Final partnership adjustment not issued timely

The Tax Court held that to the extent Regs. Sec. 301.6235–1(b)(2)(i)(A) holds the period for issuing a final partnership adjustment (FPA) open longer than Sec. 6235(a)(2), the regulation is contrary to the statute and invalid. Therefore, where the IRS, relying on Regs. Sec. 301.6235–1(b)(2)(i)(A), issued an FPA after the end of the 270–day period to file an FPA set out in Sec. 6235(a)(2) to a partnership that had made a Sec. 6225(c) imputed underpayment modification request, the regulation was invalid and the FPA was not timely issued.

BBA centralized audit procedures

In an audit conducted under the centralized audit procedures (established by the Bipartisan Budget Act of 2015 (BBA), P.L. 114–74), the IRS determines partnership adjustments, if any, at the partnership level, and any tax attributable to those adjustments is assessed and collected at the partnership level.

To make those adjustments, at the conclusion of an examination, the IRS issues a notice of proposed partnership adjustment (NOPPA) to the partnership, which includes the proposed adjustments as well as the amount of any proposed imputed underpayment due from the partnership. A NOPPA is issued when the IRS mails it to the taxpayer. After a NOPPA is issued but before assessment, within 270 days of the IRS’s issuance of the NOPPA, under Sec. 6225(c), a partnership may submit a request for modification of the imputed underpayment amount. A partnership makes this request on Form 8980, Partnership Request for Modification of Imputed Underpayments Under IRC Section 6225(c).

To make its final determination of partnership adjustments, the IRS must issue an FPA to the partnership. Like a NOPPA, an FPA is issued when the IRS mails it to the taxpayer. Within 90 days of the date an FPA is issued, the partnership may file a petition for judicial review of the IRS’s determinations in the FPA with the Tax Court, the Court of Federal Claims, or the district court where the partnership’s principal place of business is located. The IRS assesses an imputed underpayment after the close of that 90–day period or, if the taxpayer files a petition in a court, upon final decision of the court.

Generally, after the IRS has issued a NOPPA, under Sec. 6235(a)(3), it has at least 330 days to issue an FPA. However, if a partnership makes a Sec. 6225(c) imputed underpayment modification request, under Sec. 6235(a)(2), the period within which the IRS may make an FPA remains open for at least 270 days “after the date on which everything required to be submitted … is so submitted” for the modification request.

The IRS, in Regs. Sec. 301.6235–1(b)(2)(i)(A), has defined “the date on which everything required to be submitted … is so submitted” to be the date the 270–day period during which a partnership may request an imputed underpayment modification ends.

Background of the case

JM Assets LP, a limited partnership based in Texas, was subject to the BBA centralized audit procedures. In 2018, JM Assets engaged in several transactions to dispose of real property it owned, and it reported those transactions on its 2018 Form 1065, U.S. Return of Partnership Income.

The IRS audited JM Assets’ 2018 return, and on June 9, 2022, it issued a NOPPA to the partnership. The NOPPA stated an adjustment was required to increase the partnership’s overall Sec. 1231 gain relating to the installment sales of five properties for 2018. The NOPPA proposed an adjustment of $5,499,437 to net Sec. 1231 gain and an imputed underpayment of $2,034,792.

On Feb. 14, 2023, 250 days after the NOPPA was issued, JM Assets submitted a Form 8980 requesting a modification of the tax rates for two of its partners. JM Assets did not file Form 8981, Waiver of the Period Under IRC Section 6231(b)(2)(A) and Expiration of the Period for Modification Submissions Under IRC Section 6225(c)(7), with its Form 8980. In a letter dated June 5, 2023, the IRS approved the modifications in full.

On Dec. 1, 2023, 290 days after JM Assets submitted its modification request, the IRS issued an FPA, which determined an imputed underpayment relating to adjustments to Sec. 1231 gain. JM Assets timely filed a petition with the Tax Court challenging the FPA and the underlying adjustments. The partnership argued that the IRS had not timely issued the FPA pursuant to Sec. 6235(a)(2).

In Tax Court, the IRS and JM Assets made cross–motions for summary judgment on the issue of whether the IRS had timely issued the FPA within the limitation period in Sec. 6235(a). JM Assets, relying on the plain text of Sec. 6235(a), argued that the IRS could issue an FPA to a partnership that submitted a Sec. 6225(c) imputed underpayment modification request by the later of 330 days after it issued the NOPPA to the partnership or, as relevant in its case, 270 days after the partnership submitted everything required to be submitted to request the imputed underpayment modification. The IRS countered that, based on Regs. Sec. 301.6235–1, the 270 days does not begin to run until the close of the period during which a modification request may be submitted. To the extent the regulation the IRS relied on was inconsistent with the statute, JM Assets argued, the regulation was invalid.

The IRS also made two other motions, through which it sought to amend its pleadings in the case to add the alternative argument that the FPA was timely because JM Assets omitted a substantial amount of income on its 2018 return, extending the statute of limitation under Sec. 6235(a) to six years.

The Tax Court’s decision

The Tax Court held that when a regulation attempts to change an unambiguous provision of a statute, the regulation falls outside the boundaries of any rulemaking authority that Congress may have delegated to the IRS. Accordingly, it held that to the extent Regs. Sec. 301.6235–1(b)(2)(i)(A) holds the period for issuing an FPA open longer than Sec. 6235(a)(2), the regulation is contrary to the statute and invalid. Thus, Regs. Sec. 301.6235–1, as applied to JM Assets’ facts, was invalid, and the FPA the IRS issued to the partnership was untimely.

