IRS Practice & Procedure Tax Controversy & Dispute Resolution

IRS Practice & Procedure Tax Controversy & Dispute Resolution March 23, TEI Florida Chapter IRS Liaison Meeting Deerfield Beach, Florida

Agenda Part I Uncertain Tax Position Statement: Background and Recent Developments Foreign Bank Account Report (FBAR): Technical Aspects for Consideration Understanding the Basics and Issues Surrounding EIN Assignment and "Check the Box" Entity Classification Part II Foreign Tax: Election to Deduct or Credit IRS Implementation of Unique Reference Identification Number Requirement Form 1139: Utilizing Losses and Credits to Successfully Obtain a Quick Refund Statute of Limitations: Nuts and Bolts Protective Claims Part III Quality Examination Process (QEP) TEFRA Partnerships: Background, Penalty Application & Audit Procedures 2

www.pwc.com Part I Devin W. Blackburn

Uncertain Tax Position Statement: Background and Recent Developments 4

Uncertain Tax Positions Development of Schedule UTP Need for increased transparency - Currently, the IRS spends as much as 25% of audit time searching for issues rather than actually auditing issues - Primary goal of the IRS is to reduce time spent searching for issues, and enhance focus on completing examinations Reasons IRS released Schedule UTP - Political environment - Economic factors - Challenges sustaining tax base Final Schedule UTP released on September 24, 2010 5

Uncertain Tax Positions Key Elements of Reporting Who Must File? - Corporate taxpayers who file: Form 1120 Form 1120-F Form 1120-L Form 1120-PC Phased Effective Date - Calendar year 2010 for corporate taxpayers with total assets $100 Million - Calendar year for corporate taxpayers with total assets $50 Million - Calendar year 2014 for corporate taxpayers with total assets $10 Million 6

Uncertain Tax Positions Key Elements of Reporting Disclosure on Schedule UTP is required if two criteria are met: 1. Corporation has taken a tax position on its U.S. Federal income tax return for the current tax year or a prior tax year; and 2. Either the corporation or a related party has recorded a reserve with respect to that tax position for U.S. Federal income tax in audited financial statements, or did not record a reserve for that tax position because the corporation or related party expects to litigate the position. The initial recording of a reserve will trigger reporting of a tax position taken on a return. However, subsequent reserve increases or decreases with respect to the tax position will not. Transition Rule A corporation is not required to report a UTP for a tax position taken in a tax year beginning before January 1, 2010 7

Uncertain Tax Positions Key Elements of Reporting Taxpayers must provide a concise description for each tax position listed on Schedule UTP, including: - A description of the relevant facts affecting the tax treatment of the position; and - Information that can reasonably be expected to apprise the IRS of the identity and nature of the tax position. The concise description should not include: - Assessment of the hazards of a tax position; - Analysis of the support for or against the tax position; or - Any privileged information. 8

Uncertain Tax Positions IRS Implementation & Guidance IRS will not assert waiver of privilege during examinations solely because taxpayer has provided the document to their independent auditor (Announcement 2010-76) - Does not apply if taxpayer has waived privilege - Does not apply to requests for tax accrual workpapers with respect to the taxpayer s involvement in listed transactions and unusual circumstances IRS has established a centralized repository to process all Schedule UTPs shortly after the filing of the return Schedule UTP is provided to examination teams to review in conjunction with the CAP program - CAP Account Coordinators may request copies from taxpayers to expedite review - Examiners may consult with taxpayers to confirm intent of disclosures - Examiners may not ask taxpayers about the make-up of reserves 9

Uncertain Tax Positions Planning for Schedule UTP Develop an effective and efficient UTP reporting process beginning with the initial calendar tax year of reporting - Identify positions to be reported given changes in reserves - Develop or modify existing processes and operational controls to capture necessary information to comply with reporting requirements Strategically address IRS examination issues Reduce or eliminate uncertainty prior to the release of the year-end financial statements and/or prior to the filing of the initial Schedule UTP 10

Uncertain Tax Positions Compliance and Management of Schedule UTP Now Initial Disclosure Ongoing Assess the process consider the impact on resources, controls and procedures Determine additional information needed during provision cycle Mitigate uncertainty Prepare descriptions Consider solutions for compliance or technology issues Improve infrastructure and processes Streamline and enhance the use of financial data Determine IRS examination strategy Communicate UTP and other tax risk matters to the Board Evaluate and document UTPs as transactions occur Develop a strategy to manage all disclosures Monitor legislative and judicial changes that impact Schedule UTP 11

Foreign Bank Account Report (FBAR): Technical Aspects for Consideration 12

Foreign Bank Account Reporting (FBAR) What to File Form TD F90-22.1 Part I and Part V for consolidated report Part IV for individuals with signature authority only and no financial interest When to File By June 30 th of the year following the year in which the account is maintained No process for requesting an extension available Mailbox Rule does not apply Under the simplified reporting rules, a US entity may file a consolidated FBAR report on behalf of itself and entities in which it owns a greater than 50% interest by vote or value Other Rules If reporting signature authority of 25+ accounts, limited information regarding such foreign accounts is required FBAR is filed separately from an income tax return, but must be disclosed on returns 13

Foreign Bank Account Reporting (FBAR) Specifics of reporting requirements U.S. Person U.S. citizen or resident Any entity formed under laws of U.S. (corporations, partnerships, LLCs, estates, trusts) Beginning with 2010 filing, persons in and doing business in US on regular and continuous basis Financial Account Bank or securities accounts, insurance and annuity policies with a cash value, mutual funds or similar pooled funds Exceptions: Bonds, notes, stock certificates Hedge funds (currently, but see FATCA) Financial Interest or Signature Authority Owner of record or legal title Authority of an individual to control the disposition of money, funds, assets held in financial account by direct communication to person maintaining account Test Whether financial institution will act upon direct communication Foreign Country Any geographic area outside of the US Situs of the account, not the situs of the institution controls Account with a foreign bank at a branch in US is not a foreign account Account with a US bank at a branch outside of US is a foreign account If these requirements are met, FBAR must be filed if the aggregate balance of foreign accounts is greater than $10,000 14

FBAR Compliance Entity s Consolidated FBAR Filing Collect data necessary to identify foreign financial accounts owned by the consolidated filer and all entities in which the consolidated filer has a greater than 50% interest Prepare and file FBARs by June 30 Officers and Employees with Signature or Other Authority Identify US citizens and residents with signature or other authority over foreign financial accounts Determine to the extent possible application of FBAR exceptions Communicate information about FBAR reporting and account information to affected employees - Employees need the information in time to complete Line 7 of Schedule B of the Form 1040 Decide what FBAR compliance assistance to provide to employees 15

Foreign Bank Account Reporting (FBAR) Signature Authority Exceptions Foreign Parent Publicly traded on a US exchange (ADR) U.S. Parent Publicly traded on a US exchange SEC Act 12(g) filer (not publicly traded on US exchange) Regulated banks and financial institutions registered with SEC or CFTC RIC Authorized Service Provider registered and examined by SEC 1010.350(f)(2)(iv) 1010.350(f)(2)(iv) 1010.350(f)(2)(v) 1010.350(f)(2)(i) & (ii) 1010.350(f)(2)(iii) Employee of the Entity Covered by (iv) exception and account owned by the entity Covered by (iv) exception and account owned by the subsidiary Covered and account owned by the subsidiary by (v) exception Covered by (ii) exception and account owned by the subsidiary Covered by (iii) exception and account owned by the subsidiary Employee of a Foreign Sub Not covered by the exception Not covered by the exception Not covered by the exception Not covered by the exception Not covered by the exception Employee of a U.S. Sub Not covered by the exception; no consolidated report Covered if account included in the consolidated FBAR filed for parent and subsidiary and account owned by the subsidiary Not covered by the exception Not covered by the exception Not covered by the exception Employee employed within the group, but not by the owner of the account Not covered by the exception Not covered by the exception Not covered by the exception Not covered by the exception Not covered by the exception 16

FBAR Examples and Decision Tree 17

Example 1 U.S. Parent (public company) U.S. parent employee (U.S. person) No employee filing requirement Foreign Bank Accounts (employee has signature authority, but no financial interest) 18

Example 2 U.S. Parent (public company) U.S. parent employee (U.S. person) Foreign sub Employee required to file Foreign Bank Accounts (employee has signature authority, but no financial interest) 19

Example 3 U.S. Parent (public company) Foreign sub employee (U.S. person) Foreign sub Employee required to file Foreign Bank Accounts (employee has signature authority, but no financial interest) 20

Example 4 U.S. Parent (public company) U.S. employee seconded to foreign sub (U.S. person) Foreign sub Employee required to file Foreign Bank Accounts (employee has signature authority, but no financial interest) 21

Example 5 U.S. Parent (public company) U.S. employee seconded to foreign sub (U.S. person) Foreign sub Employee required to file Foreign Bank Accounts (employee has signature authority, but no financial interest) 22

Example 6 U.S. Parent (public company) Foreign sub employee (U.S. person) Foreign sub (disregarded entity) Employee required to file Foreign Bank Accounts (employee has signature authority, but no financial interest) 23

Example 7 U.S. Parent (public company) Foreign branch employee (U.S. person) Foreign branch (not a legal entity in the foreign country) No employee filing requirement Foreign Bank Accounts (employee has signature authority, but no financial interest) 24

