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Tax Matters Partner: Power & Responsibility Partnership Committee

American Bar Association, Tax Section January 21, 2011

1. Scope

a. The term “Tax Matters Partner” carries meaning only within TEFRA unified partnership audit and redetermination proceedings. See I.R.C. §§ 6221 – 6234.

i. General rule: All partnerships required to file a return are TEFRA partnerships. I.R.C. § 6231(a)(1)(A).

1. Exception: small partnerships are generally not subject to TEFRA proceedings. I.R.C. § 6231(a)(1)(B). Small partnerships have ten or fewer partners, each of whom is an:

a. Individual (other than a nonresident alien),

b. C corporation, or

c. Estate.

2. Exclusion from the exception: All partnerships with pass-thru partners are TEFRA partnerships. Treas. Reg. § 301.6231(a)(1)-1(a)(2); Rev. Rul. 2004-88 (disregarded entity wholly owned by individual is a pass-thru partner, so five-partner partnership is subject to TEFRA proceedings).

3. Election: a small partnership may elect into TEFRA. I.R.C. § 6231(a)(1)(B)(ii). Once made, the election remains valid until revoked.

2. What Does the Tax Matters Partner Do?

a. The TMP generally represents the partnership before the Internal Revenue Service, and the TMP enjoys the first option to represent the partnership in federal civil tax litigation. But every partner has a right to participate in a TEFRA proceeding, both in the administrative and judicial phases. See, e.g. I.R.C. § 6224(a); Tax Court Rule 247.

b. The TMP is required, by regulation, to keep the partners informed of the partnership proceedings. See generally Treas. Reg. § 301.6223(g)-1.

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3. Who May Be a Tax Matters Partner?

a. A general partner. I.R.C. § 6231(a)(7)(A); Treas. Reg. § 301.6231(a)(7)-1; Transpac Drilling Venture 1983-63 v. Commissioner, 16 F.3d 383 (Fed. Cir. 1994) (rejecting TMP designation made by limited partners).

i. A member-manager of a limited liability corporation is deemed to be a general partner. Treas. Reg. § 301.6231(a)(7)-2.

1. If no member-manager is identified in operating agreement, any member may be TMP.

b. General partner may be TMP only if that person was a general partner at some time during the tax year at issue, or is a general partner at the time of the designation.

c. An indirect partner may be a TMP. PAE Enterprises v. Commissioner, T.C. Memo 1988-222. This option is only available to the IRS, not the partnership, in almost all cases other than when a partner holds its partnership interest through a disregarded entity. A disregarded entity owned by a general partner or a disregarded entity owned by a managing-member may be a TMP. Rev. Rul. 2004-88. Therefore, a 0% general partner wholly owned by a partner with a profits or capital interest may be TMP.

d. A non-U.S. person may become TMP only with the consent of IRS. Treas. Reg. § 301.6231(a)(7)-1(b)(2).

4. How Does a Partnership Designate a TMP?

a. Designation—or termination—of TMP must follow the terms of Treas. Reg. § 301.6231(a)(7)-1. Three options to designate TMP:

i. Designate TMP on partnership return;

ii. Certification by current TMP of successor TMP; or

iii. Designation of TMP by general partners with majority of general partners profits interest.

b. Actions taken by a partner after TMP status has been terminated do not bind the partnership. Termination events:

i. Death of TMP;

ii. Incompetence of TMP declared by court;

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iii. Liquidation or dissolution of TMP;

iv. Partnership items become nonpartnership items under I.R.C. § 6231(c) (e.g., partner files bankruptcy). See Treas. Reg. § 301.6231(c)-7, Computer Programs Lambda Ltd. V. Commissioner, T.C. Memo. 1989-506). But see I.R.C. § 6229(b)(2)(providing that an extension of the period of limitations that was executed by a bankrupt TMP will be binding on all partners unless the IRS is properly notified of the bankruptcy).

v. Resignation of TMP, subsequent certification or designation of a new TMP, or a revocation.

c. Criminal investigation of the TMP does not automatically terminate TMP status, Chef’s Choice Product Ltd. V. Commissioner, 95 T.C. 388 (1990), but written notification that TMP is the subject of IRS criminal investigation and notice of conversion of partnership items to nonpartnership items under Treas. Reg. § 301.6231(c)-5 does terminate TMP status.

d. A partner with a disabling conflict of interest with the partnership cannot act as TMP if IRS knows of the conflict. See, e.g., In re Martinez, 366 B.R. 604 (E.D. La. 2007). But see River City Ranches #1 Ltd. V. Commissioner, T.C. Memo 2007-171 (no disabling conflict).

