Vince Nardone: Tax and Controversy

Frequently Asked Questions Regarding the Unified Partnership Audit And Litigation Procedures

 Guest Author: M. Pilar Honer, Esq., Columbus, Ohio

 

The Chief Counsel’s office recently published a notice that answered the most frequently asked questions regarding the unified partnership audit and litigation procedures set forth in  Internal Revenue Code (the “Code”) §§ 6221-  6234 (the “TEFRA partnership procedures”). 

 

The following is a background of how partnerships are taxed and how the Service assesses additional tax on the partnership.  First of all, partnerships do not pay federal income taxes.  Instead, partnerships must file annual information returns reporting the partners' distributive shares of tax items. See Code §§ 701; 6031.  The partners then report their distributive shares of the tax items on their respective federal income tax returns. See Code § 701 through Code § 704.  And, the partnership items flow through, appearing in the computation of the taxable income of the partners and affecting nonpartnership items on a partner's tax return. See Code § 6230(a)(1); Code § 6231(a)(4) through Code § 6231(a)(6); Treas. Reg. § 301.6231(a)(5)-1.  There are two types of affected items: those that require only a computation of the tax immediately assessable; and those that require partner-level determinations made through a notice of deficiency. See Code § 6230(a); Reg. § 301.6231(a)(6)-1.

 

To remove the substantial administrative burden occasioned by duplicative audits and litigation, and to provide consistent treatment of partnership tax items among partners in the same partnership, Congress enacted the TEFRA partnership procedures.  Under the TEFRA partnership procedures, before the Service may assess the tax liability of the partners, the Service must determine the tax treatment of partnership items in a partnership-level proceeding. See Code §§ 6221, 6225.  Determinations at the partnership level are binding upon all direct and indirect partners of the partnership.  The Service must notify partners of when the audit of the partnership begins (a notice of beginning of administrative proceeding or the “NBAP”), and of proposed adjustments to the partnership's information return, if any (a notice of final partnership administrative adjustment or the “FPAA”). See Code § 6223.  During the ninety-day period after the mailing of the notice of FPAA, the tax matters partner (the “TMP”) may file a petition for judicial review. See Code § 6226(a).  If the TMP does not file a petition within that ninety-day period, any notice partner or any five percent group may, within sixty days after the close of the TMP's ninety-day period, file a petition for judicial review. See Code § 6226(b).  

 

This is a very brief overview of the TEFRA partnership procedures.  There are many technical details and nuisances with these procedures that the notice explains.  For further detail see the attached FAQs and answers. Download FAQs regarding TEFRA

 

 

Internal Revenue Service, Office of Professional Responsibility Announces Enforcement Actions

In Announcement 2009-68, the Office of Professional Responsibility (OPR) published its recent disciplinay sanctions involving attorneys and certified public accountants.  These individuals are subject to the regulations governing practice before the Internal Revenue Service (IRS), which are set out in Title 31, Code of Federal Regulations, Part 10, and which are published in pamphlet form as Treasury Department Circular No. 230. The regulations prescribe the duties and restrictions relating to such practice and prescribe the disciplinary sanctions for violating the regulations.  These announcements continue to emphasize the Internal Revenue Service’s commitment to the oversight of tax professionals.  Please see the announcement attached to this blog entry.

Download OPR - announcements

Reclassification of Officer Compensation

Guest Author: M. Pilar Honer, Esq., Columbus, Ohio

 

The Service recently issued an internal memorandum regarding the taxation of an officer’s compensation when a business fails to report the compensation on a Form W-2.  As background, businesses must pay Federal Insurance Contributions Act (“FICA”) taxes on wages issued to employees.  The FICA taxes include the Social Security and Medicare taxes.  But if a business classifies a worker as an independent contractor instead of an employee or if it treats compensation as a distribution instead of wages, it avoids paying FICA taxes.  When the Service determines that the business misclassified the worker or the wages, however, the Service will assess the delinquent FICA taxes.  This memorandum goes through various legal avenues a business has to mitigate the imposition of FICA taxes and explains how the Service would apply each of them to a situation involving the reclassification of an officer’s compensation.

The first avenue is through Code §§ 3509 (a) and (b), which require the Service to use the lower income tax withholding rates in all reclassification cases, unless the taxpayer intentionally disregarded the rules and regulations.  Thus, in every reclassification case, the memorandum advises the Service personnel to initially determine whether the taxpayer intentionally disregarded the rules and regulations.  The Service points out that in situations involving the reclassification of an officer’s compensation it is easy for the Service to establish that the taxpayer intentionally disregarded the rules and regulations.  This is because officers who perform services for a corporation are employees by statute.  See Code §§ 3401(c), 3121(d)(1), and 3306(i)—officers are considered employees for Federal Income Tax Withholding (“FITW”), FICA, and Federal Unemployment Tax Act (“FUTA”) tax purposes.  Thus, in cases where the officer is aware of this rule, performs substantial services for the corporation, and intentionally structures his pay as a distribution instead of wages, the Service has a strong case that the corporation intentionally disregarded the rules and regulations.  The Service, however, must still develop the facts in each case to support their position for the taxpayer’s intentional disregard for the rules and regulations. 

Another avenue of relief is Code § 530 of the Revenue Act of 1978, which provides complete relief of employment tax liability so long as the following conditions are met:

1.      The employer did not treat the individual as an employee;

2.      The employer filed federal employment tax returns on a consistent basis with the employer’s treatment of the worker as a non-employee;

3.      The employer had a reasonable basis for not treating the individual as an employee; and

4.      The employer did not treat any individual in a substantially similar position as an employee.

The Service notes that in cases involving the reclassification of an officer’s compensation, it is hard for a business to satisfy requirement number 3 above.  Since officers are employees by statute, it is hard for a business to argue that there was a reasonable basis for not treating the officer as an employee.  See Code §§ 3401(c), 3121(d)(1), and 3306(i).

Finally, the last avenue the Service addressed in this memorandum is the classification settlement program (“CSP”).  The CSP establishes a standard settlement agreement in a worker classification case, which allows a business and the tax examiner to resolve worker classification cases as early as possible in the administrative process. See Employment Tax Handbook, Section 4.23.6.  CSP is available for cases involving officer compensation if the business treated the officer as an independent contractor instead of an employee and timely issued Form 1099s. See Employment Tax Handbook, Section 4.23.6.7.  Thus, CSP is not available where either (1) no Form 1099 was filed, even if schedule K-1 was issued treating the officer as a partner or (2) the officer was treated as an employee but the officer’s compensation was reported as distributions instead of wages.

See the attached IRS memorandum and the relevant sections of the Employment Tax Handbook. Download IRS Memorandum and Employment Tax Handbook - Reclassification of Officer Compensation