Special Care Needed in Dealing With Statute-of-Limitation Issues for TEFRA Partnerships

By Matt McCall, CPA, MT, Cleveland

Editor: Anthony S. Bakale, CPA, M.Tax.

Audits of flowthrough entities such as partnerships cause administrative complexity for the IRS and taxpayers because the audit sometimes drags on longer than the statute-of-limitation period for the IRS to make an adjustment. For individual or C corporation audits, this is easily handled by having the taxpayer agree to extend the statute-of-limitation period. However, the situation is more complicated for flowthrough entities.

Sec. 6501(a)

It is well-settled that the limitation period for partnerships is the Sec. 6501(a) period of the partner. Sec. 6501(a) provides that taxes shall be assessed by the later of three years from the time the tax return is filed or the original due date for the tax return. In most cases the filing date of the flowthrough entity's return is not relevant in determining the limitation period for the IRS to make an adjustment.

Example 1: A partnership has two individual partners, Partner A and Partner B, and files its 2010 partnership tax return on July 15, 2011. Partner A files his 2010 individual return on April 15, 2011, and Partner B files her 2010 individual return on Oct. 15, 2011.

On May 1, 2014, the IRS audits the partnership and makes an adjustment to increase the income on the partnership return. Because Partner A's Sec. 6501 limitation period expired on April 15, 2014, the IRS is precluded from adjusting his individual return for the change in the partnership unless the IRS obtained Partner A's consent to extend the statute of limitationbefore April 15, 2014. The IRS can adjust Partner B's individual return because her Sec. 6501 statute-of-limitation period does not expire until Oct. 15, 2014. Interestingly, under Sec. 6501(a), the IRS could have made the partnership adjustment for Partner B after July 15, 2014 (three years from the filing of the partnership return), which is beyond what most people would think is the limitation period for the partnership.

Dealing with small partnerships under the Sec. 6501(a) rules was not excessively burdensome for the IRS. However, the rules presented great administrative challenges for the IRS when dealing with partnerships with a large number of partners. The IRS needed to track the Sec. 6501 limitation period for each partner and, if necessary, obtain a consent to extend the statute of limitation from each individual partner.

The challenge to the IRS was even more cumbersome when dealing with multitiered partnerships that have large numbers of partners, some of which are flowthrough entities with a large number of partners or shareholders themselves. Before 1982, the IRS had to handle multitiered partnerships with flowthrough-entity partners exactly the same as simple partnerships that had a couple of individuals as partners. In that era, tax shelters were prevalent among many high-income taxpayers. When the IRS challenged some of these tax shelters, the audits often dragged on for years and sometimes, even when the IRS prevailed on the issue at the partnership level, it was precluded from flowing through the adjustments to some of the individual partners because their Sec. 6501 limitation period had expired, and the IRS had not obtained the appropriate consent from the individual partners to extend the statute of limitation.

Sec. 6229(a)

The difficulty the IRS had in auditing these partnerships and issuing adjustments became such an issue at the time that Congress enacted special rules for partnerships in the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), P.L. 97-248. Partnerships covered by these rules, which generally apply to all partnerships except those having 10 or fewer partners who are either individuals or C corporations, have become known as TEFRA partnerships. One of the TEFRA provisions was an attempt to ease the administrative burden on the IRS for handling these statute-of-limitation issues. TEFRA established Sec. 6229(a), which provides:

Except as otherwise provided in this section, the period for assessing any tax imposed by subtitle A with respect to any person which is attributable to any partnership item (or affected item) for a partnership taxable year shall not expire before the date which is 3 years after the later of—

(1) the date on which the partnership return for such taxable year was filed, or

(2) the last day for filing such return for such year (determined without regard to extensions).

This new provision caused some confusion as to how this rule interacted with Sec. 6501. Some taxpayers whose Sec. 6501(a) limitation period was open longer than the new Sec. 6229(a) period tried to argue that the IRS was precluded from making adjustments to their individual return for a TEFRA partnership because the Sec. 6229(a) period was controlling.