5. What Happens if There Is No TMP (or TMP is Terminated with No Replacement)?

a. The regulations provide ordering rules for IRS to select a TMP:

i. The general partner with the largest profits interest will be selected based on Schedules K-1 filed for the year at issue. Treas. Reg. § 301.6231(a)(7)-1(m)(2), Rev. Proc. 88-16, 1988-1 C.B. 691.

ii. IRS will select a TMP if the general partner with the largest profits interest cannot be determined, or if that person is disqualified (suspended from practice, incarcerated, outside the U.S., or cannot be located). See Treas. Reg. § 301.6231(a)(7)-1(p)(1), -1(p)(3).

iii. IRS may select a limited partner to serve as TMP if no general partner is eligible. Treas. Reg. § 301.6231(a)(7)-1(p)(3)(ii).

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6. What Are the Responsibilities of the TMP?

a. Generally, the TMP must give partners notice of all significant events in a TEFRA partnership proceeding. Nevertheless, TMP’s failure to do so does not affect the validity of the proceedings or determinations. Vander Heide v. Commissioner, T.C. Memo 1996-74.

b. Specific Notice Obligations:

i. Under Treas. Reg. § 301.6223(g)-1(a), the TMP must furnish the following items to all partners who are not entitled to notice from the Service under I.R.C. § 6223 (i.e., to all partners who are in a partnership with more than 100 partners and who have less than a one percent interest in the partnership’s profits):

1. The notice of beginning of the partnership proceeding (or “NBAP”); and

2. The notice of final partnership administrative adjustment (or “FPAA”).

ii. Under Treas. Reg. § 301.6223(g)-1(b)(1), TMP must furnish information concerning the following items to all “notice partners” and all representatives of “five-percent notice groups”:

1. The closing conference with the examining agent;

2. Proposed adjustments, rights of appeal, and requirements for filing a protest;

3. The time and place of any Appeals conference;

4. The acceptance by the Service of any settlement offer;

5. Consent to the extension of the period of limitations with respect to all partners;

6. Filing of a request for administrative adjustment on the partnership’s behalf;

7. Filing by the TMP or any other partner of any petition for judicial review under I.R.C. §§ 6226 or 6228(a);

8. Filing of any appeal with respect to any judicial determination provided for in I.R.C. §§ 6226 or 6228(a); and

9. Final judicial redetermination.

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iii. I.R.C. § 6230(e) requires the TMP to furnish the name, address, profits interest, and taxpayer identification numbers for all partners to the Service upon receiving an NBAP.

iv. I.R.C. § 6223(g) requires the TMP to keep each partner informed of all administrative and judicial proceedings for the adjustment at the partnership level of partnership items.

v. Tax Court Rule 241(f)(1) requires the TMP to send notice of filing of all Tax Court petitions to all other partners in the partnership within five days after receiving the Tax Court’s Notification of Receipt of Petition.

vi. Tax Court Rule 241(f)(2) requires the TMP to notify all partners of a Tax Court petition even when the TMP was not the partner who filed the petition within five days of receiving the petition from the petitioning partner.

vii. Tax Court Rule 241(g) requires the TMP to provide -- to any partner who makes a request -- a copy of any Tax Court petition to the requesting partner.

viii. During the Tax Court proceeding, the court and the parties must directly serve the TMP with all papers, even if the TMP did not file the petition. Tax Court Rule 246.

ix. The TMP -- who has the authority to settle a Tax Court case on behalf of all the partners -- must communicate the settlement and solicit responses from all of the partners before entering into the Tax Court decision. Tax Court Rule 248.

7. What are the Inherent Powers of the TMP?

a. Choice of Forum

i. I.R.C. § 6226(a) grants the first choice of forum to the TMP, who has 90 days from receiving the FPAA to file a petition in the Tax Court, the district court, or the Claims Court. A TMP with a small stake may choose district court despite inability of other partners to pay. (IRS will assess and collect from the other partners). Note that, although a TMP may also be permitted to file a petition during the subsequent 60-day period, by doing so the TMP loses the ability to select the forum.

ii. I.R.C. § 6228(a) gives the TMP the choice of forum if the Service disallows any part of an administrative adjustment request filed by the TMP on behalf of the partnership.

