What Was IRC § 6231(a)(7)’s Partnership Item Definition?
Examine the historical definition of a partnership item under TEFRA, a classification that shaped unified audit procedures prior to the current BBA regime.
The Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) introduced rules to create a more efficient method for the Internal Revenue Service (IRS) to audit partnerships. A central component of these rules was the concept of a “partnership item,” which established which financial elements would be examined in a single, unified proceeding. The TEFRA framework was repealed for most partnerships for tax years beginning after December 31, 2017. The Bipartisan Budget Act of 2015 (BBA) introduced a new centralized audit system, changing how partnership audits are conducted.
Defining a Partnership Item under TEFRA
Under the TEFRA rules, a “partnership item” was defined as any item required to be taken into account for a partnership’s taxable year, to the extent that regulations specified the item was more appropriately determined at the partnership level rather than at the individual partner level. The core idea was to resolve issues common to all partners in one place, avoiding repetitive and potentially inconsistent outcomes that could arise from separate audits of each partner.
The regulations provided a comprehensive list of what constituted a partnership item. These included:
- The partnership’s total income, gains, losses, deductions, and credits, and each partner’s share of these amounts
- The partnership’s liabilities
- The characterization of its transactions
- Amounts related to contributions to and distributions from the partnership
- The determination of who qualifies as a partner
The Procedural Impact of the Partnership Item Classification
The classification of an item as a “partnership item” dictated the entire audit and litigation process. By grouping these items, the IRS could initiate a single audit of the partnership that would be legally binding on every partner with respect to those items. This unified approach prevented the administrative burden of auditing each partner individually for the same underlying partnership transaction.
This centralized process was managed by the “Tax Matters Partner” (TMP), a role established by TEFRA. The TMP, a general partner designated by the partnership, acted as the primary liaison with the IRS, responsible for receiving notices, keeping other partners informed, and representing the partnership. The final determination from the partnership-level proceeding would then be applied to the individual tax returns of all partners, ensuring consistent treatment.
Distinguishing from Nonpartnership and Affected Items
A “nonpartnership item” was an item that was not, or was no longer, treated as a partnership item. This could occur if a partner entered into a separate settlement agreement with the IRS regarding their share of partnership items, converting them into nonpartnership items for that partner. The amount a partner paid for their interest in the partnership was also considered a nonpartnership item.
An “affected item” represented a link between the partnership-level audit and an individual partner’s tax liability. An affected item is any item on a partner’s return that is impacted by an adjustment to a partnership item, such as a partner’s basis in their partnership interest or at-risk limitations. While the underlying partnership item was determined in the unified audit, the tax consequence of the affected item was calculated at the individual partner level, sometimes requiring a separate notice of deficiency.
Transition to the Current BBA Centralized Audit Regime
The landscape of partnership audits changed with the repeal of the TEFRA rules for tax years starting after December 31, 2017. The Bipartisan Budget Act of 2015 (BBA) established a new centralized audit regime that operates with different mechanics and roles. This new system applies to all partnerships unless they make a valid election out of the regime, an option available to smaller partnerships with 100 or fewer eligible partners.
A change under the BBA was the replacement of the Tax Matters Partner with a “Partnership Representative” (PR). The PR has more authority than the former TMP and is the sole individual empowered to act on behalf of the partnership in an audit. Unlike under TEFRA, partners no longer have a statutory right to participate in the audit or receive notice from the IRS, which concentrates power and responsibility in the hands of the PR.
A fundamental change introduced by the BBA is how audit adjustments are paid. The default rule under the BBA is that the partnership itself pays any tax deficiency, referred to as an “imputed underpayment,” calculated at the highest individual or corporate tax rate. Under the TEFRA system, the liability for adjustments flowed through and was assessed against the individual partners from the year under review.
As an alternative to the partnership paying the imputed underpayment, the BBA provides an election to “push out” the adjustments. If this election is made, the partnership provides statements to the partners from the year that was audited. Those partners must then take the adjustments into account on their own individual tax returns, paying the associated tax, interest, and penalties.