audit procedures added to the 
Internal Revenue Code by the Tax Equity and Fiscal Responsibility Act 
of 1982 (TEFRA). The unified partnership audit procedures generally 
provide administrative rules for the auditing of partnership items at 
the partnership level. These regulations modify the existing unified 
partnership audit procedures to comply with the Taxpayer Relief Act of 
1997 (1997 Act) and the Internal Revenue Service Restructuring and 
Reform Act of 1998 (1998 Act), and add new regulations to administer 
the new unified partnership audit provisions added by the 1997 Act. In 
general, the text of these temporary regulations also serves as the 
text of the proposed regulations set forth in the notice of proposed 
rulemaking on this subject in the Proposed Rules section of this issue 
of the Federal Register.

DATES: Effective Date: These regulations are effective January 26, 
1999.

FOR FURTHER INFORMATION CONTACT: Robert G. Honigman, (202) 622-3050 
(not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    This document contains temporary amendments to the Procedure and 
Administration Regulations (26 CFR Part 301) relating to the unified 
partnership audit procedures found in sections 6221 through 6233 of the 
Internal Revenue Code (Code) and final regulations pertaining to the 
applicable dates of Sec. 301.6231(a)(7)-1T(p)(2) and 
Sec. 301.6231(a)(7)-1T(r)(1). Sections 1231 through 1243 of the 
Taxpayer Relief Act of 1997, Public Law 105-34, 111 Stat. 788, modified 
some of the existing procedures and added certain new rules. Section 
3507 of the Internal Revenue Service Restructuring and Reform Act of 
1998, Public Law 105-206, 112 Stat. 685, modified section 6231. This 
document modifies existing regulations that, because of the 1997 Act or 
the 1998 Act, no longer reflect current law.

Explanation of Provisions

Penalties Determined at the Partnership Level

    Before the 1997 Act, the Internal Revenue Service (Service) could 
impose penalties on a partner only through the application of the 
deficiency procedures after the completion of a partnership level 
proceeding. Forcing the Service to open deficiency proceedings against 
the individual partners was inconsistent with the efficiency goal of 
the unified partnership audit rules. The 1997 Act cured this problem by 
providing that, for partnerships under audit for taxable years ending 
after August 5, 1997, partnership level proceedings include the 
determination of applicable penalties at the partnership level. 
Partners now may raise any partner level defenses to the imposition of 
penalties only in a subsequent refund action.
    Consistent with these statutory changes, the temporary regulations 
mandate that the partnership's penalty defenses are to be resolved 
during the partnership proceeding. Nevertheless, any individual 
defenses that a partner may have to the imposition of a penalty may be 
brought by the partner in a refund action subsequent to the partnership 
level determination. In order to minimize the burden on individual 
partners to defend themselves by bringing their own refund suits, the 
temporary regulations incorporate a large number of defenses at the 
partnership level. The majority of a partner's defenses to the 
imposition of penalties are not specific to a particular partner, but 
can be determined by reference to the activities of the partnership. 
The applicability of these defenses may be resolved at the partnership 
level during the partnership proceeding. In addition, the temporary 
regulations modify the computational adjustment rules to allow the 
Service to assess penalties under those procedures.

Partial Settlements

    The period for assessing tax with respect to partnership items 
generally is the longer of the periods provided by section 6229 or 
section 6501. For partnership items that convert to nonpartnership 
items, section 6229(f) provides that the period for assessing tax shall 
not expire before the date which is one year after the date that the 
items became nonpartnership items. Section 6231(b)(1)(C) provides that 
the partnership items of a partner for a partnership taxable year 
become nonpartnership items as of the date the partner enters into a 
settlement agreement with the Service with respect to such items. In 
some audits, however, the taxpayer and the Service will enter into a 
settlement agreement regarding some, but not all, of the taxpayer's 
partnership items. The 1997 Act added a special rule for these partial 
settlement agreements in section 6229(f)(2), providing that the period 
for assessing any tax attributable to the settled items is determined 
as if the partial settlement had not been executed. Thus, the 
limitations period applicable to the last partnership item to be 
resolved for the partnership's taxable year under audit is controlling 
with respect to all disputed partnership items (including settled 
items) for such partnership taxable year.
    The temporary regulations state that the one year period for 
assessing partnership items that convert to nonpartnership items 
applicable to settlement agreements under section 6231(b)(1)(C) does 
not apply to partial settlement agreements under section 6229(f)(2). 
Moreover, the temporary regulations clarify that the partner remains 
subject to the unified audit procedures regarding the nonsettled items.