Example 8 U.S. Parent (private company*) U.S. parent employee (U.S. person) Employee required to file Foreign Bank Accounts (employee has signature authority, but no financial interest) * Not a SEC 12(g) filer (generally more than $10 million in assets and more than 500 or more shareholders) 25

Example 9 Foreign Parent (public company ADRs on NYSE) Foreign parent employee (U.S. person) No employee filing requirement Foreign Bank Accounts (employee has signature authority, but no financial interest) 26

Example 10 Foreign Parent (public company ADRs on NYSE) U.S. sub employee (U.S. person) U.S. sub Employee required to file Foreign Bank Accounts (employee has signature authority, but no financial interest) 27

FBAR Decision Tree to Identify Required Filers 1. Identify foreign accounts Bank Accounts Securities Accounts Other Financial Accounts On an account by account basis, perform the following step: 2. Identify officers and employees with signature or other authority Continue to Step 3 28

FBAR Individuals with signature or other authority 3. Is the individual a citizen or resident of the US or a US territory or possession? Yes No 4. Is the individual an officer or employee of the entity that owns the account? STOP No filing requirement with respect to this account Yes No 5. Identify type of entity that owns or maintains the account (or provides services in the case of an authorized service provider) Continue to Step 6 FBAR must be filed by the employee with respect to this account 29

FBAR Entity that owns or maintains the account 6. Is the entity (foreign or domestic) publicly traded on a US exchange, an SEC 12(g) filer ($10 million in assets and 500 or more shareholders), a covered regulated bank or financial institution, or a regulated RIC Authorized Service Provider? No Yes 7. Is the account owned by a US subsidiary that is greater than 50% owned by a US parent AND the account is included in the US parent s consolidated FBAR filing? STOP No filing requirement with respect to this account Yes No STOP No filing requirement with respect to this account FBAR must be filed by the employee with respect to this account 30

IRS Enforcement 31

Foreign Bank Account Reporting (FBAR) Risks of Non-Compliance Six year statute of limitations from the FBAR due date - June 30, 2013 Extended filing deadline for individuals with Signature Authority Failure to File Penalties - Willful Violation Greater of $100,000 or 50% of highest balance in accounts - Non-Willful Violation - $10,000 per unreported account 32

Foreign Bank Account Reporting (FBAR) Illustration of potential penalties Assume a taxpayer has the following amounts in a foreign account over a period of years, and willfully fails to file complete and correct FBARs Year Amount on Deposit Interest Income Account Balance Penalties 2006 $1,000,000 $50,000 $1,050,000 $525,000 2007 $50,000 $1,100,000 $550,000 2008 $50,000 $1,150,000 $575,000 2009 $50,000 $1,200,000 $600,000 2010 $50,000 $1,250,000 $625,000 Total Penalties $2,875,000 33

Foreign Bank Account Reporting (FBAR) OVDI Offshore Voluntary Disclosure Initiative - No Set Deadline - Maximum Penalty 27.5% of highest aggregate balance in foreign accounts during tax years within the OVDI period - Lowered Penalty 12.5% or 5%, but must qualify 34

Foreign Bank Account Reporting (FBAR) Next Steps Appoint someone in your company to be responsible for FBAR matters Consult stakeholders and external advisors regarding FBAR requirements and how they impact your business Create procedures to gather and process information Consider available technology assistance for more efficient FBAR compliance Document FBAR procedures and management/employee communications, set timetable Prepare FBARs for entities required to file Participate in OVDI to take advantage of reduced penalties Consider whether to prepare FBARs for employees who are required to report company accounts 35

Understanding the Basics and Issues Surrounding EIN Assignment and "Check the Box" Entity Classification 36

Default and Elective Classifications of Domestic Entities Default Classification Rules of Business Entities - Corporation Organized under a Federal or State Statute, if the statute refers to the entity as incorporated or as a corporation, corporate body - Other Business Entity Unless otherwise elected, it is: A partnership if it has two or more members; Disregarded as an entity separate from its owner if it has a single owner. 37

Default and Elective Classifications of Foreign Entities What is a foreign entity? - An entity organized under laws other than a U.S. State or a Federal Statute Foreign entities classified as per-se corporations for federal tax purposes are not eligible to make an entity classification election (See Treas. Reg. 301.7701-2(b)(8) for a list of such per se corporations per country) Default Classification Rules - Foreign Eligible Entities Unless otherwise elected, it is: A partnership if it has two or more members and at least one member does not have limited liability; An association if all members have limited liability; or Disregarded as an entity separate from its owner if it has a single owner that does not have limited liability. 38

Form 8832 Entity Classification Election Due Date - Within 75 days following the desired effective date of the election; or - No more than 12 months prior to the desired effective date. Late Election Relief - Rev. Proc. 2009-41 Electing entity must demonstrate that: Entity has not filed federal income tax or information return for the first year in which its election was intended; or entity timely filed all required federal tax returns and information returns consistent with its requested classification; Entity has reasonable cause for its failure to timely make the election; 3 years and 75 days from the requested effective date of the election has not passed. 39

Form 8832 Entity Classification Election What to watch for: - Obtain EIN for foreign entity prior to filing Form 8832 - Ensure that the Form is signed by each member of the electing entity who is an owner at the time the election is filed - Ownership change during lookback period Each person who was an owner between the date the election is effective and the date the election is filed, but not at the time of the filing must also sign the election - Attach a copy of Form 8832 to the entity s U.S. federal income tax return for the year in which the election is effective - If Form 8832 is filed to change an entity s federal tax classification, such entity may not file another Form 8832 to change its classification again for 60 months. Exception: If there has been a 50% ownership change 40

Issues Surrounding EIN Assignment Dormant Entities Example: - In the midst of a reorganization in Year 1, Profit Corporation organizes multiple LLCs for which it obtains EINs and elects to have each taxed as a corporation. After the reorganization the LLCs do not have any activity, but continue to exist. In Year 4, each LLC receives IRS notices regarding Form 1120 filing requirements. Erroneous or Multiple EINs Example: - In Year 1, ACME Corporation is formed and a representative obtains an EIN. In Year 3, it changes its name to ABC Corporation and a representative erroneously applies for an EIN. In Years 3 and 4, ABC Corporation files Form 1120 under the second erroneously EIN. However, in Year 5, Form 1120 is somehow filed under the originally issued EIN. The IRS return processor realizes that the EIN does not match the entity name, and assigns a third EIN. 41

www.pwc.com Part II Janice Flood

Foreign Tax: Election to Deduct or Credit 43

10 Year Statute to Elect Foreign Tax Deduction Maybe Not In recent CCA 201136021 and 04008, the IRS determined that the filing of an amended return to claim a refund based on a change from a foreign tax credit to a foreign tax deduction is not timely under I.R.C. 6511(d)(3)(A). The IRS states that the 10 year period of limitations provided by I.R.C. 6511(d)(3) only applies if the claim for refund or credit relates to an overpayment attributable to any taxes paid or accrued for which credit, and only a credit, is allowed against U.S. income tax under I.R.C. 901. - The 10 year period is not applicable if the claim for refund or credit results from a deduction of foreign income taxes paid. 44

10 Year Statute to Elect Foreign Tax Deduction Maybe Not CCA 04008 states that pursuant to the plain language of I.R.C. 6511(d)(3)(A), the 10 year period of limitations only applies if the claim for refund or credit related to an overpayment attributable to any taxes paid or accrued for which credit is allowed against U.S. income tax under I.R.C. 901 (emphasis in CCA). - The CCA emphasizes allowed credit in the section, instead of the usage of allowable credit; the distinction between these two words is an important one according to the CCA. - Citing the Random House Dictionary, the CCA states that allowable is defined as that which may be allowed, legitimate, permissible. In seeming contrast, according to the CCA, allowed is defined as that which is permitted. 45

Deduction vs. Credit IRS Position The CCA attempts to apply its distinction of allowed and allowable to the application of I.R.C. 6511(d)(3). It first establishes that I.R.C. 164(a)(3) provides that a deduction is allowed for the taxable year within which foreign income, war profits, and excess profits taxes are paid or accrued. The CCA then provides: Under I.R.C. 275(a)(4) and the regulations under IRS I.R.C. 164 and 901, a deduction for foreign taxes paid or accrued is allowable unless and until the foreign tax credit has been claimed with respect to the such taxes [emphasis added]. Once a credit is taken, such deduction is not allowed; similarly a foreign tax credit is allowable for such taxes unless and until a deduction has been claimed at which point the credit is not allowed. The IRS pairs the term allowed with a requirement that the foreign tax credit actually and finally be claimed and produce a tax benefit for the taxpayer in order to be allowed. Therefore, in reading 6511(d)(3), an allowed credit, to which the special 10 year period of limitations applies, can only refer to the foreign tax credit, and not the allowable foreign tax deduction. 46

Deduction vs. Credit Allow or Allowable that is the Question Allow versus Allowable - These two terms cannot be given static definitions that carry through every Code section. The definition of each word is more appropriately determined section by section based on the Congressional purpose and intent of the particular section. Distinctions between the Code's usage and definition of allow and allowable cannot simply be made by referencing a single English dictionary as the IRS has done in the CCA. - Dictionaries have multiple and different definitions of allowed and allowable. - Example: The Oxford English Dictionary defines allowed among other things as not prevent the occurrence of; not prevent a person from doing something; permit; and allowable as "appropriate, satisfactory, permissible, tolerable, legitimate." 47