To illustrate this argument, refer to the example at the beginning of this item and assume the partnership is a TEFRA partnership. If the IRS attempted to adjust Partner B's return for a partnership adjustment after July 15, 2014, but before Oct. 15, 2014, Partner B would argue that the IRS was precluded from making the adjustment as the Sec. 6229(a) statute expired on July 15, 2014.

Courts that have reviewed the interaction between Sec. 6501(a) and Sec. 6229(a) have determined that the language in Sec. 6229(a) does not create a separate limitation period, but simply sets a minimum period for adjusting returns. This operation of the statute ensures that the IRS can assess a partnership item to a partner up to the later of three years from when the TEFRA partnership filed its return or three years from the original due date of the TEFRA partnership return regardless of when the statute of limitation expires for the partners' individual returns.

This interpretation is consistent with the administrative issue that Congress was attempting to resolve. The IRS no longer needs to worry about extending the individual limitation periods of the partners in the partnership. If a partner's individual limitation period has expired, Sec. 6229(a) automatically extends the statute for partnership items of a TEFRA partnership. Sec. 6229(a) was not intended to limit the IRS's ability to adjust taxpayers' returns whose normal Sec. 6501(a) statute was open (AD Global Fund, LLC, 481 F.3d 1351 (Fed. Cir. 2007), aff'g 68 Fed. Cl. 663 (2005)).

The interplay between Sec. 6229(a) and Sec. 6501(a) can cause a trap for partners and practitioners who are not aware of these nuances when a TEFRA partnership is under audit. The following example illustrates how a taxpayer can be hurt by this situation.

Example 2: TEFRA Partnership X files its 2010 tax return on Sept. 15, 2011. Partner A files his 2010 individual return on April 15, 2011. The same tax preparer prepares Partnership X and Partner A's 2010 returns. In 2013 the IRS begins an audit of Partnership X that ultimately closes on June 15, 2014.

During the course of the audit, the tax preparer notifies Partner A that there is likely going to be an adjustment made to X's return that will result in a $10,000 increase in taxable income to Partner A. At the same time, Partner A discovers that he failed to take a $15,000 charitable deduction for 2010 on his individual return.

The tax preparer assumes that he will file an amended return for Partner A claiming the $15,000 deduction and pick up the audit adjustment from the partnership after the IRS makes the adjustment. Unfortunately for the tax preparer, under the TEFRA provisions the IRS automatically adjusts Partner A's 2010 individual return for the $10,000 increase in partnership X's income allocated to Partner A on June 15, 2014. After learning this, the tax preparer prepares an amended 2010 return for Partner A claiming the $15,000 charitable deduction. The preparer is shocked when the IRS denies the amended return because Partner A's Sec. 6501(a) limitation period for claiming refunds or credits had expired on April 15, 2014, for all items on the return except for the Partnership X items.


The advent of limited liability companies (LLCs) has led to a substantial increase in the number of partnership tax returns being filed. In many cases, these entities are multilevel partnerships and include combinations of other flowthrough entities such as S corporations and other LLCs. The result is that many more taxpayers are treated as partners in TEFRA partnerships.

Combine this development with clients who often do not want to extend their individual returns and thus push partnerships to give them their Schedules K-1, even if the partnership is not ready to file for reasons other than items that affect taxable income, and preparers are put in a tough spot. Preparers should caution individual taxpayers who invest in TEFRA partnerships and insist on filing returns by April 15 to be aware of this issue and that, if they choose to file before the TEFRA partnership files its final return, they need to monitor the statute-of-limitation issues if the IRS subsequently audits the partnership. Also, all partners in TEFRA partnerships need to consider this issue and whether to extend their individual statute of limitation if the audit of the TEFRA partnership extends beyond the later of three years from when the partners filed their individual returns or three years from the original due date of the individual returns.


Anthony Bakale is with Cohen & Company Ltd. in Cleveland. For additional information about these items, contact Mr. Bakale at 216-774-1147 or tbakale@cohencpa.com. Unless otherwise noted, contributors are members of or associated with Cohen & Company Ltd.

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