CCA said a partnership audit is not always required before adjusting a partner's return

Plain-English summary

The Office of Chief Counsel advised that, when a partnership is not subject to TEFRA, the IRS is not legally required to audit the partnership before adjusting an individual partner’s return based on third-party information about the partner’s underreporting. A notice of deficiency may be based on third-party information. If the partnership is subject to TEFRA, any adjustment must follow TEFRA procedures.

Ruling snapshot

• Question: Must the IRS audit a partnership before adjusting an individual partner’s return based on third-party information?
• Outcome: Advice given
• Key authorities: IRC §§ 6221 and 7491; TEFRA procedures; IRC § 6110(k)(3) not-precedent notice

Full text (IRS public release)

ID: CCA_2010080917514539 Number: 201035018
Release Date: 9/3/2010
Office: --------------
UILC: 7491.00-00 R 1970

From: -------------------------
Sent: Monday, August 09, 2010 5:51:48 PM
To: ------------------
Cc: --------------------------------------------------------------------------------
Subject: Third Party Partnership examination question, -----------------------

You asked whether the Service is legally required to open a partnership audit before
making an adjustment to an individual partner's return under certain circumstances.
Based on the facts as we understand them, in the case of a partnership that is not
subject to TEFRA, the Service is under no legal obligation to conduct an examination of
a partnership in order to make an adjustment to an individual partner's return based on
information received from third parties as to underreporting on the part of the individual.
A Notice of Deficiency can lawfully be based on third party information. If the
partnership is subject to TEFRA, any partner adjustment based on third party
information must be made according to TEFRA procedures.

Our answer is best explained by way of example.

P, an individual, is a partner in Partnership 1, which makes sales in State X.
Partnership 1 is not subject to TEFRA. State X determines that Partnership 1
understated its gross sales for State X and ultimately made adjustments to the State X
liability of P. State X informed the Service of the underreporting by P. The Service
wants to use the information to assert an additional federal tax liability on P.

You asked whether the adjustment could be made without first opening the Partnership
return for federal income tax purposes. The short answer is yes. There is no legal
requirement that a federal examination be conducted before the Service proposes an
adjustment to the federal tax liability of P. Consistent with other guidance you've
received on this program, however, the Service must be prepared to defend the
adjustments if challenged.

Please feel free to contact us with further questions.