Code Usage of Allow and Allowable The usage of the terms allow and allowable in the Code are too great and varied to equate one particular definition to each word for each particular Code section the words are used in. Usage in Code - "allow" 44 - "allowed" 517 - "allowable" 312 - "allowance" 517 - "shall be allowed 345 - "may be allowed" 10 In other words, allow in one Code section could have a different denotation and connotation than in another Code section based on the Congressional intent for that section; the same can be said for the term allowable. 48

Supreme Court Interpretation Thus, to say that allow always means X, and allowable always means Y in every Code section, would be taking an overly simplified, and unreasonable, position. Therefore, there is no plain or dictionary definition of the terms that can be derived from the term allowed in section 6511(d)(3)(A). In United States v. Hemme, 476 U.S. 558 (1986) the Supreme Court held that allowed as used in the Code does not have a standard definition but must be interpreted by context and Congressional Intent - Addresses whether there is a distinction in meaning between "allowed" and "allowable." - "The term 'allowed' is a familiar denizen of the Tax Code. In some sections it appears unqualified, while in others, Congress has clearly embellished the term with the 'tax benefit" qualification..." - In Hemme, the Government argued that "allowed" simply meant "allowable" or provided by the Code, and did not require any actual claim or benefit to the taxpayer. - The Supreme Court held that the term "allowed" has no fixed meaning in the Code, but the context of the term needs to be examined to determine its meaning in a given case. 49

Foreign Tax: Deduction vs. Credit I.R.C. 901 and Treasury Regulations The IRS concludes that the statute of limitations for claims of refunds where the overpayment is related to a choice of a deduction is three years. However, it is clear that under I.R.C. 901 and its regulations, the period is 10 years. While the CCA recognizes the election under I.R.C. 901, it does not recognize that its interpretation conflicts with those provisions. - I.R.C. 901(a) provides, in pertinent part, that: Such choice [of credit or deduction] for any taxable year may be made or changed at any time before the expiration of the period prescribed for making a claim for credit or refund of the tax imposed by this chapter for such taxable year. Treas. Reg. 1.901-1(d) provides the times prescribed for making the credit/deduction choice, and hence the period of limitations for claims resulting from that choice: (d) Period during which election can be made or changed. The taxpayer may, for a particular taxable year, claim the benefits of section 901 (or claim a deduction in lieu of a foreign tax credit) at any time before the expiration of the period prescribed by section 6511(d)(3)(A) (or section 6511(c) if the period is extended by agreement).[emphasis added] 50

Foreign Tax: Deduction vs. Credit Treasury Regulation Not Considered by CCA Thus, in the context of the equating by I.R.C. 901(a) of conterminous periods for making the election and the refund period of limitations, this regulation clearly states that the period of limitations for refunds attribution to foreign tax deductions is the 10 year period (the only period prescribed by section 6511(d)(3)(A)). In its current position, the CCA fails to recognize that the above regulation in the context of the statute specifies that a taxpayer may claim a foreign tax credit under I.R.C. 901 or claim a deduction in lieu of a foreign tax credit, and obtain a refund at any point during the 10 year period of limitations. 51

URI: IRS Implements Unique Reference Identification Number Requirement 52

URI Number Little known requirement Beginning with U.S. federal tax return filed for the tax year, taxpayers who file certain forms will be required to provide a Unique Reference Identification Number (URI) or Employer Identification Number (EIN) for all foreign entities reported on the following forms: 1. Form 5471 (Information Return of US Persons With Respect To CFCs) 2. Form 8858 (Information Return of US Disregarded Entities) 3. Form 8865 (Return of US Persons With Respect to Certain Foreign Partnerships) A URI is a alpha numeric number limited to 50 characters or less that is selected by the taxpayer. The taxpayer need not apply nor have approved by the IRS. Once a URI is selected by a taxpayer it must remain the same for the foreign entity to which it is assigned. If a liquidation or disposition of the entity occurs the URI may not be transferred or used with a different entity. 53

URI Number The IRS website suggests that where multiple taxpayer each have an independent filing requirement with respect to a single foreign entity, a URI will be established separately by each taxpayer. Change of ownership of the foreign entity may result in the need to correlate the URIs - Example 1 In the case of a merger or acquisition, Form 5471 must correlate a new URI assigned to the foreign corporation by the acquired entity with the previous URI used by the target. - Example 2 If Form 8832 is filed to change a foreign entity s classification to be disregarded, then the URI previously used on Form 5471 must be correlated to the new URI used on Form 8858. 2011 Forms 5471, 8858 and 8865 have been updated to include a line for reporting of the URI. Although the instructions to these forms state the URI is mandatory for years beginning in, the IRS website states that a penalty may be assessed for failure to provide the URI. 54

URI Number In brief, it appears that the implementation of URIs is part of the IRS s continued enforcement efforts in the international area. The use of URIs will allow the IRS the ability to identify taxpayers foreign entities and follow their activities more closely. The IRS has been working with software providers to ensure they are prepared to handle the URI implementation. However, the IRS has said little to taxpayers about the new requirement and therefore taxpayers should take the time this year to ensure their system will comply with the new requirements. 55

Form 1139: Utilizing Losses and Credits to Successfully Obtain a Quick Refund 56

Utilizing Losses & Credits to Obtain a Quick Refund via Form 1139 Form 1139, Corporation Application for Tentative Refund - Carry back NOLs, net capital losses and business credits NOLs 2 years Capital Losses 3 years Business Credits 1 year - Timing Must be filed within 12 months after the end of the tax year in which the loss or credit was generated; but May not be filed before the filing of Form 1120 for the year in which the loss or credit was generated (Exception: Barebones Return) Barebones Return - Ability to obtain refund before the filing of Form 1120 for the year in which the loss or credit was generated First File Barebones Return for Form 1120 Second File Form 1139 Last File Superseding Return for Form 1120 by extended due date 57

Utilizing Losses & Credits to Obtain a Quick Refund via Form 1139 Form 1139 Form 1120X Tentative adjustment of tax liability Formal claim for refund or adjustment Taxpayer receives refund before IRS audits the return May be subject to an IRS examination before it is paid No matter the amount, refunds are not subject to pre-refund review However, amounts in excess of $2M will be subject to post-refund review Refunds in excess of $2M are subject to review by the Joint Committee on Taxation IRS must act within 90 days of filing, and typically pays refund within 45 days Refund may take up to two years to be received 58

Statute of Limitations: Nuts and Bolts 59

Statute of Limitations Overview The periods of limitation establish the period in which the IRS can assess additional tax, and the period in which the taxpayer may recover a refund of taxes already paid The two periods of limitation that are most significant: 1. I.R.C. 6501 Statute of Limitations on Assessments 2. I.R.C. 6511 Statute of Limitations on Claiming a Refund There are separate periods of limitation that may apply to overpayment interest and collection matters 60

Limitation on Adjustments Generally, there is no limitation on the making of adjustments in any year, to the extent that the adjustment, applying the normal carryover or carryback provisions of the Code, would affect another year for which the period of limitations for assessment or refund remains open Other procedural issues, i.e., elections, estoppel, and methods of accounting principles, however, may provide restrictions on adjustments after a period of time 61

Assessments I.R.C. 6501(a) provides that the amount of tax must be assessed within 3 years after the original return was filed. "Filed" means received by the IRS. Original return also includes a "superseding" return which is a later return which is nevertheless received by the due date. - An original return filed before the last day prescribed by law or by regulations for filing the return is deemed filed on the last day prescribed by such law or regulations but this rule applies only to original due dates, not extended due dates - Returns mailed before the due date of the return (including extensions), but received by the IRS after the due date are deemed to be filed on the date the envelope is postmarked Effect of Amended Returns - Amended return reporting additional tax - IRC 6501(c)(7) - Amended returns claiming refunds have no effect on limitations 62

Assessments Common exceptions to 3-year Statute of Limitations period - False or fraudulent return - No return filed - Extension by agreement - Substantial omissions - Net operating losses or capital loss carrybacks - Credit carrybacks under IRC section 39 - Tentative carryback adjustments 63

Exceptions to 3 Year Statute Listed Transactions - Current guidance on the extended period of limitations for undisclosed listed transactions exists in Rev. Proc. 2005-26 - Recent proposed regulations were issued - Under I.R.C. 6501(c)(10), where a taxpayer fails to disclose participation in a listed transaction the period of limitations for those taxable years to which the failure to disclose relates, will not expire before the earlier of: One year after the date on which the taxpayer makes a disclosure as described in the regulations; or One year after the date on which a material advisor makes a section 6112 disclosure 64

Exceptions to 3 Year Statute During the extended limitations period, any tax with respect to the listed transaction may be assessed including: - The tax consequences of the transaction, interest and penalties; - Items affected by the listed transaction even if those items are unrelated (e.g., as the result of a change to AGI) The proposed regulations operate to extend the general limitations period for assessment of tax; however, the limitations period is never shortened The rules of Treas. Reg. 301.6501(c)-1(g) apply on a taxpayer-by-taxpayer basis - Even if a partnership complies with disclosure provisions with respect to a listed transaction, the extended period of limitations will still apply to the partners if they do not 65

