CCA 200913032: Disregarded-entity partners prevented use of the small-partnership exception

Plain-English summary

Chief Counsel advised that an examination should use TEFRA's unified partnership procedures because the partnership had disregarded entities as partners. Although the returns listed only corporations and said TEFRA did not apply, information obtained during the examination showed that passthrough partners made the small-partnership exception unavailable. The writer concluded that the IRS could no longer reasonably rely on the contrary return representations under section 6231(g). Revenue Ruling 2004-88 supported treating a disregarded entity as a passthrough partner. The advice also noted that Harrell v. Commissioner might support a taxpayer argument that TEFRA status had to be determined at the start of the audit from the return, leaving some uncertainty about when section 6231(g) applied.

Ruling snapshot

• Question: Did the small-partnership exception apply when returns listed corporate partners but examination facts revealed disregarded-entity partners?
• Outcome: Advice given: conduct the examination under TEFRA, subject to a possible timing argument about the section 6231(g) determination.
• Key authorities: IRC §§ 6221 through 6233, 6231(a)(1), 6231(a)(9), 6231(g); Treas. Reg. § 301.6231(a)(1)-1; Rev. Rul. 2004-88; Harrell v. Commissioner, 91 T.C. 242 (1988).

Full text (IRS public release)

ID: CCA-822854-08 Number: 200913032
Office: -------------
Release Date: 4/9/2010

UILC: 6231.01-01

From:---------------
Sent: Fri 8/22/2008 8:54 AM
To:-------------------
Cc:--------------------------------------------------------------------------------------------------------
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Subject: RE: TEFRA -- gut check

I agree with your analysis. See also Rev. Rul. 2004-88 (Disregarded entity is a pass-thru partner making the small partnership exception inapplicable----------------------------------------------------------------------------------
-------------------------------------------------------- In Harrell v. Commissioner, 91 T.C. 242 (1988) the court held that the application of the TEFRA procedures is determined at the beginning of the audit based on the partnership return rather than on subsequent adjustments/determinations). This case might also control the date on which the application of section 6231(g) is applied. Taxpayers could argue that TEFRA does not apply on this basis.

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From: ---------------------------------
Sent:-------------Thursday, August 21, 2008 11:49 PM
To:---------------------------------
Cc:-----------------------------------
Subject:----------TEFRA -- gut check

Hi ----,
It was nice to see you at the CLE. When we talked, you told me I had 4 years and some months to continue to ask you TEFRA questions, so I am going to avail myself of the opportunity. I wanted to send the e-mail below to a revenue agent. I think its right, but I lack quite a bit of confidence when it comes to TEFRA. --------------------------------------------------------------------------------------------------------------------------------
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Thanks in advance--
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--------,
You asked for advice regarding whether your examination of -----------------------------------------------------------
--------(“Taxpayer”) is subject to the unified partnership audit proceedings in IRC §§ 6221 through 6233 (“TEFRA procedures”) for taxable years ------------------------------.

Short answer: Based on the facts set forth below, for taxable years ------------------------------, your examination of the Taxpayer is subject to TEFRA procedures. Note, however, that this conclusion may change if any of the facts relied upon below are inaccurate or you have additional facts that I have not considered.

Facts
The Taxpayer (-------------------------------------------------------------------) is a calendar year taxpayer that was created on or about -----------------. You are examining its taxable years ------------------------------. In ------, the Taxpayer was formed pursuant to a ---------------------------------------------------------------------dated ----------
------------------------, as amended (“Formation Agreement”).

The Formation Agreement contains several definitions regarding membership (e.g., “Members,” “Initial Members,” “----------------------------------------------------------------------------”). A “Member” is as provided in the
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-----------dated as of ------------------(“LLC Agreement”).

The LLC Agreement (schedule 4.1) lists the members of the Taxpayer as follows:

Membership
Member Name
Interest

------------------------------------
----------
------------------------------------------------------------ ----------
-------------------------------------------- ----------
------------------------------------------------------ --------

-------------------------------------is a disregarded entity for tax purposes. It is wholly owned by --------------------
-------------------, which is wholly owned by ----------------------------.

