Modifications & Additions to the
Unified Partnership Audit Procedures

DEPARTMENT OF THE TREASURY
Internal Revenue Service 26 CFR Part 301 [TD 8808] RIN 1545-AW23

TITLE: Modifications and Additions to the Unified Partnership Audit
Procedures

AGENCY: Internal Revenue Service, Treasury.

ACTION: Final and temporary regulations.

SUMMARY: This document contains final and temporary regulations
relating to the unified partnership audit procedures added to the
Internal Revenue Code by the Tax Equity and Fiscal Responsibility
Act of 1982 (TEFRA). The unified partnership audit procedures
generally provide administrative rules for the auditing of
partnership items at the partnership level. These regulations modify
the existing unified partnership audit procedures to comply with the
Taxpayer Relief Act of 1997 (1997 Act) and the Internal Revenue
Service Restructuring and Reform Act of 1998 (1998 Act), and add new
regulations to administer the new unified partnership audit
provisions added by the 1997 Act. In general, the text of these
temporary regulations also serves as the text of the proposed
regulations set forth in the notice of proposed rulemaking on this
subject in the Proposed Rules section of this issue of the Federal
Register.

DATES: Effective Date: These regulations are effective January 26,
1999.

FOR FURTHER INFORMATION CONTACT: Robert G. Honigman, (202) 622- 3050
(not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

This document contains temporary amendments to the Procedure and
Administration Regulations (26 CFR Part 301) relating to the unified
partnership audit procedures found in sections 6221 through 6233 of
the Internal Revenue Code (Code) and final regulations pertaining to
the applicable dates of �301.6231(a)(7)-1T(p)(2) and �301.6231(a)
(7)-1T(r)(1). Sections 1231 through 1243 of the Taxpayer Relief Act
of 1997, Public Law 105-34, 111 Stat. 788, modified some of the
existing procedures and added certain new rules. Section 3507 of the
Internal Revenue Service Restructuring and Reform Act of 1998,
Public Law 105-206, 112 Stat. 685, modified section 6231. This
document modifies existing regulations that, because of the 1997 Act
or the 1998 Act, no longer reflect current law.

Explanation of Provisions

Penalties Determined At The Partnership Level

Before the 1997 Act, the Internal Revenue Service (Service) could
impose penalties on a partner only through the application of the
deficiency procedures after the completion of a partnership level
proceeding. Forcing the Service to open deficiency proceedings
against the individual partners was inconsistent with the efficiency
goal of the unified partnership audit rules. The 1997 Act cured this
problem by providing that, for partnerships under audit for taxable
years ending after August 5, 1997, partnership level proceedings
include the determination of applicable penalties at the partnership
level.

Partners now may raise any partner level defenses to the imposition
of penalties only in a subsequent refund action.

Consistent with these statutory changes, the temporary regulations
mandate that the partnership's penalty defenses are to be resolved
during the partnership proceeding. Nevertheless, any individual
defenses that a partner may have to the imposition of a penalty may
be brought by the partner in a refund action subsequent to the
partnership level determination. In order to minimize the burden on
individual partners to defend themselves by bringing their own
refund suits, the temporary regulations incorporate a large number
of defenses at the partnership level.

The majority of a partner's defenses to the imposition of penalties
are not specific to a particular partner, but can be determined by
reference to the activities of the partnership.

The applicability of these defenses may be resolved at the
partnership level during the partnership proceeding. In addition,
the temporary regulations modify the computational adjustment rules
to allow the Service to assess penalties under those procedures.

Partial Settlements

The period for assessing tax with respect to partnership items
generally is the longer of the periods provided by section 6229 or
section 6501. For partnership items that convert to nonpartnership
items, section 6229(f) provides that the period for assessing tax
shall not expire before the date which is one year after the date
that the items became nonpartnership items.

Section 6231(b)(1)(C) provides that the partnership items of a
partner for a partnership taxable year become nonpartnership items
as of the date the partner enters into a settlement agreement with
the Service with respect to such items. In some audits, however, the
taxpayer and the Service will enter into a settlement agreement
regarding some, but not all, of the taxpayer's partnership items.
The 1997 Act added a special rule for these partial settlement
agreements in section 6229(f)(2), providing that the period for
assessing any tax attributable to the settled items is determined as
if the partial settlement had not been executed. Thus, the
limitations period applicable to the last partnership item to be
resolved for the partnership's taxable year under audit is
controlling with respect to all disputed partnership items
(including settled items) for such partnership taxable year.

