Refund Claims Stemming from TEFRA Partnerships

The Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) enacted Secs. 6221–6232, providing procedures for all partnerships with more than 10 partners or with a flowthrough entity as a partner; see Sec. 6231(a)(1)(B). In general, these rules provide that although a partnership is a nontaxpaying entity, all adjustments to an originally filed partnership return—whether by examination or amendment—must be made at the partnership level; see Sec. 6221. These adjustments then flow mechanically to the ultimate partners.

Because adjustments are made at the nontaxpayer level, the normal refund processes and limitations periods either may not apply or apply in a unique way. The TEFRA partnership procedures’ many nuances require special attention, to avoid unintended consequences. This item discusses four often-overlooked issues in refund claims stemming from adjustments to TEFRA partnership items.

Differing Treatment of Refund Claims

While a refund claim generally can be initiated only by a taxpayer, under the TEFRA rules it can be initiated by either the partnership or a partner; see Sec. 6230. Taxpayer-initiated adjustments to filed partnership returns use Form 8082, Notice of Inconsistent Treatment or Administrative Adjustment Request (AAR), with an essentially blank Form 1065, Return of Partnership Income, attached. The AAR may be filed by the partnership (i.e., by the tax matters partner (TMP)) for all partners, or by any partner claiming adjustments to its own return due to partnership items; see Secs. 6227(c) and (d) and 6231(a)(7).

Filed by partnership: If the partnership files the AAR, Sec. 6227(c)(3) requires attaching amended Schedules K-1 for all partners. Although it is common for the partnership also to send copies of the K-1s to the partners, this is not required; further, the Code does not mandate partners to amend their own returns if they receive amended K-1s. In general, IRS Service Centers process TMP-filed AARs. Depending on that review, the IRS might initiate an examination of the partnership, take no action or accept the AAR and process the effects as applied to the partners (i.e., as set forth in the amended K-1s). In such case, the partners will receive a “Notice of Beginning of Administrative Proceedings”; see Internal Revenue Manual (IRM) 4.31.4.2.3.2.

Filed by partner: A partner may also file an AAR for changes to partnership items affecting the partner’s return. Because a refund claim filed by the partner apparently puts the partner into disagreement with the partnership, it ensures that the Service will take action on the claim, either by (1) allowing the refund, (2) beginning a TEFRA examination of the partnership return or (3) converting the partnership items to nonpartnership items and using normal deficiency procedures to resolve the issue at the partner level; see IRM 4.31.4.2.3.1.

No guarantees: If a partner does not file a refund claim on its own, it is relying solely on the IRS to process the TMP-filed AAR and generate a refund claim as a flow-through adjustment to each partner. However, such reliance provides no guarantee that the partner will receive a refund. Although the IRS generally will process the claim and assess the tax, schedule a refund or start a TEFRA examination after a TMP files an AAR, it is not required to take any action; see Sec. 6227(c) and IRM 4.31.4.5.1.1.

In practice, “no action” frequently occurs. Thus, if a partner is due a refund because of partnership-level adjustments, that refund may never be processed through the TMP-filed AAR; partner action may be needed to obtain it. If a taxable partner has received an amended K-1 from the partnership indicating an overstatement, it should calculate and file the appropriate amended return itself (e.g., Form 1040X, Amended U.S. Individual Income Tax Return, or 1120X, Amended U.S. Corporation Income Tax Return). The partner should note on the amended return that the partnership has also filed an AAR, so that the IRS does not process duplicate refunds for the partner.

Limitations Period

Secs. 6227 and 6229 provide specific rules on the period of limitations for items flowing from TEFRA partnerships. For about 15 years following the TEFRA’s enactment, there was a debate as to whether these rules set forth the exclusive periods for determining the timeliness of adjustments of partnership items, or whether the partnership provisions were merely “minimum periods” supplementing the regular periods set forth in Secs. 6501 and 6511. Initially, the IRS took the position that Sec. 6229 described a separate and exclusive limitations period for partnership items; see Litigation Guideline Memo. (LGM) TL-81 (rev. 1, 3/7/91) and Rhone-Poulenc Surfactants and Specialties, L.P., 114 TC 533 (2000). However, in the late 1990s, the IRS reversed course and opined that the Sec. 6229 assessment limitations period was not exclusive to partnership items, but merely supplemented Sec. 6501 (i.e., whichever was longer applied); see LGM TL-81 (rev. 2, 9/25/98). The courts have adopted the IRS’s position; see, e.g., Rhone-Poulenc and Andantech L.L.C., 331 F3d 972 (DC Cir. 2003), aff’g on this point TC Memo 2002-97.

However, the IRS position on assessments (i.e., the longer of Sec. 6501 or 6229) is not the same as its position on Sec. 6227 refund claims; Sec. 6227 sets forth the exclusive period for making such claims. Sec. 6511(g) specifically bars refund claims stemming from partnership items except as provided in Secs. 6227 and 6230(c) and (d); see IRM 4.31.4.3(1). Further, there is a distinction between Secs. 6229 and 6227, according to the Service. Sec. 6229(a), in general, provides that the assessment period will not expire before three years after the date the partnership return was filed (or the due date excluding extensions, if later). Under Sec. 6227(a), however, a partner may file an AAR for a partnership item at any time within three years after the later of the date the partnership return was filed or the due date (excluding extensions).

Thus, taxpayers have “the worst of both worlds” as to the limitations periods—for additional assessments, the IRS has the longer of the partnership’s or partner’s limitations period to make adjustments, but the partnership or partner has only the (generally shorter) partnership period to make refund claims.

Extension of Limitations Period

As with Sec. 6501(c), under Sec. 6229(b)(1), the three-year assessment period can be extended for any or all partners by agreement between the partnership or a partner and the IRS. There is no corresponding provision in Sec. 6227 for extending the period to file a refund claim. However, Sec. 6227(b) ties the refund period to an extension of the assessment period; the period for filing an AAR is extended for the same period provided by agreement for assessment, and for six months thereafter. Thus, if the limitations period for refund claims needs to be extended for later potential adjustments, the partnership (or partner) will need to extend the assessment period for that year.

While this link of the refund period to the assessment period normally would be deemed undesirable by taxpayers, it also arguably carries with it an unexpected benefit: if the statutory extension agreement is reached within the “longer of” period discussed above (i.e., while the partner’s regular statute is open, but the partnership’s specific period is closed), apparently, the partnership refund statute, already closed, may be “reopened”; see Rhone-Poulenc, 114 TC at p. 562–563 (Halpern, J., concurring in part and dissenting).

Partnership Limitations Period More Restrictive

For TEFRA partnerships, the limitations period for filing refund claims stemming from certain credits or deductions is limited when compared to that available to nonpartnerships or non-TEFRA partnerships. For example, Sec. 6511(d)(3)(A) allows a 10-year period of limitations for filing a refund claim for taxes paid or accrued to a foreign country for which a credit is allowed under Sec. 901 or a treaty provision. A parallel provision is not available for TEFRA partnerships. Because the TEFRA refund period of limitations is exclusive, the partners cannot use their own limitations periods for these credits, which flow through the partnership.

Thus, certain partnership-level adjustments may not be allowed if the limitations period for the partnership has expired, even if the partner itself would be able to make a claim for that item if directly held. For this reason, either an extension of the period of limitations or a protective claim AAR must be filed at the partnership level for the partners to benefit from later adjustments to these partnership items.

From Daniel J. Wiles, J.D., and Ruth Perez, J.D., Washington, DC