- TEFRA, Sometimes Forgotten But Not Gone
- February 16, 2015
- Law Firm: Pessin Katz Law P.A. - Towson Office
The Tax Equity and Fiscal Responsibility Act of 1982 (“TEFRA”), as codified in Internal Revenue Code. § 6221, et seq., (“IRC”) is sometimes lost in the maze of more recent tax enactments. But, occasionally, it does rear its head, particularly in the field of partnership taxation. A Legal Advice Issued by Field Attorneys from the Dallas Area Counsel of the IRS (20145001F, dated 8/13/14 and released 12/12/14) dealt with a question that arose from an IRS Revenue Agent’s query engaged in an Employment Tax Field Audit arising out of worker classification.
Partnerships are generally subject to TEFRA which imposes “special procedures” in partnership income tax cases. (An exception exists for any small partnership, which is any partnership with ten or fewer members, all of which are individuals (other than a non-resident alien), subchapter C corporations, or estates of deceased partners.) The subject of the audit (the “taxpayer”) was a limited liability company treated as a partnership for income tax purposes.
A determination that a taxpayer owes a deficiency in taxes permits the IRS to send a notice of the deficiency to the taxpayer. The taxpayer may petition the United States Tax Court for a pre-assessment review of the deficiency determination. An entity that is classified as a partnership for federal income tax purposes usually owes no income tax as a “pass through” entity. However, the partnership must still report its income. Each partner is liable for income tax on the partner’s distributive share of various items of income and loss from the partnership. While an income tax examination of a partnership will not usually result in the partnership owing a deficiency, examination adjustments to a partnership’s income or losses could result in a partner owing a deficiency based upon the partner’s distributive share of the adjustments and the other items on the partner’s income tax return.
Prior to TEFRA, income tax examinations of partnerships involved a series of audits for each partner of the partnership. However, TEFRA put in place unified audit and litigation procedures in order to avoid such multiple audits and tax cases and to provide consistent treatment for all partners.
Audits of partnerships usually involve “partnership” and “non-partnership” items. The Internal Revenue Code and Regulations provide a list of “partnership items”. A “non-partnership item” is an item that is (or is treated as) not a partnership item.
For IRS to adjust any partnership items, it must send a final partnership administrative adjustment (“FPAA”) to the partners identified as notice partners on the partnership return for the year at issue. For 90 days after issuance of an FPAA, the partnership’s tax matters partner (“TMP”) has the exclusive right to petition the Tax Court, Court of Federal Claims, or a U.S. District Court for an adjustment of the partnership items. Thereafter, other partners have 60 days to file a petition for readjustment.
The IRC provides that, if, in connection with the audit of any person, there is an actual controversy involving a determination by IRS as part of an examination that (1) one or more persons performing services for such person are employees of the person for purposes of Employment Taxes and Collection of Income Tax; or (2) the person is not entitled to treatment under §530(a) of the Revenue Act of ’78 with respect to the individual (the Employment Tax “safe harbor”), then the Tax Court may determine the correctness of IRS’s determination and the amount of employment tax owed following the filing of an appropriate pleading.
TEFRA makes no mention of Employment Tax or worker classification issues on audit of a partnership. As a result, the IRS need not send a final partnership administrative adjustment (“FPAA”) in order to make an employment tax assessment. Any determination regarding Employment Tax or worker classification may be reviewed for correctness by the Tax Court upon the filing of an appropriate pleading by the partnership.
The moral of this article is that partnerships need to be particularly wary of an Employment Tax and worker classification audit by the IRS as the procedures are not the same as usual under TEFRA.