Exceptions to 3 Year Statute Foreign Tax Credit - I.R.C. 905(c) provides that adjustments are made in two instances: 1. When accrued taxes, when paid, differ from the amounts claimed as credits; or 2. If any taxes paid are refunded by the foreign jurisdiction. Note: The taxpayer is required to notify the IRS when this occurs - When the adjustment causes a deficiency in the domestic tax liability, there is no period of limitations 66

Exceptions to 3 Year Statute Foreign Tax Credit (continued) - Not every change in FTC will give rise to an exception to the 3-year period of limitations. Must have an actual redetermination by the foreign jurisdiction Does not include adjustments that are caused by factors knowable within the normal period of limitations Does not include adjustments that are computational (as opposed to those that result from substantive judgment of the foreign jurisdiction) 67

Exception to 3 Year Period Carrybacks NOLs, Capital Loss, Credits - Statute of Limitations period runs from the date of the loss or credit return year, not to the year to which carried - May impact other years if carryback dislodges items of carryback year which must now be carried to a different year Tentative Carryback Adjustments - Statute of Limitations period for assessment runs from the date the return is filed for the year of NOL, capital loss, or credit giving rise to carryback - Tentative carryback claim must be filed within one year of close of loss year on either Form 1139 or 1045 68

Other Exceptions to 3 Year Statute I.R.C. 6503(h) Bankruptcy Stay I.R.C. 6672(b)(3)(A) After Protest of Preliminary Notice of 100% Liability expires not before 90 days after notice I.R.C. 7508(a)(1)(G) Service in Combat Zone I.R.C. 7508A Presidentially Declared Disaster Areas Tax Treaties Many treaties waive periods of limitations for competent authority actions 69

Exception to 3 Year Statute Refunds Unlike the statute of limitations period for assessments, two separate periods must be examined for refunds 1. There is the period of limitations for which a claim for the refund must be filed 2. There are separate but somewhat coordinated rules which provide, given the claim filed at a particular time, the extent of the refund that can be recovered Timeliness General Rule A claim for credit or refund of any tax with respect to which a taxpayer is required to file a return must be filed within 3 years from the time the return was filed or 2 years from the time the tax was paid Look-back General Rule As a general rule, the amount recoverable is the amount paid within three years of the time the claim was filed (if filed under three-year rule), or two years before the claim was filed (if the claim was filed under two-year rule) 70

Exception to 3 Year Statute Refunds Amount of credit or refund limitation Voluntary extensions NOL or capital loss carrybacks Foreign Tax Credit I.R.C. 39 General Business Credits I.R.C. 6511(h) Financially Disabled Individuals Protective Refund Claims Barred Years: IRS may adjust deductions/credits in closed year if the carryforward of those adjustments affects tax due in an open year IRS may not assess additional tax or authorize refund in a closed year But, look for mitigation 71

Protective Claims 72

Concept of Protective Claim A protective claim for refund is well-established, even though the term does not appear in the Code or regulations - Commonly filed when a taxpayer's right to a refund is contingent on future events that will not be resolved until after the statute of limitations has expired - In these circumstances, a timely and proper protective claim will preserve the taxpayer's right to obtain a refund. Conditioned on the timely filing and compliance with the procedural requirements of Treas. Reg. 301.6402-2, protective claims will constitute valid refund claims pursuant to which the IRS may issue refunds (or credit overpayments against other liabilities of the taxpayer) Upon resolution of the future event, protective claims may (and should) be perfected by filing complete Forms 1120X 73

When to File a Protective Claim General Counsel Memorandum 38786 describes various circumstances in which filing a protective claim would be appropriate when the expiration of the refund SOL is imminent: - Pending Litigation - Competent Authority - Change in statutory or regulatory law - SOL imminent but supporting documentation not currently available 74

Disallowance of Protective Claim There have been instances in which the IRS has formally disallowed protective refund claims when the taxpayer specifically described the grounds on which it believed it was entitled to a refund (e.g., entitled to a larger Sec. 41 research credit), but was unable to quantify precisely the overpayment amount because of an incomplete research credit study Service Center Advice Memorandum 199941039 IRS sought to distinguish protective refund claims from what it calls incomplete claims. However, the memorandum does not discuss GCM 38786, which includes the most comprehensive discussion of protective refund claims. Some support for the incomplete claim concept can be found in Treas. Reg. 301.6402-3(a)(5), which provides [a] return or Amended Return shall constitute a claim for refund or credit if it contains a statement setting forth the amount determined as an overpayment... 75

Action to Take Upon Disallowance of Claim If the IRS disallows a protective claim, the taxpayer might be forced to file a refund suit because the 2-year statute of limitations for doing so runs from the date the claim is disallowed. In reality, the Service has great discretion in the way it handles refund claims. The IRS has set forth a current procedure to alert taxpayers on a yearly basis of their protective claim and procedures set forth to perfect if the contingent aspect has been resolved. 76

www.pwc.com Part III Bill Laverty,

Quality Examination Process (QEP) 78

Quality Exam Process (QEP) Background A decade has passed since the implementation of the Joint Audit Planning Process which was jointly developed with Tax Executives Institute Agents found the process useful but it needed streamlining, additional flexibility, and more opportunities for taxpayer involvement Taxpayers and their advisors observed inconsistent use of the process; some very involved and others not at all The new Quality Examination Process replaces the Joint Audit Planning Process While Joint Audit Planning was a set of suggested best practices, the new QEP contains requirements for the Service and encourages taxpayer participation which cannot be mandated 79

Quality Exam Process (QEP) Background Joint Audit Planning Process ended for examinations started after May 30, 2010. Quality Exam Process took place of Joint Audit Planning Process for all examinations initiated after June1, 2010. The Joint Audit Planning check sheet eliminated. The QEP is incorporated in the IRM. QEP focuses on three elements or PER - Planning - Examination - Resolution For revenue agents the shoulds of Joint Audit Planning are now wills QEP is required. The QEP process brochure must be shared with taxpayer at beginning of audit. 80

Quality Exam Process (QEP) Collaborative audit process Rules of the road Educate both parties Reach agreements regarding procedures to obtain related party returns, claims, affirmative issues and third party contacts Obtain basic data needed to prepare exam plan Clarify use/role of specialists, Counsel, and Technical Advisors Discussion of potential issues/risk analysis Discussion of the Information Document Request (IDR) process Develop and agree on schedule for periodic meetings Issue Resolution Process including early submission of Technical Advice Requests, Industry Issue Resolution program, etc. Statute Extensions understandings 81

Quality Exam Process (QEP) Audit scope and issue priority The exam team and taxpayer discuss: Limited scope audits include LIFE exams, follow-up on issues raised in preceding cycle and repeat examinations where unabsorbed claimed credits (e.g., foreign tax credits) are so large as to preclude a productive full scope audit Prior audit results Claims and affirmative issues Mandatory issues including Tiered issues, Coordinated issues and compliance checks Permanent or timing issues; accounting or non-accounting issues 82

Quality Exam Process (QEP) Audit scope and issue priority Materiality: Total dollars Dollars to income Dollar value of deductions to total deductions Tax benefit to total tax Credit to tax Compare to gross receipts and/or gross assets Materiality was used for financial statements and tax return Absence of an item 83

Quality Exam Process (QEP) The exam plan: Audit scope and issue priority Ongoing Risk Analysis But must be conducted during initial planning, and when 50% of time applied, or significant event occurs Level of compliance Adjustment potential/expected result of examination Future impact Industry trends, practices, issues Financial state of entity Compliance Prior experience Cost benefit resources/time Taxpayer systems and internal controls Appeals and litigation considerations 84

Quality Exam Process (QEP) The exam plan: Audit scope and issue prioritization All of the factors used to determine scope and issue prioritization should be shared and discussed with taxpayer during planning discussions/meetings and in the exam plan The Exam Team will explain to the taxpayer why the issue was selected Taxpayers should also discuss the audit team s proposed examination techniques to determine that the most effective and efficient methods are employed The Exam Team solicits the taxpayer s input on best approaches for examining the issue/transaction 85

Quality Exam Process (QEP) The exam plan: Establishing timelines Teams will establish mutually agreeable timelines including: Start and completion dates Risk Analysis review, completed, and shared Last date for IDRs to be issued Last date for claims to be filed Last date for F5071(s) to be issued RAR target date Specialist work timeline 86

Quality Exam Process (QEP) Information document request process Establish contact points for both parties for IDRs to go to/from Before issuing an IDR the team will discuss and agree on the records necessary to address the examiner s issues/concerns, what sources for obtaining information are available, alternative records, and the purpose/intent of request Should be specific, clear, and concise Will specify timeframes for taxpayer to respond after discussion Will specify timeframes for IRS to notify taxpayer that response is complete or what else is needed Will agree on process to elevate concerns or address delays quickly Note: The IDR management process should be documented and become a part of the Exam Plan. 87