The temporary regulations state that the one year period for
assessing partnership items that convert to nonpartnership items
applicable to settlement agreements under section 6231(b)(1)(C) does
not apply to partial settlement agreements under section 6229(f)(2).
Moreover, the temporary regulations clarify that the partner remains
subject to the unified audit procedures regarding the nonsettled
items.

Tax Matters Partner As A Debtor In Bankruptcy Section 6229(b)(1)(B)
provides that the statute of limitations under section 6229 is
extended with respect to all partners in the partnership by an
agreement entered into between the tax matters partner (TMP) and the
Service. Treas. Reg.

�301.6231(a)(7)-1(l)(1)(iv) (1996) and Temp. Treas. Reg.

�301.6231(c)-7T(a) (1987), however, provide that upon the filing of
a petition naming a partner as a debtor in a bankruptcy proceeding,
the partner/debtor's partnership items convert to nonpartnership
items, and if the partner/debtor was the TMP, that status
terminates. These rules were promulgated to avoid the complications
that the automatic stay provision contained in 11 U.S.C. 362(a)(8)
would have on a unified partnership audit. As a result, if a TMP
executed a consent to extend the statute of limitations during a
period when the TMP was a debtor in a bankruptcy proceeding, the
consent would not be binding on the other partners. Under the
regulations, the person signing the agreement was ineligible to act
as the TMP and extend the statute as to all partners.

To resolve the uncertainty under prior law in the situation where a
TMP executes an agreement extending the statute of limitations as to
all partners while, unknown to the Service, the TMP is a debtor in a
bankruptcy proceeding, the 1997 Act provides that the Service may
rely on the executed statute extension agreement unless it is
notified of the TMP's bankruptcy proceeding. If the Service is not
notified of the TMP's bankruptcy proceeding, statute extensions
granted by the TMP are binding on all partners in the partnership.

The temporary regulations provide a mechanism for the TMP, or other
partners, to provide notice to the Service that the TMP is a debtor
in a bankruptcy proceeding and therefore is ineligible to serve as
TMP and extend the statute under section 6229. This mechanism is
derived from existing regulations that provide guidance on how to
notify the Service of information concerning a partnership's
partners.

Small Partnership Exception

The 1997 Act amended the small partnership exception to the unified
partnership audit procedures found in section 6231.

Formerly, in order to qualify for the small partnership exception,
the partnership had to have 10 or fewer partners at all times during
the tax year, each of whom was a natural person (other than a
nonresident alien) or an estate, and for which each partner's share
of each partnership item was the same as that partner's share of
every other partnership item. The 1997 Act amended the small
partnership exception by allowing partnerships to qualify for the
exception even if they have a C corporation for a partner or
specially allocate some partnership items. The temporary regulations
modify the existing regulations interpreting the small partnership
exception to take account of this change in the law.

Effective Date

These final and temporary regulations are applicable January 26,
1999. In accordance with section 7805(e)(2), the temporary
regulations contained herein shall expire January 25, 2002.

Special Analyses

It has been determined that this Treasury decision is not a
significant regulatory action as defined in EO 12866. Therefore, a
regulatory assessment is not required. It also has been determined
that section 533(b) of the Administrative Procedures Act (5 U.S.C.
chapter 5) does not apply to these regulations.

For the applicability of the Regulatory Flexibility Act (5 U.S.C.
chapter 6) refer to the Special Analyses section of the preamble to
the cross reference notice of proposed rulemaking published in the
Proposed Rules section in this issue of the Federal Register.

Pursuant to section 7805(f) of the Internal Revenue Code, these
final and temporary regulations will be submitted to the Chief
Counsel for Advocacy of the Small Business Administration for
comment on their impact on small business.

Drafting Information

The principal authors of these temporary regulations are Robert G.
Honigman, Office of the Assistant Chief Counsel (Passthroughs &
Special Industries), and William A. Heard, Office of the Assistant
Chief Counsel (Field Service). However, other personnel from the
Service and Treasury Department participated in their development.

List of Subjects in 26 CFR Part 301

Employment taxes, Estate taxes, Excise taxes, Gift taxes, Income
taxes, Penalties, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

Accordingly, 26 CFR part 301 is amended as follows:

PART 301--PROCEDURE AND ADMINISTRATION Paragraph 1. The authority
citation for part 301 continues to read in part as follows:

Authority: 26 U.S.C. 7805 * * *

Par. 2. Amend �301.6221-1T by:

1. Redesignating paragraph (c) as paragraph (e).

2. Adding new paragraphs (c) and (d).

The additions read as follows:

�301.6221-1T Tax treatment determined at partnership level
(temporary).