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b. Settlement

i. I.R.C. § 6224(c)(3)(A) provides that the TMP can enter into a binding settlement agreement at the administrative stage of the TEFRA proceeding, but the settlement only binds non-notice partners.

ii. If a non-notice partner files a “no-settlement” statement with the Service, he is not bound by the TMP’s settlement. I.R.C. § 6224(c)(3)(B).

iii. Tax Court Rule 248(a) gives the TMP the authority to bind all partners in the partnership to a settlement reflected in a Tax Court decision.

c. Statute of Limitations

i. Under I.R.C. § 6229(b)(1)(B), the TMP has the power to execute an extension of the statute of limitations for the partnership items and affected items of all partners in the partnership.

d. Substituted Returns

i. TMP may file a request for an administrative adjustment (AAR), and request that the AAR be treated as a substituted return. I.R.C. § 6227(c)(1). If IRS accepts the request, the adjustments will be treated as computational adjustment (that is, not subject to TEFRA or deficiency proceedings.) IRS rarely agrees to this.

8. Some Partnership Agreements Give the TMP Too Much Power – Examples and War Stories

a. Tax shelters where promoter is the TMP. See, e.g., Philips v. Commissioner, 272 F.3d 1172 (9th Cir. 2001) (Hoyt partnerships).

b. TMP with no stake in the fight.

c. TMP leaves the partnership (or liquidates), and there is no general partner leftto replace him.

d. TMP behaves badly (no notice to other partners, conflict of interest, etc.)

e. TMP with power to make all tax elections including § 704(b) “book up” election that dramatically changed how Cancellation Of Debt (COD) income would be allocated because book up would have reversed prior losses with non-taxable book-up income vs. taxable COD income if no book up.

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9. Top Mistakes when Drafting Tax Matters Section of Partnership Agreement

a. Appointing an ineligible TMP, including limited partners, non-managing members, and non-partners;

b. Too narrowly, or too broadly, defining who may be TMP;

i. Consider limiting TMP designations to partners who have an economic interest in any tax dispute arising in a given year. For example, the TMP rules permit the partners to designate someone as TMP if that person is a partner “at the time the designation is made” regardless of whether that person was a partner during the year at issue. That person, however, may not have an interest in a tax dispute. Therefore:

1. Designate someone who has an interest in the potential tax dispute or

2. Draft the agreement in such a way that the person who has an interest in the potential tax dispute is eligible to be designated as TMP later if such a dispute should arise.

c. Imposing no restriction on TMP’s ability to extend the statute of limitations or choose litigation forums;

i. While these restrictions may give rise to a cause of action against a TMP who violates them, it is not clear that they have any affect on the validity of the TMP’s actions.

d. Failing to provide how costs of TEFRA proceedings, including litigation, will be covered;

e. Giving TMP power to make substantive tax elections with little or no limitation;

f. Failing to provide deadlines for partners and the partnership to provide information to each other;

g. Failing to provide for minimum tax distributions if necessary (when TMP chooses district court litigation, for instance).

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10. Common Myths

a. Only TMP can sign the return.

b. The TMP can settle the partnership examination on behalf of the partners.

c. A manager (non-member) can be a TMP.

d. Query: Can a partner with no economic stake in the tax year at issue (e.g., 0% G.P. be a TMP?

11. Other Planning Considerations

a. Controlling the proceeding while having a negligible interest

i. A “member-manager” can have a very small interest and be designated as TMP. Thus, for example, if the members want a non-member to be TMP, granting a very small membership interest is sufficient to be able to designate that member as TMP.

b. Controlling a prior year

i. A newly admitted member may be designated as TMP for prior years. This often enables an entity to admit a member (effectively) for the purpose of controlling the proceeding.

c. Contracting TMP responsibilities

i. If the person who the members want to be TMP cannot own an economic interest or cannot be a general partner or member manager, the parties can by contract agree that the designated TMP will be bound to take direction from the non-member.

d. Minimizing deposits

i. TMP designations can be changed up until the moment of filing a court petition for the purpose of affecting:

1. The amount of the necessary jurisdictional deposit.

2. Who controls the proceeding.