Quality Exam Process (QEP) The exam plan: Overview Part I: Taxpayer Information Section includes overall plan of examination and the taxpayer is asked to sign off Part II: Service Management Information Section is the team manager s instructions to the audit team members Part III: Examination Procedures Section contains each team member s assignment and the procedures to be used to accomplish that assignment; includes planned start and completion dates, estimate of time by issues, description of exam technique/sampling, prioritization of issues ALL parts of the plan should be shared with the taxpayer (unless Law Enforcement Criteria or Official Use Only) Representatives for the IRS and the taxpayer sign the examination plan acknowledging understanding and commitment 88

Quality Exam Process (QEP) Establish issue resolution process Generally, before issuing a Form 5701 - Notice of Proposed Adjustment (NOPA), the taxpayer and exam team will discuss the issue associated with the proposed adjustment. NOPAs should not be a surprise. The taxpayer will, at a minimum, confirm the facts of the issue in question and clarify their position. Taxpayers should provide additional facts and/or supporting evidence to validate facts presented during issue discussion. The exam team may engage specialists, technical advisors, Counsel, and other experts in issue discussions. 89

TEFRA Partnerships 90

Course objectives At the end of this session you will be able to: Understand why Congress enacted the TEFRA partnership provisions Identify the entities to which the rules apply Define partnership items, non-partnership items and affected items How penalties apply in to TEFRA partners Understand the different statute rules when TEFRA applies How to amend a TEFRA partnership return How the IRS TEFRA audit procedures differ from general audit procedures Identify the important roles and responsibilities of the Tax Matters Partner. 91

Agenda Session Introduction & Objectives Background of TEFRA and IRC Structure TEFRA entities defined Partnership Items, non-partnership items, & affected items Penalties application for TEFRA partners Statute of limitations applicable to TEFRA partners Amending a TEFRA partnership return Different Audit procedures for TEFRA partnerships Roles and responsibilities of the TMP Total Time 5 min 5 min 5 min 10 min 5 min 5 min 10 min 10 min 5 min 60 mins 92

Background of TEFRA and IRC Structure 93

Background of TEFRA and IRC Structure Prior to the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), any partnership examination was performed at the partner level The Service was required to audit each partner's return separately and its determination as to the treatment of a partnership item applied only to that partner Previously, a form 1065 was simply an information return: it was not binding on the partners in any way the IRS was required to individually examine and adjust the items of each partner each partner's period for assessment and refund depended entirely upon the partner's unique circumstance and no "extension" could be obtained from the partnership for all partners Individual partners also filed claims on their own and no "amended" partnership return was required 94

Background of TEFRA and IRC Structure With the Tax Equity and Fiscal Responsibility Act of 1982 Congress enacted I.R.C. 6221 through 6233 which created two different partnership types for procedural purposes: TEFRA" partnerships, governed by special procedures, and other partnerships (now called small partnerships" or non-tefra partnerships) which remain governed by the pre-tefra -the old rules still apply 95

Background of TEFRA and IRC Structure TEFRA rules are significantly different than the old rules: All adjustments to partnership items are determined in a single proceeding at the partnership level Each partner must either report his partnership items consistently with the partnership return or notify the Service that he is not doing so - Failure to do so permits the IRS to adjust the partner return, by "computational adjustment" to be consistent with the filed partnership The Service must audit the partnership under TEFRA proceeding to make changes in the return with respect to partnership items When the partnership is audited, the Service will generally deal with one partner--the Tax Matters Partner, but other partners are entitled to participate fully in the audit, and in appeals conferences and litigation. 96

Background of TEFRA and IRC Structure TEFRA rules are significantly different than the old rules, (contd): The Service can settle separately with one or more partners, but must allow any partner to enter into a settlement consistent with that offered to another partner, if requested by a partner All partners have the right to participate in litigation; however, only the Tax Matters Partner or a notice partner may commence such litigation The statute of limitations for assessing tax to the partners from a change in the treatment of a partnership item is generally controlled at the partnership level 97

What entities are subject to the TEFRA rules? 98

What entities are subject to the TEFRA rules? The TEFRA rules apply to all partnerships required to file a return under 6031(a), except, for Small Partnerships that have not otherwise elected the TEFRA procedures The Small Partnership exception includes partnerships if: - It has 10 or fewer partners tested by number or partners at any time during the year) A husband and wife and estates count as one - All partners are natural persons, C corps or estates at all times during the year If any partner is a passthrough entity at any time during the year, the partnership is disqualified from the Small Partnership exception An entity which has properly elected classification of a partnership (for instance LLC or LLP), or which defaults to a partnership, is treated as a partnership which may be subject to TEFRA Therefore an entity may be subject to TEFRA audit procedures even though it may be treated differently under local business law or state tax law 99

What entities are subject to the TEFRA rules? Uncertain Status Based on Partnership Return IRC 6231(g) provides that the TEFRA non-tefra determination should be made by the IRS from the partnership return alone The IRS can determine (a) the number of partners, (b) the nature of the partners, and (c) whether the partnership has elected out of the small partnership exception all from the partnership return itself without further inquiry and can apply that information to determine TEFRA qualification and status - -generally, the number and nature of the partner can be determined by examining form K-1's since Part II, line I requires that the type of entity of the partner be stated -In addition, see Schedule B, item 2 which asks if any partner is a passthrough If, based on the return, the IRS reasonably determines that TEFRA applies, it applies If, based on the return the IRS reasonably determines that TEFRA does not apply, it does not apply 100

What entities are subject to the TEFRA rules? Nature of Partners Generally, a partner is whatever classification it gets under Treas. Reg. 301.7701-3 Thus, an LLC can be either a partnership, corporation, or disregarded entity depending on the number of members and its election - A tax-exempt organization is considered to be a C corporation. Rev. Rul. 2003-69 - A foreign corporation is also considered to be a C corporation. Rev. Rul. 2003-69 However, a foreign individual is not an eligible partner for the small partnership exception - Thus, if an alien individual wishes to hold a partnership interest and it desires non-tefra procedures, it should hold the interest through an entity regarded as a corporation for US purposes under 301.7701-3 (regardless of its treatment for foreign purposes). 101

What entities are subject to the TEFRA rules? Nature of Partners For classification of partners, a disregarded entity is not disregarded but is rather considered a "pass-through" entity, rather than the partner having the classification of the DE's owner. - Therefore, if a disregarded entity of a corporation holds an interest in a partnership, the interest is treated as being held by a flow-through entity and therefore the partnership is a TEFRA Partnership, not eligible for the small partnership exception. Rev. Rul. 2004-88. - See Primco Management Co., T.C. Memo. 1997-332, which held that the fact that a grantor trust which was ignored as an entity separate from its owner for federal tax purposes, was nevertheless a flow-through partner for the TEFRA rules and disqualified the partnership from the small partnership exception. While disregard entities (including grantor trusts) may disqualify an otherwise qualifying small partnership, if the DE and its owner are the only partners, the entity is not a partnership. Rev. Rul. 2004-77. See also CCA 200250012 102

What entities are subject to the TEFRA rules? Electing Out of Small Partnership Exception Even if a partnership meets the small partnership exception criteria, it may elect out of the exception and back into the TEFRA procedures. 6231(a)(l)(B)(ii). Form 8893 is designed for the election and must be signed by all partners See also Schedule B, item 5 of the Form 1065 which asks if the election was made. Treas. Reg. 301.9100-2 will permit an automatic extension to 6 months after the original due date of the partnership return. The return can be amended to make the election until that time. Once an election is made, it continues from year to year unless revoked with the consent of the Commissioner. Treas. Reg. 301.6231 (a)(l )-1 (b)(3). 103

Partnership Items, non-partnership items, & affected items 104

Partnership Items, non-partnership items, & affected items Partnership Items In General A partnership item is any item more appropriately determined at the partnership level than at the partner level. 1.R.C 6231 (a)(3). 1. Important because section 6221 states that the tax treatment of any partnership item is to be determined at the partnership level which means that a TEFRA proceeding is necessary to resolve that item, it cannot be adjusted in a normal deficiency or refund proceeding. 2. The TEFRA audit rules apply only to "partnership items." Therefore, all other aspects of a partner's tax liability for a given year will continue to be subject to the general audit, deficiency and refund procedures, and cannot be part of the TEFRA proceeding. 105

Partnership Items, non-partnership items, & affected items Partnership Items The Regs 1. Treas. Reg. 301.623 1(a)(3)-1 states that "partnership items" include the following: a) the partnership aggregate and each partner's share of items of income, gain, loss, deduction, or credit of the partnership; b) expenditures by the partnership that are not deductible in computing its taxable income, such as foreign taxes or charitable contributions; c) any item that could be a tax preference item for any partner; d) exempt income; e) the amount and type of any partnership liabilities (e.g., recourse or no recourse); f) guaranteed payments; g) optional adjustments to the basis of partnership property pursuant to a section 754 election (including necessary preliminary determinations, such as the determination of a transferee partner's basis in a partnership interest); and h) Other amounts determinable at the partnership level with respect to partnership assets, investments, transactions, and operations necessary to enable the partnership or the partners to determine the investment credit, recapture of the investment credit, and amounts at risk in the activity. 106

Partnership Items, non-partnership items, & affected items Partnership Items The Regs 2. A partnership needs to determine the character of - any amount received from a partner, - the amount of money contributed, and - the basis to the partnership of contributed property. a) To the extent that a determination of an item relating to a contribution can be made from determinations that the partnership is required to make, that item is a partnership item. b) To the extent that the above-mentioned determination requires information that the partnership is not required to determine under Subtitle A of the Internal Revenue Code, that determination is not a partnership item. Treas. Reg. 301.623 1(a)(3)-1 (c). 107