* * * * *

(c) Penalties determined at partnership level (partnership taxable
years ending after August 5, 1997). Any penalty, addition to tax, or
additional amount that relates to an adjustment to a partnership
item, shall be determined at the partnership level. Partner level
defenses to such items can only be asserted through refund actions
following assessment and payment. Assessment of any penalty,
addition to tax, or additional amount that relates to an adjustment
to a partnership item shall be made based on partnership level
determinations.

Partnership level determinations include all the legal and factual
determinations that underlie the determination of any penalty,
addition to tax, or additional amount, other than partner level
defenses specified in paragraph (d) of this section.

(d) Partner level defenses. Partner level defenses to any penalty,
addition to tax, or additional amount that relates to an adjustment
to a partnership item, may not be asserted in the partnership level
proceeding, but may be asserted through separate refund actions
following assessment and payment. See section 6230(c)(4). Partner
level defenses are limited to those that are personal to the partner
or are dependant upon the partner's separate return, and cannot be
determined at the partnership level. Examples of these
determinations are: whether any applicable threshold underpayment of
tax has been met with respect to the partner or whether the partner
has met the criteria of section 6664(b)(penalties applicable only
where return is filed), or section 6664(c)(1)(reasonable cause
exception) subject to partnership level determinations as to the
applicability of section 6664(c)(2).

* * * * *

Par. 3. Amend �301.6223(c)-1T by adding a sentence to the end of
paragraph (c) to read as follows:

�301.6223(c)-1T Additional information regarding partners furnished
to the Service (temporary).

* * * * *

(c) * * * Furthermore, reference to a prior general notification to
the Service that a partner who would otherwise be the tax matters
partner is a debtor in a bankruptcy proceeding or has had a receiver
appointed for him in a receivership proceeding is not sufficient
unless a copy of the notification document referred to is attached
to the statement.

* * * * * Par. 4. Amend �301.6224(c)-3T by:

1. Revising the section heading.

2. Revising paragraphs (b), (c)(3)(ii), and (d), Example (1).

The revisions read as follows:

�301.6224(c)-3T Consistent settlement terms (temporary).

* * * * *

(b) Requirements for consistent settlement terms --

(1) In general. Consistent settlement terms are those based on the
same determinations with respect to partnership items.

However, consistent settlement terms also may include partnership
level determinations of any penalty, addition to tax, or additional
amount that relates to partnership items. Settlements with respect
to partnership items shall be self-contained; thus, a concession by
one party with respect to a partnership item may not be based upon a
concession by another party with respect to any item that is not a
partnership item other than any penalty, addition to tax, or
additional amount that relates to an adjustment to a partnership
item. Consistent agreements, whether comprehensive or partial, must
be identical to the original settlement (that is, the settlement
upon which the offered settlement terms are based). A consistent
agreement must mirror the original settlement and may not be limited
to selected items from the original settlement. Once a partner has
settled a partnership item, or penalty, addition to tax, or
additional amount that relates to an adjustment to a partnership
item, that partner may not subsequently request settlement terms
consistent with a settlement that contains the previously settled
item. The requirement for consistent settlement terms applies only
if--

(i) The items were partnership items (and any related penalty,
addition to tax, or additional amount) for the partner entering into
the original settlement immediately before the original settlement;
and

(ii) The items are partnership items (and any related penalty,
addition to tax, or additional amount) for the partner requesting
the consistent settlement at the time the partner files the request.

(2) Effect of consistent agreement. Consistent settlement terms are
reflected in a consistent agreement. A consistent agreement is not a
settlement agreement which gives rise to further consistent
settlement rights because it is required to be given without
volitional agreement of the Secretary. Therefore, a consistent
agreement required to be offered to a requesting taxpayer is not a
settlement agreement under section 6224(c)(2) of the Internal
Revenue Code, or paragraph (c)(3) of this section which starts a new
period for requesting consistent settlement terms. For all other
purposes of the Internal Revenue Code, however, (e.g., binding
effect under section 6224(c)(1), and conversion to nonpartnership
items under section 6231(b)(1)(C)) a consistent agreement is treated
as a settlement agreement.

