The potential for court cases involving new and old partnership audit rules along with early opt-ins to the new rules and partnerships opting out “is my idea of tax procedure hell,” Tax Court Chief Judge L. Paige Marvel said June 16.
Speaking at the New York University School of Professional Studies Tax Controversy Forum in New York, Marvel said that for a long time after the new partnership audit regime enacted by the Bipartisan Budget Act of 2015 (BBA) takes effect, the Tax Court will simultaneously have cases under the new rules, the old rules under the 1982 Tax Equity and Fiscal Responsibility Act, early opt-ins to the BBA, and partnership cases not subject to either the new or the old rules which must be tried at the partner level. She said that after 35 years, the Tax Court is still finding issues of first impression within TEFRA.
On June 13 the IRS and Treasury reproposed (REG-136118-15) the highly anticipated rules for implementing the BBA rules, which take effect on January 1, 2018. Those proposed rules are little changed from the rules originally proposed early this year and have reserved on a couple of key questions.
Marvel said that the BBA is “riddled” with issues that courts will have to address. The BBA is much less detailed than TEFRA, so “gaps in those procedures will either be filled by regulations or will end up coming before the court for the court to try and deal with a solution,” she said.
One of those gaps is the designation and powers of the partnership representative, Marvel said. For example, what would happen if a partnership representative files a partnership case and then disappears, perhaps because of a conflict of interest? she asked. “The statute doesn’t address those kinds of problems,” she said.
“It will be up to the court and the litigants to help fill in those holes,” Marvel said, “and we are not entirely sure how that is going to play out. We don’t know what the answers are.”
Marvel said that another issue with any statute giving the Tax Court new jurisdiction is the question of the standard of review. “We are all struggling with the issue of how to fit administrative law concepts into what we do as litigants and the court,” she said.
Kathryn Keneally of DLA Piper, a former assistant attorney general for the Justice Department Tax Division, asked Marvel what would happen if a Tax Court case has one year subject to TEFRA and one year subject to the BBA. “At that point in time, I think the judge who has that case is going to say ‘I am retiring,’” Marvel quipped.
A Bit More on Push Out Comments
Speaking on a later panel, Gregory Armstrong, branch 7 senior technician reviewer, IRS Office of Associate Chief Counsel (Procedure and Administration), echoed and expanded upon IRS remarks made on June 15 regarding seeking comments on pushing out through tiered partnerships under the new rules, an issue the proposed regs reserved on.
“I know there are a lot of ideas out there of how it would work. This is an area we would like to see comments; the more specific the better,” Armstrong said, noting that tax administration issues would have to be considered in drafting any rule. Armstrong cited comments made May 31 by the Texas Society of Certified Public Accountants as a good example of the type of specificity the IRS is looking for on the tiered issue.
“We strongly believe a pass-through partner who receives a statement described in proposed section 301.6226-2 should also have the option to flow the adjustment through to its owners instead of paying tax on the adjustment,” the comments state. “We could support a limit in the number of ultimate owners to 100 Schedule K-1 recipients for each intervening partnership to keep the process manageable, consistent with the elect-out part of the proposed regulations. We might also agree that the adjustment that flows through should be not less than a certain amount, say $10,000, so the IRS is assured someone pays the tax and it is not diluted away through tiers of partnerships to an insignificant amount.”
Jerald David August of Kostelanetz and Fink LLP said one of the main areas drafters of partnership agreements are grappling with under the new regime is the alternative methods of payments under the new regime and how those methods affect partners’ economics, their capital accounts, their outside basis, and the basis of partnership assets.
“When the partnership itself pays tax, how do we economically adjust the interest of the former partners who may no longer be partners for taxes that they are relieved of having to pay without committing a Commissioner v. Glenshaw Glass [Co., 348 U.S. 426 (1955)] realization event to them?” August asked.
August added that fiduciary duty of a non-partner partnership representative should also be covered in a partnership agreement.
“I do think if you have any leverage in your partnership agreement, you’re going to want the partnership representative to act as a fiduciary. If that person is exculpated or indemnified even for acts of gross negligence, et cetera, you’ve got to wonder what you have under this system. You have the czar of the partnership deciding what everybody else will eat, when everybody else will sleep, and when everyone else will exercise,” August said. He contrasted the new regime to TEFRA, which has rights to notice, participation, and intervention. “Here, due process is thrown to the wind,” he said.
Tax Court Case Numbers
On the earlier panel, Marvel said that while the Tax Court is seeing the normally varied influx of cases, there “seems to be a not insignificant downturn in the number of filings in the court.” In the last few years, the Tax Court has closed approximately 2,000 to 3,000 more cases than were filed each year, she said.
The Tax Court is currently seeing 3,000 to 4,000 fewer filings annually than in the recent past, Marvel said, adding that she has not seen a corresponding uptick in tax cases filed in the district courts or the Court of Federal Claims. “That means that as a general proposition, at least it means to me, that the number of cases coming out of the enforcement mechanism are lower than they have been historically,” she said. The result is not surprising, because of the “fairly amazing” cuts to the IRS budget in recent years, reducing its enforcement footprint, she said.
Keneally said, “The tax system is vital to this country, and the under-funding of the IRS is a problem for both sides — for both government enforcement and for practitioners — because we need to have clients’ issues addressed. And it is frustrating.”