Partnership Items, non-partnership items, & affected items Partnership Items Other Partnership Items 3. The following issues have also been held to involve partnership items: a) Whether a particular entity is or is not a partner. b) Whether the period of limitations for making a partnership adjustment has expired with respect to a partner. c) A partner's distributive share of a special partnership item. (distributive share of a cancellation of indebtedness income) Blonien v. Commissioner, 118 T.C. 541 (2002) and 86 T.C.M. 548 (2003) (Supplemental Opinion). d) Whether partnership has terminated. Harbor Cove Marina v Commissioner, 123 T.C. 64 (2004) e) Withholding taxes under 1446. f) Since 1997, penalties and additions to taxes relating to partnership items, 6221, except these defenses "that are personal to the partner or are dependent upon the partner's separate return." Treas. Reg. 301.6221- l(d). 108

Partnership Items, non-partnership items, & affected items Non-partnership Items In General Section 6231 (a)(4) states that a non-partnership item is an item that is not (or is not treated as) a partnership item. Items which have been held to be non-partnership items include: Effect of partner's note as to the basis of the partner's partnership interest. Character of the partnership interest in the hands of the partner. Character of guaranteed payment as a qualifying tax-exempt disability payment under 104 (a) (3). Equitable recoupment. Innocent Spouse Relief - 6230 (a)(3). 109

Partnership Items, non-partnership items, & affected items Non-partnership Items Conversion A partnership item will become a non-partnership item as to a particular partner when and as of the date: 1. The Service sends the partner a notice that such item is to be treated as a nonpartnership item, but only if it is sent before a notice of the beginning of an administrative proceeding is mailed to the TMP. I.R.C 623 l(b)(l) (A) and 623 1 (b)(3). 2. The partner files suit under section 6228(b) after the Service fails to allow an administrative adjustment request with respect to any of the items. I.R.C. 6231 (b)(l)(b). 3. The Service and the partner enter into a settlement agreement with respect to such items. I.R.C. 623 l(b)(l)(c). 4. The Service determines that treating an item as a partnership item would interfere with enforcement. I.R.C. 6230(b)(l)(D). 110

Partnership Items, non-partnership items, & affected items Non-partnership Items Conversion special circumstances 5. Special Enforcement Areas -items automatically convert to non-partnership items when: a) a termination or jeopardy assessment is made (conversion occurs the moment before the assessment is made); b) a criminal investigation is instituted (conversion occurs on the date written notice of conversion is received by the taxpayer); c) an indirect method of proof is used (conversion occurs on the date the deficiency notice is mailed); d) a petition in bankruptcy is filed or receiver is appointed (conversion occurs on the date the petition is filed or the receiver appointed); e) a request for prompt assessment is filed (conversion occurs on the date the request is filed). 111

Partnership Items, non-partnership items, & affected items Non-partnership Items Conversion IRS Options The IRS may treat partnership items with respect to a partner as non-partnership items when: 1. The partner has: reported the item on his return inconsistently with its treatment by the partnership, has properly notified the Service of the inconsistency, and has not subsequently requested that his return be conformed to the partnership return. I.R.C. 6231 (a)(2)(a), 2. Subsequent to the filing of his original return, the partner has filed an administrative adjustment request ("AAR"), that would result in its treatment of the item being inconsistent with its treatment by the partnership. I.R.C. 623 l(b)(l)(a) and (b)(2)(b). 112

Partnership Items, non-partnership items, & affected items Non-partnership Items Conversion The Effect Generally, the tax treatment of items that become non-partnership items is determined under the regular audit, deficiency, and refund procedure instead of the TEFRA procedures thus regular procedures apply However, if the item is converted because of settlement, then the deficiency proceedings do not apply Instead, the settled items may be immediately assessed In this case, the Service Center TEFRA Unit prepares an RAR (including Form 4549 and accompanying schedules and explanations) and mails to partner Partner may not Protest or Petition, but may have brief opportunity to question the computation of effect of the settlement to the partner If questioned, IRS may still assess, leaving partner with only option of paying the deficiency and filing claim to correct the report See 6230(c) Claim must be filed within six months of mailing of the notice of computational adjustment 113

Partnership Items, non-partnership items, & affected items Affected Items _ In General An "affected item" is defined in section 6231(a)(5) as any item to the extent such item is affected by a partnership item There are two types of affected items 1. those that maybe directly assessed following the proceeding, i.e., a computational adjustment, and 2. those which require partner level determinations to be made once the partnership level proceeding is complete. See Maxwell v. Commissioner, 87 T.C. 783 (1986); N.C.F. Enerrzv Partners v. Commissioner, 89 T.C. 741,744 (1987); Treas. Reg. 301.623 1(a)(5)-1. 114

Partnership Items, non-partnership items, & affected items Affected Items That May Be Immediately Assessed A computational adjustment is defined as the change in tax liability of a partner that properly reflects the treatment of a partnership item under ' Subchapter C of Chapter 63. I.R.C. 6231(a)(6). Assessment of tax pursuant to a computational adjustment is specifically excluded from the deficiency procedures of subchapter B of chapter 63 by section 6230(a)(l) unless a partner level determination is first required. A computational adjustment may also include any interest attributable to such tax. Treas. Reg. 301.623 1(a)(6)-1(b). A computational adjustment may be immediately assessed at the conclusion of the partnership proceeding where the effect of the partnership item on the partner's tax liability can be computed mechanically or mathematically without further determinations at the partner level. Olson v. United States, 172 F.3d 13 1 1 (Fed. Cir. 1999). 115

Partnership Items, non-partnership items, & affected items Affected Items That May Be Immediately Assessed Examples of computations that may be directly assessed after the partnership proceeding include: a) Items unrelated to items on the partnership return, but which vary if there is a change in an individual partner's adjusted gross income, e.g., the threshold for the medical expense deduction under section 213 which varies with the amount partnership income. Treas. Reg. 30 1.6231 (a)(5)-l(a). b) Alternative Minimum Tax computational adjustment resulting in a refund may be made irrespective of the otherwise applicable period of limitations for filing claims under 6511. See 6230(d)(6) and Harris v. Commissioner, 99 T.C. 121 (1992). This should be done by the IRS without the necessity of the partner filing a claim. As mentioned, Section 6230(c) provides the exclusive means for challenging a directly assessed computational adjustment. Under certain circumstances, 6230(c) permits a partner to challenge the accuracy of a computational adjustment, but not its substance, except for partner level defenses, by filing a claim for refund. 116

Partnership Items, non-partnership items, & affected items Affected Items - which require partner level determinations to be made once the partnership level proceeding is complete: Affected items that generally require factual determinations at the partner level include at risk limitations, a partner's basis in his partnership interest, and the application of the passive loss limitations. These types of affected items are subject to the deficiency procedures of subchapter B of chapter 63 of the Code. I.R.C. 6230(a)(2). The partnership proceeding may make determinations regarding aspects of those items, and to the extent determinable at the partnership level, those determinations are binding on the parties in the affected item proceeding. However, other aspects of the item are determined at the partner level and the ultimate conclusion of the item is determined in the affected item deficiency proceeding. For example outside basis of partner -see Domulewicz v. Commissioner, 129 T.C. No. 3 (August 8, 2007) 117

Penalties application for TEFRA partners 118

Penalties application for TEFRA partners For taxable years ending after August 5, 1997, penalties, additions to tax, and additional amounts may be directly assessed if their application is determined at the partnership level. I.R.C. 6230 (a)(2). The applicability of any penalty, addition to tax, or additional amount may be determined in the partnership proceeding and assessed immediately following the partnership proceeding. I.R.C. 6221 and 6230(a). Partner level defenses (i.e., reasonable cause and good faith under I.R.C. 6664) must be raised through refund claims. Domulewicz v.commissioner, 129 T.C. No. 3 (August 8,2007). Penalties determined in the Partnership proceeding includes accuracy penalties related to all partnership items in the proceeding, despite no inaccuracy in reporting that item on the partnership return. See Jade Trading LLC. v. United States, Supp. Op. (Ct. Fed. Cls. March 20, 2008) 119

Amending a Partnership Return 120

Amending a Partnership Return In General TEFRA Partnership returns are amended by initiating an "Administrative Adjustment Request" (AAR) pursuant to 6227, via new Form 1065X 1. TEFRA Partnership returns are not amended by checking the box "amended return, that box is for amending non-tefra returns as an information matter or as a "superseding" partnership return if filed on or before the original or extended partnership return filing date. 2. The IRM provides that the IRS may treat an amended Form 1065 as a "nonsubstituted AAR" but it is possible that the IRS will ignore it completely as a not in conformance with the TEFRA rules. TEFRA partnership return amendments are made on Form 8082 as an "Administrative Adjustment Request Either the individual partners on their own behalf, or the TMP, on behalf of the Partnership may file and AAR 121

Amending a Partnership Return In General The Form 8082 is can be a confusing and difficult form because it is used for multiple purposes: 1. For the TMP to file an amended return on behalf of the partnership (all the partners); 2. For a partner (or S Corporation shareholder) to file a notice of inconsistent treatment of an item different than reported by the partnership (or S-Corporation); 3. For a partner to file an amended partnership return applicable only to it; and 4. For a partner (or S Corporation shareholder) to report that it has received no final Form K-1 from the partnership or S Corporation and therefore is estimating the amount of the items on its return. 122