(c) * * *

(3) * * *

(ii) The 60 day after the day on which the settlement th agreement
was entered into.

(d) * * *

Example (1). The Service seeks to disallow a $100,000 loss reported
by Partnership P. The Service agrees to a settlement with X, a
partner in P, in which the Service allows 60 percent of the loss,
accepts the treatment of all other partnership items on the
partnership return, and imposes a penalty for negligence related to
the loss disallowance. Partner Y, which owns a 10 percent interest
in the partnership, requests settlement terms which are consistent
with the settlement made between X and the Service. The items are
partnership items (and a related penalty) for X immediately before X
enters into the settlement agreement and are partnership items (and
a related penalty) for Y at the time of the request. The Service
must offer Y settlement terms allowing a $6,000 loss, a negligence
penalty on the $4,000 disallowance, and otherwise reflecting the
treatment of partnership items on the partnership return.

* * * * *

Par. 5. Add �301.6229(b)-2T to read as follows:

�301.6229(b)-2T Special rule with respect to debtors in Title 11
cases (temporary).

(a) In general. Notwithstanding any other law or rule of law, if an
agreement is entered into under section 6229(b)(1)(B), and the
agreement is signed by a person who would be the tax matters partner
but for the fact that, at the time that the agreement is executed,
the person is a debtor in a bankruptcy proceeding under Title 11 of
the United States Code, such agreement shall be binding on all
partners in the partnership unless the Service has been notified of
the bankruptcy proceeding in accordance with paragraph (b) of this
section.

(b) Procedures for notifying the Service of a partner's bankruptcy
proceeding. (1) The Service shall be notified of the bankruptcy
proceeding of the tax matters partner in accordance with the
procedures set forth in �301.6223(c)-1T.

(2) In addition to the information specified in �301.6223(c)-1T,
notification that a person is (or was) a debtor in a bankruptcy
proceeding shall include the date the bankruptcy proceeding was
filed, the name and address of the court in which the bankruptcy
proceeding exists (or took place), the caption of the bankruptcy
proceeding (including the docket number or other identification
number used by the court), and the status of the proceeding as of
the date of notification.

Par. 6. Add �301.6229(f)-1T to read as follows:

�301.6229(f)-1T Special rule for partial settlement agreements
(temporary).

(a) In general. If a partner enters into a settlement agreement with
the Service with respect to the treatment of some of the partnership
items in dispute for a partnership taxable year, but other
partnership items for such year remain in dispute, the period of
limitations for assessing any tax attributable to the settled items
shall be determined as if such agreement had not been entered into.

(b) Other items remaining in dispute. Pursuant to section 6226(c), a
partner is a party to a partnership level judicial proceeding with
respect to partnership items. When a partner settles partnership
items, the settled partnership items convert to nonpartnership items
under section 6231(b)(1)(C) and will not be subject to any future or
pending partnership level proceeding pursuant to section 6226(d)(1).
The remaining unsettled partnership items, however, will remain
subject to determination under partnership level administrative and
judicial procedures.

Consequently, any remaining unsettled items will be deemed to remain
in dispute. Thus, the period for assessing settled items will be
governed by the period for assessing the remaining unsettled items.

Par. 7. Amend �301.6231(a)(1)-1T by:

1. Revising the first two sentences of paragraph (a)(1).

2. Removing paragraph (a)(3).

3. Redesignating paragraph (a)(4) as paragraph (a)(3).

The revision reads as follows:

�301.6231(a)(1)-1T Exception for small partnerships (temporary).

(a) * * * (1) A 10 or fewer.

@ The A 10 or fewer @ limitation described in section 6231(a)(1)(B)
(i) is applied to the number of natural persons (other than
nonresident aliens), C corporations, and estates of deceased
partners that were partners at any one time during the partnership
taxable year. Thus, for example, a partnership that at no time
during the taxable year had more than 10 partners may be treated as
a small partnership even if, because of transfers of interests in
the partnership, 11 or more natural persons, C corporations, or
estates of deceased partners owned interests in the partnership for
some portion of the taxable year. * * *

* * * * *

Par. 8. Amend �301.6231(a)(6)-1T by:

1. Revising paragraph (a).

2. Removing paragraph (c).

The revision reads as follows:

�301.6231(a)(6)-1T Computational adjustments (temporary).