Tax Matters Partner as a Debtor in Bankruptcy

    Section 6229(b)(1)(B) provides that the statute of limitations 
under section 6229 is extended with respect to all partners in the 
partnership by an agreement entered into between the tax matters 
partner (TMP) and the Service. Treas. Reg. Sec. 301.6231(a)(7)-
1(l)(1)(iv) (1996) and Temp. Treas. Reg. Sec. 301.6231(c)-7T(a) (1987), 
however, provide that upon the filing of a petition naming a partner as 
a debtor in a

[[Page 3838]]

bankruptcy proceeding, the partner/debtor's partnership items convert 
to nonpartnership items, and if the partner/debtor was the TMP, that 
status terminates. These rules were promulgated to avoid the 
complications that the automatic stay provision contained in 11 U.S.C. 
362(a)(8) would have on a unified partnership audit. As a result, if a 
TMP executed a consent to extend the statute of limitations during a 
period when the TMP was a debtor in a bankruptcy proceeding, the 
consent would not be binding on the other partners. Under the 
regulations, the person signing the agreement was ineligible to act as 
the TMP and extend the statute as to all partners.
    To resolve the uncertainty under prior law in the situation where a 
TMP executes an agreement extending the statute of limitations as to 
all partners while, unknown to the Service, the TMP is a debtor in a 
bankruptcy proceeding, the 1997 Act provides that the Service may rely 
on the executed statute extension agreement unless it is notified of 
the TMP's bankruptcy proceeding. If the Service is not notified of the 
TMP's bankruptcy proceeding, statute extensions granted by the TMP are 
binding on all partners in the partnership.
    The temporary regulations provide a mechanism for the TMP, or other 
partners, to provide notice to the Service that the TMP is a debtor in 
a bankruptcy proceeding and therefore is ineligible to serve as TMP and 
extend the statute under section 6229. This mechanism is derived from 
existing regulations that provide guidance on how to notify the Service 
of information concerning a partnership's partners.

Small Partnership Exception

    The 1997 Act amended the small partnership exception to the unified 
partnership audit procedures found in section 6231. Formerly, in order 
to qualify for the small partnership exception, the partnership had to 
have 10 or fewer partners at all times during the tax year, each of 
whom was a natural person (other than a nonresident alien) or an 
estate, and for which each partner's share of each partnership item was 
the same as that partner's share of every other partnership item. The 
1997 Act amended the small partnership exception by allowing 
partnerships to qualify for the exception even if they have a C 
corporation for a partner or specially allocate some partnership items. 
The temporary regulations modify the existing regulations interpreting 
the small partnership exception to take account of this change in the 
law.

Effective Date

    These final and temporary regulations are applicable January 26, 
1999. In accordance with section 7805(e)(2), the temporary regulations 
contained herein shall expire January 25, 2002.

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in EO 12866. Therefore, a 
regulatory assessment is not required. It also has been determined that 
section 533(b) of the Administrative Procedures Act (5 U.S.C. chapter 
5) does not apply to these regulations. For the applicability of the 
Regulatory Flexibility Act (5 U.S.C. chapter 6) refer to the Special 
Analyses section of the preamble to the cross reference notice of 
proposed rulemaking published in the Proposed Rules section in this 
issue of the Federal Register. Pursuant to section 7805(f) of the 
Internal Revenue Code, these final and temporary regulations will be 
submitted to the Chief Counsel for Advocacy of the Small Business 
Administration for comment on their impact on small business.
    Drafting information. The principal authors of these temporary 
regulations are Robert G. Honigman, Office of the Assistant Chief 
Counsel (Passthroughs & Special Industries), and William A. Heard, 
Office of the Assistant Chief Counsel (Field Service). However, other 
personnel from the Service and Treasury Department participated in 
their development.