Amending a Partnership Return Form 8082 A Form 8082 AAR filed as an amended return: 1. Is essentially like a 1040X or 1120X in that it only describes the differences between the original return and itself. 2. Contains no signature itself - an essentially blank first page of Form 1065 is attached showing the information for the partnership and a signature on the Form 1065 by the TMP or partner (as applicable). 3. If filed by the TMP, must also contain revised Forms K-1 for all the partners in accordance with the 8082 changes. 4. Many taxpayers include a pro forma Form 1065 "as amended" for the convenience of the IRS - however, this is not required. 5. Must be filed at the same IRS Service Center where the original partnership return was filed. The IRS has illogically insisted on this, even though the filing locations for partnerships have now changed, and all partnership returns are now housed in either Cincinnati or Ogden. 123

Amending a Partnership Return Form 8082 TMP Filed AARs - Substituted Return vs Regular AAR When a TMP files an AAR, the TMP has the option of filing it as: - a "Substituted Return" or - a regular AAR. A Substitute Return can be treated as mathematical corrections, and the IRS may pass through the effect of the AAR to the partners without opening a TEFRA administrative proceeding A regular AAR is treated in the same manner as a Substituted Return AAR, except: - Must open a partnership level procedure because it has no option to flow-through any deficiency items to the partners - However, in a few instances the IRS has accepted the adjustments and flowthrough refunds to the partners, because the statute provides that the partners do not need to file claims in order to receive credits or refunds. 124

Amending a Partnership Return Form 8082 TMP Filed AARs - Substituted Return vs Regular AAR A TMP chooses the Substitute Return procedure by checking Item 2 of the Form 8082 "Substituted Return otherwise, it is a regular AAR The desired effect of a substituted return AAR is that the IRS can treat the changes as mathematical corrections, without opening a TEFRA administrative proceeding. When the IRS receives a TMP Substituted Return AAR, it can proceed along any of the following paths: Treat as mathematical corrections and flow the adjustments to the partners; Accept return and pass-through credits and/or refunds to partners in accordance with the Forms K-1; Conduct a partnership level proceeding; or Do nothing. Caution: because the IRS can, and often does "do nothing," the partnership and partners should be prepared to further act to get refunds or finalize deficiencies, if desired. 125

Amending a Partnership Return Form 8082 Partner Filed AARs Any partner may file an AAR on behalf of itself, by filing the same Form 8082. In that event, the information for the Partnership is contained in a different location on the Form 8082. A partner filed AAR affects only the items of that partner. The IRS has a different set of options as to how to handle the filing: 1. It may process the items as non-partnership items and credit or refund to the partner the tax effect of the adjustment 2. It can immediately assess any tax resulting from the adjustment to the partner 3. It can mail a notification to that partner that all of the partnership items of the partner for that partnership year shall be treated as non-partnership items. In this event, the IRS will conduct a regular deficiency or claim examination of the partner; the AAR is treated as a claim for refund. See section 6228(b)(l)(A). 4. Conduct a partnership level proceeding. Caution: In the event the IRS does nothing, the partner needs to be prepared to bring suite for refund. 126

Statute of Limitations TEFRA Partnerships 127

Statute of Limitations TEFRA Partnerships - Assessments Simply stated, adjustments attributable to partnership items may be assessed within three years of the later of the date of filing or due date of the partnership return. In essence, section 6229 holds open the section 6501 limitation period as to all partners for a fixed period of time, providing a minimum period within which to assess adjustments attributable to partnership items against all partners In addition, it provides some additional safeguards to the Government: No statute in event of fraud No statute if no partnership return Six years in event of 25% omission of income and no statute until one year after partners are identified to the Secretary 128

Statute of Limitations TEFRA Partnerships in General 6501 (assessments) and 6511 (refunds) provide the rules for all non-tefra entities, including, individuals, corporations, trusts, etc. Prior to TEFRA, all items from a partnership were controlled at the partner level by those sections TERA rules introduced: 6229 for statute of limitations on assessment of TEFRA related adjustments 6227(c) for statute of limitations on refund claims based on TEFRA related adjustments 129

Statute of Limitations TEFRA Partnerships - Assessments 6501 remains the primary control of statutes for partners 6501(n)(2) expressly references 6229 for additional provisions regarding partnership items 6229(a) provides that except as otherwise provided, the period for assessment of partnership items (or affected items) for a partnership year will not expire before 3 years after the later of- 1. The date the partnership return is filed, or 2. The last day for filing such return (without regard to extensions) 6229(b)(1) provides the period in (a) may be extended A. With respect to a single partner, by written agreement with the single partner (Form 872) and B. With respect to all partners, by written agreement with the TMP (872-P) 130

Statute of Limitations TEFRA Partnerships - Assessments 6229(b)(3) provides any extension under 6501(c)(4) will extend the statute for partnership items, only if the agreement expressly provides that such agreement applies to tax attributable to partnership items Because of the interplay between 6227 and 6229, the IRS lost a significant number of statutes As a result, in 2009 it changed its standard extension Form 872 to include boiler plate language that builds in the 6229(b)(3) language in every extension The language now includes two new paragraphs: 3. Paragraph (4) applies only to any taxpayer who holds an interest, either directly or indirectly, in any partnership subject to subchapter C of chapter 63 of the Internal Revenue Code. 4. Without otherwise limiting the applicability of this agreement, this agreement also extends the period of limitations for assessing any tax (including additions to tax and interest) attributable to any partnership items (see section 6231 (a)(3)), affected items (see section 6231(a)(5)), computational adjustments (see section 6231(a)(6)), and partnership items converted to nonpartnership items (see section 6231(b)). This agreement extends the period for filing a petition for adjustment under section 6228(b) but only if a timely request for administrative adjustment is filed under section 6227. For partnership items which have converted to nonpartnership items, this agreement extends the period for filing a suit for refund or credit under section 6532, but only if a timely claim for refund is filed for such items. 131

Statute of Limitations TEFRA Partnerships - Assessments Converted and Affected Items As discussed, certain situations cause partnership items to be converted to nonpartnership items most commonly when the audit issues are settled When that happens, 6229(f)(1) provides that the Service has one year from date of conversion to assess tax attributable to those converted items 6229(f)(1) acts to extend the otherwise applicable 6501 statute see 6501(o)(1) 132

Statute of Limitations TEFRA Partnerships - Assessments 6229 vs 6501 which controls? The courts have consistently held that the statutory scheme is that the statute is open for assessment for the later of 6229 or 6501 See Rhone-Poulenc Surfactants and Specialties, 114 T.C. 553 (2000) and subsequent cases 133

Statute of Limitations TEFRA Partnerships -Refunds Under 6227(a)(l), a partner may file a AAR at any time which is: 1. Within 3 years after the later of: A. The date which the partnership return is filed, or B. The last day for filing the partnership return (without regard to extensions), and 2. Before the mailing of an FPAA 6227(c) provides that if an extension for assessment was extended under 6629, then the period for refund is also extended 6 months after the expiration of the extended statute The statute under 6227 does not use the later of rule used for 6229 However, if the 6229 is extended, that extension applies to refunds as well, plus 6 months 134

How TEFRA Audit Procedures Differ from Other Audit Procedures 135

How TEFRA Audit Procedures Differ from Other Audit Procedures TEFRA audits must begin with a Notice of Beginning of Administrative Adjustment (NBAP) The NBAP must be given to the TMP at least 120 days before the Service can issue a Final Partnership Administrative Adjustment (FPAA) - 6223(d) FPAA is the TEFRA equivalent of a Statutory Notice of Deficiency contained in 6212 for income taxes not subject to TEFRA The agent has 45 days from issuance of the NBAP to determine whether to pursue the audit, if the agent decides not to audit, the NBAP is withdrawn this does happens occasionally Sometimes agents will request some initial information and based on that decide not to audit so depending on facts, may be wise to comply If agent begins the audit, the agent will link all partners in the PCS system The NBAP is sent by the PCS unit to all notice partners 136

How TEFRA Audit Procedures Differ from Other Audit Procedures Notice Partners Defined- For partnerships with 100 or fewer partners, all partners are notice partners For partnerships with more than 100 partners: Only partners with a 1% or greater interest, and Partners who form a 5% notice group The partnership interest is defined as interest in the profits A 5% notice group is a group of partners having a 5 percent or more interest request and designate one of their members to receive the notice 6223(c) TMP is under obligation for forward notice to non-notice partners Pass-through partners (second tier) are required to forward notice to indirect partners However, if either TMP or Pass-through partners fail in this requirement, Government is not harmed - 6230(f) 137

How TEFRA Audit Procedures Differ from Other Audit Procedures The Audit- After the NBAP, audit proceeds generally as any other audit- Agents should follow the Joint Audit Planning Process Agent issues IDRs TMP responsible for responding to IDRs Agent issues informal Form 5701s (Notice of Proposed Adjustments) On completion, Agent issues a Summary Report (similar to normal RAR) Within 30 days of Summary Report, Agent offers a Summary Report Conference Agents normally request Waiver of Right to Summary Conference Since issues have normally be discussed with TMP, waiver is normally given, as long as not partner wishes to attend If issues are agreed, TMP will provide a waiver and bind the non-notice partners and all other partners will sign Form 870-P(AD) 138