(a) In general. A change in the tax liability of a partner to
properly reflect the treatment of a partnership item under
subchapter C of chapter 63 of the Internal Revenue Code is made
through a computational adjustment. A computational adjustment
includes a change in tax liability that reflects a change in an
affected item where that change is necessary to properly reflect the
treatment of a partnership item, or any penalty, addition to tax, or
additional amount that relates to an adjustment to a partnership
item. However, if a change in a partner's tax liability cannot be
made without making one or more partner level determinations, that
portion of the change in tax liability attributable to the partner
level determinations shall be made under the provisions of
subchapter B of chapter 63 of the Internal Revenue Code (relating to
deficiency procedures), except for any penalty, addition to tax, or
additional amount which relates to an adjustment to a partnership
item.

(1) Changes in a partner's tax liability with respect to affected
items that do not require partner level determinations (such as the
threshold amount of medical deductions under section 213 that
changes as the result of determinations made at the partnership
level) are computational adjustments that are directly assessed.
When making computational adjustments, the Service may assume that
amounts the partner reported on the partner's individual return
include all amounts reported to the partner by the partnership,
absent contrary notice to the Service (for example, a A Notice of
Inconsistent Treatment @ ). Such an assumption by the Service does
not constitute a partner level determination. Moreover, substituting
redetermined partnership items for the partner's previously reported
partnership items (including partnership items included in carryover
amounts) does not constitute a partner level determination where the
Service otherwise accepts all nonpartnership items (including, for
example, nonpartnership item components of carryover amounts) as
reported.

(2) Changes in a partner's tax liability with respect to affected
items that require partner level determinations (such as a partner's
at-risk amount to the extent it depends upon the source from which
the partner obtained the funds that the partner contributed to the
partnership) are computational adjustments subject to deficiency
procedures. Nevertheless, any penalty, addition to tax, or
additional amount that relates to an adjustment to a partnership
item may be directly assessed following a partnership proceeding,
based on determinations in that proceeding, regardless of whether
partner level determinations are required.

* * * * *

Par. 9. Amend �301.6231(a)(7)-1 by adding a sentence at the end of
paragraphs (p)(2) and (r)(1) to read as follows:

�301.6231(a)(7)-1 Designation or selection of tax matters partner.

* * * * *

(p) * * *

(2) * * * For regulations applicable on or after January 26, 1999
(reflecting statutory changes made effective July 22, 1998) and
before January 25, 2002, see �301.6231(a)(7)-1T(p)(2).

* * * * *

(r) * * * (1) * * * For regulations applicable on or after January
26, 1999 (reflecting statutory changes made effective July 22, 1998)
and before January 25, 2002, see �301.6231(a)(7)-1T( r)(1).

* * * * *

Par. 10. Add �301.6231(a)(7)-1T to read as follows:

�301.6231(a)(7)-1T Designation or selection of tax matters partner
(temporary).

(a) through (p)(1) [Reserved]. For further guidance, see
�301.6231(a)(7)-1(a) through (p)(1).

(p)(2) When each general partner is deemed to have no profits
interest in the partnership. If it is impracticable under
�301.6231(a)(7)-1(o)(2) to apply the largest-profits-interest rule
of �301.6231(a)(7)-1(m)(2), the Commissioner will select a partner
(including a general or limited partner) as the tax matters partner
in accordance with the criteria set forth in �301.6231(a)(7)-1(q).
The Commissioner will notify, within 30 days of the selection, the
partner selected, the partnership, and all partners required to
receive notice under section 6223(a), effective as of the date
specified in the notice. For regulations applicable before July 22,
1998, see �301.6231(a)(7)-1( p)(2).

(p)(3) through (q) [Reserved]. For further guidance, see
�301.6231(a)(7)-1(p)(3) through (q).

(r) Notification of partnership--(1) In general. If the Commissioner
selects a tax matters partner under the provisions of �301.6231(a)
(7)-1(p)(1) or (3)(i), the Commissioner will notify, within 30 days
of the selection, the partner selected, the partnership, and all
partners required to receive notice under section 6223(a), effective
as of the date specified in the notice. For regulations applicable
before July 22, 1998, see �301.6231(a)(7)-1(r)(1).

(r)(2) [Reserved]. For further guidance, see �301.6231(a)(7)-1(r)
(2).

Robert E. Wenzel
Deputy Commissioner of Internal Revenue Service
Approved: December 30, 1998
Donald C. Lubick
Assistant Secretary of the Treasury

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