During the period of this update (Nov. 1, 2021, through Oct. 31, 2022), the IRS issued guidance for taxpayers regarding changes made to Subchapter K over the past few years. Also, the Service issued guidance related to foreign partners. In addition, the courts and the IRS issued various rulings that addressed partnership operations and allocations.

Partnership item issues

Several court cases decided during the period turned on whether the treatment of an item was properly reported or determined at the partnership level or at the partner level.

In Gluck, the taxpayers sold a condominium and then attempted to complete a like-kind exchange within the meaning of Sec. 1031 by purchasing a partnership interest in an apartment building. Under Sec. 1031, taxpayers can defer the tax on the gain from a sale of real property held for productive use in a trade or business or for investment if they exchange it for the property of a like-kind within a certain period. However, a partnership interest is not considered of like kind to real property and thus does not qualify for Sec. 1031 exchange treatment. In this case, the taxpayers filed their tax return and claimed like-kind exchange treatment for their interest in the property purchased to replace their condominium.

The IRS audited the taxpayers’ return and found that they had purchased an interest in a partnership that owned the property, not a direct interest in the property itself. Thus, the IRS determined, the transaction did not qualify as a like-kind exchange, and the gain on the sale was taxable. The IRS based this determination on the tax return that was filed for a partnership that represented that it owned the property and included the taxpayers as a partner. The taxpayers received notice of the partnership tax return having been filed and did not file Form 8082, Notice of Inconsistent Treatment or Administrative Adjustment Request (AAR), which would have notified the IRS they were taking a position on their tax return that was inconsistent with items on the partnership tax return or that they wanted to challenge the partnership’s characterization of those items. Since the taxpayers had not alleged any inconsistencies with the partnership tax return, the IRS followed the information provided on the Form 1065, U.S. Return of Partnership Income.

The Tax Court rejected the taxpayers’ filing on the grounds that it lacked jurisdiction to hear the petition because the adjustment the IRS made on their tax return was treated as a computational adjustment of an affected partnership item, which required no further determinations at the partner level and thus was outside the Tax Court’s jurisdiction. The taxpayers appealed to the Second Circuit, which upheld the Tax Court’s decision. Had the taxpayers properly filed the Form 8082, the Tax Court could have heard the case.

InWarner Enterprises, Inc., the IRS had determined accuracy-related penalties in an earlier TEFRA partnership-level proceeding. One of the partners objected to the penalties, contending that the IRS had not complied with the requirement under Sec. 6751(b) to obtain supervisory approval of the penalty. The partner argued that partners were entitled to raise Sec. 6751(b) as a defense at either the partnership level or partner level. The Tax Court disagreed, noting that allowing partners to object to the penalty at either the partnership or partner level would ignore TEFRA’s framework requiring partnership items affecting all partners equally to be determined at the partnership level.

Penalty issues

Another case involved a charitable contribution deduction claimed by Excelsior Aggregates LLC for a conservation easement. The IRS issued the LLC an FPAA disallowing its deduction and determined penalties under Secs. 6662A and 6662. The Tax Court addressed whether the IRS complied with Sec. 6751(b)(1) with respect to these penalties. Sec. 6751(b)(1) requires that the initial determination of a penalty assessment be personally approved in writing by the immediate supervisor of the person making the determination.

The IRS contended that the initial determination of the penalties in question was communicated in the FPAA. Because supervisory approval for the penalties was secured before that date, the IRS argued, the approval was timely. The taxpayer contended that supervisory approval was not timely because the initial determination of the penalties occurred earlier when the IRS mentioned the possibility of penalties during a phone conference with the LLC’s representative. As part of the phone conference, the IRS faxed an agenda laying out a tentative position on each topic for discussion, including penalties.

The court ruled that the approval for the penalties was timely. The court specifically noted that the IRS submitted a supplemental civil penalty approval form in which the revenue agent recommended the assertion of penalties and that the agent’s supervisor signed the form before the FPAA was issued.

The court found that the earlier phone conference was not an initial determination of penalties because the agenda did not inform the representative that the IRS had completed its work and specifically stated that the results could change before the examination officially concluded. In addition, neither the agenda nor the telephone conference informed the partnership of any unequivocal decision by the IRS to assert penalties.