How TEFRA Audit Procedures Differ from Other Audit Procedures Conclusion of Audit -Unagreed If any of the issues are not agree, the Agent prepares the 60 Day Package and forwards to the central TEFRA processing unit for mailing 60 Day Package to all notice partners TEFRA processing units reviews and mails the 60 Day Package This is the equivalent of the 30 Day letter in other examinations Contains the RAR and explanation of items Contains Form 870-P in event TMP decides to agree Provides 60 days for the TMP to file protest TMP files protest (however any partner may also file protest) and case is sent to Appeals Appeals offers conference to any partner wishing to attend, generally this is only TMP or its representative If Agreed, Form 870-P(AD)s are obtained and Appeals forwards to TEFRA processing unit for assessment and billing 139

How TEFRA Audit Procedures Differ from Other Audit Procedures Conclusion of Audit -Unagreed If agreement not reached in Appeals, the Appeals Officers prepares a Final Notice of Partnership Administrative Adjustment (FPAA) package and forwards to TEFRA processing unit FPAA contains the listing of adjustments, explanation of issues and computes adjustments for each partner FPAA is sent to last known address for each notice partner The FPAA is the equivalent of the Statutory Notice of Deficiency in other income tax cases Note: if no protest is filed by the Partnership and thus the Appeals process is by-passed, the FPAA is prepared by the agent The TMP has 90 Days to petition and, should the TMP not petition, any notice partner (or the 5% group) may also file petition in the next 60 days 140

How TEFRA Audit Procedures Differ from Other Audit Procedures Conclusion of Audit -Litigation No "Refund" Litigation: once an FPAA is issued, the partnership and partner must act within the petition period or can be bound by the result of the FPAA. There is no default, pay, wait 2 years, then file a refund suit procedure available for TEFRA partnership items as there is with other income tax cases All partnership items must be raised in the TEFRA partnership proceeding or they are lost forever, so any affirmative issues must be raised in the petition 141

Roles and Responsibilities of the TMP 142

Roles and Responsibilities of TMP Tax Matters Partner - Defined Section 6231 (a)(7) provides that the TMP of a partnership is: The general partner designated as the TMP by the partnership in accordance with the regulations (Treas. Reg. 301.6231(a)(7)-1) If a designation has not been made by the partnership, then the TMP is the general partner having the largest profits interest at the close of the taxable year involved. If a TMP has not been designated by the partnership and the Service the Service may select any partner to be the TMP (including a limited partner). Tax matters for LLC, or LLP treated as Partnership: 1. For determining who is equivalent of a "general partner:" only a membermanager" is considered a general partner. 2. A "member-manager is someone "vested with the conduct of the business. 3. if there are no designated member-manager, then all members are considered member-managers. Treas. Reg. 30 1.623 1(a)(7)-2. 143

Roles and Responsibilities of TMP Designation by the Partnership The TMP determination is made separately for each partnership taxable year - Service may have to deal with a different TMP for each taxable year. In order to be designated the TMP, the person must have been a general partner at some time during the taxable or is a general partner at the time the designation is made If a United States person is eligible to be designated the TMP, then a non-united States person cannot be designated the TMP without the consent of the Service. The TMP need not be an individual; an entity can act as a TMP e.g. corporation or a partnership). 1. When the TMP is an entity, the person authorized to act for that entity in practice is the TMP, e.g., corporate officer of a partner corporation. 2. The IRS has ruled that even a disregarded entity can be a TMP. For this purpose, it is not disregarded so long as it exists under a local non-tax law. 144

Roles and Responsibilities of TMP CEO or CFO of an LLC (corporation for local law but partnership for federal taxes) may not act as TMP unless that person also qualifies as a general partner. Also note that the rules for being a TMP are different than the rules as to who can sign the tax return. The TMP designation can be made by the partnership in any of the following ways: - on the partnership by a general partner signing the return; - after the partnership return is filed -- by the general partners with a majority interest, or - In limited circumstances after the partnership return is filed -- by partners holding more than 50% of the profits interests in the partnership held by all partners (both general and limited partners) 145

Roles and Responsibilities of TMP Termination of the Designation A TMP may resign at any time by filing a statement to that effect the partnership can revoke the designation of a TMP at any time A designation, resignation, or revocation is effective on the day that the statement is filed, except where an NBAP has already been mailed. In that case, the Service has 30 day to recognize A designation of a TMP terminates if: the TMP dies; is declared legally incompetent; is liquidated or dissolved (if an entity); TMP's partnership items become non-partnership items under I.R.C. 623 1(c) (relating to special enforcement areas); a new TMP is designated; f. the TMP resigns; or g. there is a revocation of the designation by the partnership. Treas. Reg. 30 1.6231(a)(7)-1 specifically provides that a termination will not affect the validity of any action taken by the TMP before the termination (e.g. extension of the period of limitations). 146

Roles and Responsibilities of TMP Responsibilities of a TMP in General The TMP is required to keep each partner informed of all administrative and judicial proceedings relating to the adjustments at the partnership level of partnership items. The TMP is required to furnish information regarding: closing conference with the examining agent; proposed adjustments, appeal rights, and information for the filing of a protest; time and place of an appeals conference; acceptance by the Service of a settlement offer; consent to the extension of the period of limitations with respect to all partners filing of an administrative adjustment request (AAR), including substitute return treatment on behalf of the partnership; filing by the TMP or any other partner of a petition for judicial review; filing of any appeal; and final judicial determination. 147

Roles and Responsibilities of TMP Responsibilities of a TMP Treas. Reg. 301.6223(g)-1 The TMP is required to furnish the following notices to all non-notice partners: Notice of beginning of an administrative proceeding (NBAP) within 75 days of its mailing to the TMP; and Notice of final partnership administrative adjustment (FPAA) within 60 days of its mailing to the TMP. Treas. Reg. 301.6223 (g)-1(a)(2). Once an NBAP has been mailed to the TMP, the TMP must provide the following information to the Service: The names, addresses, profits interests, and TINS of all persons who were partners in the partnership at any time during the taxable year under audit (including indirect partners to the extent the TMP has such information) if that information was not provided on the partnership return filed for that year; and Corrections or revisions of any information required to be furnished Treas. Reg. 301.6230(e)-l(b). 148

Roles and Responsibilities of TMP In addition to providing information, the TMP may extend the period of limitations for assessing any tax attributable to partnership items (and affected items) (I.R.C. 6229(b)(l)(B)) and enter into settlement agreements which bind non-notice partners (I.R.C. 6224(c)(3)(A)). In order for the settlement agreement to be binding against the non-notice partner(s), the agreement must expressly state that the agreement is to bind the non-notice partner(s) and the non-notice partner(s) must not have filed a statement with the Secretary providing that the TMP does not have authority to enter into a settlement agreement on their behalf. 149

Roles and Responsibilities of TMP TMP Sanctions 6230(f) provides that: The failure of the tax matters partner, a pass-thru partner, the representative of a notice group, or any other representative of a partner to provide any notice or perform any act required under this subchapter or under regulations prescribed under this subchapter on behalf of such partner does not affect the applicability of any proceeding or adjustment under this subchapter to such partner. Accordingly, the Government will not be responsible or at risk for a TMP that does not comply with the IRS or Regulations Although the IRC and Regulations impose certain responsibilities on the TMP, there is no IRS sanction for failing to perform There may, of course, be other remedies as between partner against a TMP who fails to full its obligations, but IRS has no sanctions 150

Review of Course Objectives 151

Review of course objectives You are now able to: Understand why Congress enacted the TEFRA partnership provisions Identify the entities to which the rules apply Define partnership items, non-partnership items and affected items How penalties apply in to TEFRA partners Understand the different statute rules when TEFRA applies How to amend a TEFRA partnership return How the IRS TEFRA audit procedures differ from general audit procedures Identify the important roles and responsibilities of the Tax Matters Partner. 152

Questions Janice M. Flood Managing Director (Chicago) (312) 298-2521 Janice.M.Flood@us.pwc.com Bill Laverty Director (Atlanta) (678) 419-1385 William.Laverty@us.pwc.com Devin W. Blackburn Senior Associate (Chicago) (312) 298-2521 Devin.W.Blackburn@us.pwc.com This document is provided by PricewaterhouseCoopers LLP for general guidance only, and does not constitute the provision of legal advice, accounting services, investment advice, written tax advice under Circular 230 or professional advice of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal or other competent advisors. Before making any decision or taking any action, you should consult with a professional adviser who has been provided with all pertinent facts relevant to your particular situation. The information is provided as is with no assurance or guarantee of completeness, accuracy or timeliness of the information, and without warranty of any kind, express or implied, including but not limited to warranties or performance, merchantability, and fitness for a particular purpose. This document was not intended or written to be used, and it cannot be used, for the purpose of avoiding tax penalties that may be imposed on the taxpayer. 2011 PricewaterhouseCoopers LLP. All rights reserved. In this document, refers to PricewaterhouseCoopers LLP, which is a member firm of PricewaterhouseCoopers International Limited, each member firm of which is a separate legal entity.