The court also denied the IRS’s motions to add the alternative substantial–omission–of–income argument to its pleadings. The court determined that the partnership did not omit a substantial amount of income on its return, so adding the argument would be futile.

Validity of the regulation: The Tax Court found that to determine whether the FPA was issued before the limitation period expired, it was required to decide whether Regs. Sec. 301.6235–1 was valid as applied. The Tax Court, quoting the Supreme Court in International Railway Co. v. Davidson, 257 U.S. 506, 514 (1922), stated that “[a] regulation to be valid must be reasonable and must be consistent with law.” It also noted that in Loper Bright Enterprises v. Raimondo, 144 S. Ct. 2244, 2273 (2024), the Supreme Court directed lower courts reviewing agency action to “exercise their independent judgment in deciding whether [the] agency has acted within its statutory authority.” The Court also observed in Loper Bright that statutes “have a single, best meaning” (id. at 2266).

As applied to JM Assets’ case, the Tax Court found a direct conflict between the statute, Sec. 6235(a)(2), and the regulations on which the IRS relied, Regs. Sec. 301.6235–1(b)(2)(i)(A). As the court explained, Sec. 6235(a)(2) provides the period during which the IRS can issue an FPA where a partnership has submitted a Sec. 6225(c) imputed underpayment modification request. The plain text of Sec. 6235(a)(2) states that the date that period ends is “270 days … after the date” the taxpayer submits everything required for a complete modification request. Regs. Sec. 301.6235–1(b)(2)(i)(A), on the other hand, interprets the date the period ends to be 270 days after the date that the period a partnership can request a modification ends. Because there was a conflict in the end dates between the two periods, the court determined that “the regulation must give way to the statute.”

The IRS argued that, under Sec. 6225(c), it had the “broad authority” to establish procedures with respect to the modification of imputed underpayments and that the definition in Regs. Sec. 301.6235–1(b)(2) was promulgated under that authority. The IRS linked the limitation period under Sec. 6235(a) to its authority to establish procedures under Sec. 6225(c) by noting that Sec. 6235(a)(2) explicitly refers to “everything required to be submitted” pursuant to Sec. 6225(c). But the Tax Court, citing its own precedent in Varian Medical Systems, Inc., 163 T.C. 76 (2024), found that where Congress expressly delegates broad rulemaking authority, that authority does not extend to contradicting statutory text.

The IRS also argued that a modification request is not complete until a partnership submits a waiver of the modification period on Form 8981, which JM Assets did not submit. The Tax Court rejected this argument, finding that nothing in the statute or the regulations required a waiver for a submission to be complete.

Finally, the Tax Court found that, factually, there was no genuine dispute that JM Assets submitted everything it was required to submit for a complete imputed underpayment modification request on Feb. 14, 2023, the date it submitted a Form 8980 to request the modification. After that date, JM Assets did not submit further information, the IRS did not request additional information, and the IRS approved the modification request. In the court’s view, these facts established that JM Assets had “submitted everything required to be submitted” in its initial submission of the modification request on Feb. 14, 2023.

Consequently, under Sec. 6235(a)(2), the IRS had 270 days from its receipt of the submission on Feb. 14, 2023, to issue an FPA, and that date was Nov. 11, 2023, a Saturday. Thus, under Sec. 7503, the 270–day period lapsed on Monday, Nov. 13, 2023. Because the IRS issued the FPA on Dec. 1, 2023, the Tax Court held, the FPA had not been issued timely.

Substantial omission of income: The IRS also made motions for leave to amend its pleadings to include an alternative argument that the FPA had been issued timely because the normal three–year period to make an adjustment under Sec. 6235(a) was extended under Sec. 6235(c)(2) to six years in JM Assets’ case because there was a substantial omission of income on the partnership’s return. An omission of income is “substantial” if it is more than 25% of the amount of gross income stated on the return. If an item of income the IRS claims has been omitted is disclosed on the face of the return or a statement attached to it, in a manner adequate to apprise the IRS of the nature and amount of the item, it is not considered omitted (Sec. 6501(e)(1)(B)(iii)).

The Tax Court found that all the income the IRS contended was omitted from JM Assets’ return was Sec. 1231 gain from sales of property that were reported on Forms 6252, Installment Sale Income, that the partnership included with its return, so the income was not omitted from the partnership return because it had been adequately disclosed on the return. Therefore, the court concluded that the IRS’s substantial–omission–of–income argument was not supported by the facts or the law, and the court denied the IRS’s motion to add the argument to the IRS’s pleadings because it would be futile.

Reflections

As noted above, the Tax Court limited its holding that Regs. Sec. 301.6235–1(b)(2)(i)(A) was contrary to the statute to the facts of the case. In a footnote to the opinion, the court stated, “We express no view as to the application of this regulation to situations in which a partnership does not submit everything required to be submitted.”

Contributor

James A. Beavers, CPA, CGMA, J.D., LL.M., is The Tax Adviser‘s tax technical content manager. For more information about this column, contact thetaxadviser@aicpa.org.