On Form 8886, Reportable Transaction Disclosure Statement, for taxable year -------, the Taxpayer listed as its members: (1) -----------------------------; (2) ----------------------------------------; and (3) --------------------------
---------------------------- We are unclear whether -------------------------------------- existed in ------------------ and transferred its interest in the Taxpayer to ---------------------------------------------, or whether on -------------------
---, ---------------------------------------- reorganized into ----------------------------------------. We know from the Taxpayer, however, that during -------, ---------------------------------------- (1) was an owner of the Taxpayer, and (2) was a disregarded entity for Federal income tax purposes.

On its Form 10-K, Annual Report, for --------filed with the Securities and Exchange Commission (------------
----------------------------------------------------------------- states that the Taxpayer is owned by ------------------------
---------------------------------, which is owned by -------------------------------------, which is owned by ----------------
------.

On its Form 1065, U.S. Return of Partnership Income, and Schedule K-1, Partner’s Share of Income, Credits, Deductions, Etc, for taxable years -----------------------------, the Taxpayer provided the following information:

Year-End
Partnership TEFRA
Tax Year Partner Percentage Election TMP Identified

----------- ------------------------------ --------------- -------- ------------------------------------
------
--- ------------------------------ --------------- ---
---
-------------------
--- ------------------------------ ------------- ---
---
-------------------------
----------- ------------------------------ --------------- -------- ------------------------------------
------
--- ------------------------------ -------- --- ---
-------------------
--- ------------------------------ --------------- ---
---
-------------------------
----------- ------------------------------ ---------------- -------- ---------------------------------------
------ ---------------- -------------
--
--- ------------------------------ -- -- ------------------------- ----------------
----

During the course of this examination, the Taxpayer provided a written statement that --------------------------
---------------------------------------------- “is a NON-TEFRA partnership.”

Law
Generally, a partnership is subject to TEFRA proceedings unless it is a small partnership. A small partnership is a partnership is owned by 10 or fewer partners, each of whom is a C corporation, an individual, or an estate of deceased partner. IRC § 6231(a)(1)(A) and (B)(i). The small partnership exception does not apply to a partner who is a pass-thru partner during the taxable year. Treas. Reg. § 301.6231(a)(1)-1(a)(2). A pass-thru partner is “a partnership, estate, trust, S corporation, nominee, or other similar person through whom other persons hold an interest in the partnership with respect to which proceedings under this subchapter are conducted.” IRC § 6231(a)(9).

The determination of whether a partnership satisfies the small partnership exception is made each taxable year. Treas. Reg. § 301.6231(a)(1)-1(a)(3). In the first instance, a TEFRA determination is made based on the partnership’s tax return; if the Service reasonably determines that a partnership is or is not subject to TEFRA, than that determination is presumed correct, even if it is erroneous. IRC § 6231(g)(1) and (2).

For each year at issue, the partnership return states that the Taxpayer is not subject to TEFRA and lists only corporations as partners. Looking at the tax returns in isolation, we could have reasonably concluded that the Taxpayer was not subject to TEFRA. During the course of the examination, however, we obtained additional facts showing that the Taxpayer had partners that were disregarded entities in -----
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---------------------------------------), and in ----------------------------------------------------------. Disregarded entities are “other similar person[s] through whom other persons hold an interest in the partnership.” Accordingly, they are pass-thru partners. As pass-thru partners, they disqualify the Taxpayer for the small partnership exception and make the Taxpayer subject to TEFRA proceedings.

With this additional information, I do not think it is reasonable for us to rely on the representations on the Taxpayer’s return. Accordingly, your examination of the Taxpayer’s returns for ------------------------------ should be conducted using TEFRA procedures described in the Flow-Through Entity Manual at IRM 4.31.2.

Please call or e-mail me if you have any questions or would like to discuss this further.

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