List of Subjects in 26 CFR Part 301

    Employment taxes, Estate taxes, Excise taxes, Gift taxes, Income 
taxes, Penalties, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR part 301 is amended as follows:

PART 301--PROCEDURE AND ADMINISTRATION

    Paragraph 1. The authority citation for part 301 continues to read 
in part as follows:

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

    Par. 2. Amend Sec. 301.6221-1T by:
    1. Redesignating paragraph (c) as paragraph (e).
    2. Adding new paragraphs (c) and (d).
    The additions read as follows:


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

* * * * *
    (c) Penalties determined at partnership level (partnership taxable 
years ending after August 5, 1997). Any penalty, addition to tax, or 
additional amount that relates to an adjustment to a partnership item, 
shall be determined at the partnership level. Partner level defenses to 
such items can only be asserted through refund actions following 
assessment and payment. Assessment of any penalty, addition to tax, or 
additional amount that relates to an adjustment to a partnership item 
shall be made based on partnership level determinations. Partnership 
level determinations include all the legal and factual determinations 
that underlie the determination of any penalty, addition to tax, or 
additional amount, other than partner level defenses specified in 
paragraph (d) of this section.
    (d) Partner level defenses. Partner level defenses to any penalty, 
addition to tax, or additional amount that relates to an adjustment to 
a partnership item, may not be asserted in the partnership level 
proceeding, but may be asserted through separate refund actions 
following assessment and payment. See section 6230(c)(4). Partner level 
defenses are limited to those that are personal to the partner or are 
dependant upon the partner's separate return, and cannot be determined 
at the partnership level. Examples of these determinations are: whether 
any applicable threshold underpayment of tax has been met with respect 
to the partner or whether the partner has met the criteria of section 
6664(b)(penalties applicable only where return is filed), or section 
6664(c)(1)(reasonable cause exception) subject to partnership level 
determinations as to the applicability of section 6664(c)(2).
* * * * *
    Par. 3. Amend Sec. 301.6223(c)-1T by adding a sentence to the end 
of paragraph (c) to read as follows:


Sec. 301.6223(c)-1T  Additional information regarding partners 
furnished to the Service (temporary).

* * * * *
    (c) * * * Furthermore, reference to a prior general notification to 
the Service that a partner who would otherwise be the tax matters 
partner is a debtor in a bankruptcy proceeding or has had a receiver 
appointed for him in a receivership proceeding is not sufficient unless 
a copy of the notification document referred to is attached to the 
statement.
* * * * *
    Par. 4. Amend Sec. 301.6224(c)-3T by:
    1. Revising the section heading.
    2. Revising paragraphs (b), (c)(3)(ii), and (d), Example (1).

[[Page 3839]]

    The revisions read as follows:


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

* * * * *
    (b) Requirements for consistent settlement terms--(1) In general. 
Consistent settlement terms are those based on the same determinations 
with respect to partnership items. However, consistent settlement terms 
also may include partnership level determinations of any penalty, 
addition to tax, or additional amount that relates to partnership 
items. Settlements with respect to partnership items shall be self-
contained; thus, a concession by one party with respect to a 
partnership item may not be based upon a concession by another party 
with respect to any item that is not a partnership item other than any 
penalty, addition to tax, or additional amount that relates to an 
adjustment to a partnership item. Consistent agreements, whether 
comprehensive or partial, must be identical to the original settlement 
(that is, the settlement upon which the offered settlement terms are 
based). A consistent agreement must mirror the original settlement and 
may not be limited to selected items from the original settlement. Once 
a partner has settled a partnership item, or penalty, addition to tax, 
or additional amount that relates to an adjustment to a partnership 
item, that partner may not subsequently request settlement terms 
consistent with a settlement that contains the previously settled item. 
The requirement for consistent settlement terms applies only if--
    (i) The items were partnership items (and any related penalty, 
addition to tax, or additional amount) for the partner entering into 
the original settlement immediately before the original settlement; and
    (ii) The items are partnership items (and any related penalty, 
addition to tax, or additional amount) for the partner requesting the 
consistent settlement at the time the partner files the request.
    (2) Effect of consistent agreement. Consistent settlement terms are 
reflected in a consistent agreement. A consistent agreement is not a 
settlement agreement which gives rise to further consistent settlement 
rights because it is required to be given without volitional agreement 
of the Secretary. Therefore, a consistent agreement required to be 
offered to a requesting taxpayer is not a settlement agreement under 
section 6224(c)(2) of the Internal Revenue Code, or paragraph (c)(3) of 
this section which starts a new period for requesting consistent 
settlement terms. For all other purposes of the Internal Revenue Code, 
however, (e.g., binding effect under section 6224(c)(1), and conversion 
to nonpartnership items under section 6231(b)(1)(C)) a consistent 
agreement is treated as a settlement agreement.
    (c) * * *
    (3) * * *
    (ii) The 60th day after the day on which the settlement agreement 
was entered into.
    (d) * * *

