LLC validly elected into BBA partnership examination regime

Editor: Mark G. Cook, CPA, CGMA

In SN Worthington Holdings, LLC, 162 T.C. No. 10 (2024), the Tax Court held that the IRS could not create additional requirements not found in the regulations for a taxpayer to elect into the Bipartisan Budget Act (BBA), P.L. 114-74, partnership audit procedures for a year in which the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), P.L. 97-248, partnership audit procedures otherwise applied.

Background of the case

In October 2018, the IRS sent a letter notifying the taxpayer, SN Worthington Holdings, which was a limited liability company (LLC) classified as a partnership for federal income tax purposes, that its 2016 tax year had been selected for examination. The LLC’s 2016 tax year was after enactment of the BBA but before its new partnership audit procedures were the default treatment, so the audit procedures under TEFRA would ordinarily have applied.

However, Regs. Sec. 301.9100-22 allows partnerships under examination for tax years beginning after Nov. 2, 2015, and before Jan. 1, 2018, to timely submit Form 7036, Election Under Section 1101(g)(4) of the Bipartisan Budget Act of 2015, to elect into the BBA partnership audit regime. Worthington submitted this election within 30 days of the IRS’s notification letter, representing that the LLC had sufficient funds to cover any imputed underpayment, as required under Regs. Sec. 301.9100-22(b)(2)(ii) (E)(4).

The IRS denied the election, stating that it was invalid because Worthington’s tax return did not support the sufficient-asset representation, and continued the examination under the TEFRA procedures. In its denial letter, the IRS allowed Worthington 30 days to refute the determination, so long as it provided supporting documents that it could in fact resolve any potential underpayment liability. Worthington did not submit a letter in direct response to this denial. However, the LLC had subsequent communications with the IRS and signed documents referencing the TEFRA procedures.

In June 2020, Worthington sent the IRS a letter asking to be included in the Small Business/Self-Employed Fast Track settlement program. In addition, the letter addressed Worthington’s contention that the IRS examination should have been occurring under the BBA procedures instead of the TEFRA procedures. The LLC argued that its election into the BBA procedures was valid because the regulations did not require a taxpayer to provide proof that it had sufficient assets to pay an imputed tax liability.

In response to the letter, the IRS denied Worthington’s request for inclusion in the Fast Track Settlement program without addressing the LLC’s argument that it was examining its 2016 return under the wrong procedures. The IRS issued Worthington a Final Partnership Administrative Adjustment (FPAA) under the TEFRA procedures.

Tax Court holds election was valid

Worthington filed a petition in Tax Court challenging the IRS’s determination and later filed a timely motion to dismiss the case for lack of jurisdiction on the grounds that the FPAA issued to Worthington was invalid.

To determine whether the FPAA was invalid, the Tax Court was required to determine whether the LLC made a valid election into the BBA partnership audit procedures for its 2016 return. The court held that Worthington had made a valid election because, by representing in its timely Form 7036 BBA election that it had sufficient assets to pay a potential imputed underpayment for the tax year, it had met the requirements in the regulations for the election.

The Tax Court found that the IRS’s request that the partnership provide documentation to support the representation made in the election was an additional requirement that was more stringent than that of the regulations. Based on its precedent, the court determined that the IRS does not have the authority to create additional requirements to make an election that are not found in the regulations. Thus, the IRS could not deny the election into the BBA partnership audit regime based on Worthington’s failure to provide support for its representation.

Because Worthington had met the requirements in the regulations in its election into the BBA audit procedures for the 2016 tax year, the Tax Court held that the TEFRA audit procedures did not apply to that year. Thus, it further held that the FPAA the IRS issued for the 2016 tax year was invalid. This holding by the court strengthens a partnership’s ability to determine its preferred audit treatment for the tax years covered by the transition period from TEFRA to the BBA.

Editor Notes

Mark G. Cook, CPA, CGMA, MBA, is the lead tax partner with SingerLewak LLP in Irvine, Calif.

For additional information about these items, contact Cook at mcook@singerlewak.com.

Contributors are members of or associated with SingerLewak LLP.