    Example (1). The Service seeks to disallow a $100,000 loss 
reported by Partnership P. The Service agrees to a settlement with 
X, a partner in P, in which the Service allows 60 percent of the 
loss, accepts the treatment of all other partnership items on the 
partnership return, and imposes a penalty for negligence related to 
the loss disallowance. Partner Y, which owns a 10 percent interest 
in the partnership, requests settlement terms which are consistent 
with the settlement made between X and the Service. The items are 
partnership items (and a related penalty) for X immediately before X 
enters into the settlement agreement and are partnership items (and 
a related penalty) for Y at the time of the request. The Service 
must offer Y settlement terms allowing a $6,000 loss, a negligence 
penalty on the $4,000 disallowance, and otherwise reflecting the 
treatment of partnership items on the partnership return.
* * * * *
    Par. 5. Add Sec. 301.6229(b)-2T to read as follows:


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

    (a) In general. Notwithstanding any other law or rule of law, if an 
agreement is entered into under section 6229(b)(1)(B), and the 
agreement is signed by a person who would be the tax matters partner 
but for the fact that, at the time that the agreement is executed, the 
person is a debtor in a bankruptcy proceeding under Title 11 of the 
United States Code, such agreement shall be binding on all partners in 
the partnership unless the Service has been notified of the bankruptcy 
proceeding in accordance with paragraph (b) of this section.
    (b) Procedures for notifying the Service of a partner's bankruptcy 
proceeding. (1) The Service shall be notified of the bankruptcy 
proceeding of the tax matters partner in accordance with the procedures 
set forth in Sec. 301.6223(c)-1T.
    (2) In addition to the information specified in Sec. 301.6223(c)-
1T, notification that a person is (or was) a debtor in a bankruptcy 
proceeding shall include the date the bankruptcy proceeding was filed, 
the name and address of the court in which the bankruptcy proceeding 
exists (or took place), the caption of the bankruptcy proceeding 
(including the docket number or other identification number used by the 
court), and the status of the proceeding as of the date of 
notification.
    Par. 6. Add Sec. 301.6229(f)-1T to read as follows:


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

    (a) In general. If a partner enters into a settlement agreement 
with the Service with respect to the treatment of some of the 
partnership items in dispute for a partnership taxable year, but other 
partnership items for such year remain in dispute, the period of 
limitations for assessing any tax attributable to the settled items 
shall be determined as if such agreement had not been entered into.
    (b) Other items remaining in dispute. Pursuant to section 6226(c), 
a partner is a party to a partnership level judicial proceeding with 
respect to partnership items. When a partner settles partnership items, 
the settled partnership items convert to nonpartnership items under 
section 6231(b)(1)(C) and will not be subject to any future or pending 
partnership level proceeding pursuant to section 6226(d)(1). The 
remaining unsettled partnership items, however, will remain subject to 
determination under partnership level administrative and judicial 
procedures. Consequently, any remaining unsettled items will be deemed 
to remain in dispute. Thus, the period for assessing settled items will 
be governed by the period for assessing the remaining unsettled items.
    Par. 7. Amend Sec. 301.6231(a)(1)-1T by:
    1. Revising the first two sentences of paragraph (a)(1).
    2. Removing paragraph (a)(3).
    3. Redesignating paragraph (a)(4) as paragraph (a)(3).
    The revision reads as follows:


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

    (a) * * *
    (1) ``10 or fewer.'' The ``10 or fewer'' limitation described in 
section 6231(a)(1)(B)(i) is applied to the number of natural persons 
(other than nonresident aliens), C corporations, and estates of 
deceased partners that were partners at any one time during the 
partnership taxable year. Thus, for example, a partnership that at no 
time during the taxable year had more than 10 partners may be treated 
as a small partnership even if, because of transfers of interests in 
the partnership, 11 or more natural persons, C corporations, or estates 
of deceased partners owned interests in the partnership for some 
portion of the taxable year. * * *
* * * * *

[[Page 3840]]

    Par. 8. Amend Sec. 301.6231(a)(6)-1T by:
    1. Revising paragraph (a).
    2. Removing paragraph (c).
    The revision reads as follows:


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

    (a) In general. A change in the tax liability of a partner to 
properly reflect the treatment of a partnership item under subchapter C 
of chapter 63 of the Internal Revenue Code is made through a 
computational adjustment. A computational adjustment includes a change 
in tax liability that reflects a change in an affected item where that 
change is necessary to properly reflect the treatment of a partnership 
item, or any penalty, addition to tax, or additional amount that 
relates to an adjustment to a partnership item. However, if a change in 
a partner's tax liability cannot be made without making one or more 
partner level determinations, that portion of the change in tax 
liability attributable to the partner level determinations shall be 
made under the provisions of subchapter B of chapter 63 of the Internal 
Revenue Code (relating to deficiency procedures), except for any 
penalty, addition to tax, or additional amount which relates to an 
adjustment to a partnership item.
    (1) Changes in a partner's tax liability with respect to affected 
items that do not require partner level determinations (such as the 
threshold amount of medical deductions under section 213 that changes 
as the result of determinations made at the partnership level) are 
computational adjustments that are directly assessed. When making 
computational adjustments, the Service may assume that amounts the 
partner reported on the partner's individual return include all amounts 
reported to the partner by the partnership, absent contrary notice to 
the Service (for example, a ``Notice of Inconsistent Treatment''). Such 
an assumption by the Service does not constitute a partner level 
determination. Moreover, substituting redetermined partnership items 
for the partner's previously reported partnership items (including 
partnership items included in carryover amounts) does not constitute a 
partner level determination where the Service otherwise accepts all 
nonpartnership items (including, for example, nonpartnership item 
components of carryover amounts) as reported.
    (2) Changes in a partner's tax liability with respect to affected 
items that require partner level determinations (such as a partner's 
at-risk amount to the extent it depends upon the source from which the 
partner obtained the funds that the partner contributed to the 
partnership) are computational adjustments subject to deficiency 
procedures. Nevertheless, any penalty, addition to tax, or additional 
amount that relates to an adjustment to a partnership item may be 
directly assessed following a partnership proceeding, based on 
determinations in that proceeding, regardless of whether partner level 
determinations are required.
* * * * *
    Par. 9. Amend Sec. 301.6231(a)(7)-1 by adding a sentence at the end 
of paragraphs (p)(2) and (r)(1) to read as follows:


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

* * * * *
    (p) * * *
    (2) * * * For regulations applicable on or after January 26, 1999 
(reflecting statutory changes made effective July 22, 1998) and before 
January 25, 2002, see Sec. 301.6231(a)(7)-1T(p)(2).
* * * * *
    (r) * * * (1) * * * For regulations applicable on or after January 
26, 1999 (reflecting statutory changes made effective July 22, 1998) 
and before January 25, 2002, see Sec. 301.6231(a)(7)-1T(r)(1).
* * * * *
    Par. 10. Add Sec. 301.6231(a)(7)-1T to read as follows:


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

    (a) through (p)(1) [Reserved]. For further guidance, see 
Sec. 301.6231(a)(7)-1(a) through (p)(1).
    (p)(2) When each general partner is deemed to have no profits 
interest in the partnership. If it is impracticable under 
Sec. 301.6231(a)(7)-1(o)(2) to apply the largest-profits-interest rule 
of Sec. 301.6231(a)(7)-1(m)(2), the Commissioner will select a partner 
(including a general or limited partner) as the tax matters partner in 
accordance with the criteria set forth in Sec. 301.6231(a)(7)-1(q). The 
Commissioner will notify, within 30 days of the selection, the partner 
selected, the partnership, and all partners required to receive notice 
under section 6223(a), effective as of the date specified in the 
notice. For regulations applicable before July 22, 1998, see 
Sec. 301.6231(a)(7)-1(p)(2).
    (p)(3) through (q) [Reserved]. For further guidance, see 
Sec. 301.6231(a)(7)-1(p)(3) through (q).
    (r) Notification of partnership--(1) In general. If the 
Commissioner selects a tax matters partner under the provisions of 
Sec. 301.6231(a)(7)-1(p)(1) or (3)(i), the Commissioner will notify, 
within 30 days of the selection, the partner selected, the partnership, 
and all partners required to receive notice under section 6223(a), 
effective as of the date specified in the notice. For regulations 
applicable before July 22, 1998, see Sec. 301.6231(a)(7)-1(r)(1).
    (r)(2) [Reserved]. For further guidance, see Sec. 301.6231(a)(7)-
1(r)(2).

    Approved: December 30, 1998.
Robert E. Wenzel,
Deputy Commissioner of Internal Revenue Service.
Donald C. Lubick,
Assistant Secretary of the Treasury.
[FR Doc. 99-885 Filed 1-25-99; 8:45 am]
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