The Importance of Procedure in Tax Controversy and Litigation

In the realm of tax controversy and litigation, procedural rules often play a crucial role in determining the outcome of cases, sometimes even overshadowing the substantive merits of a case. One of the most significant procedural tools is the statute of limitations, which sets a time limit within which the IRS can audit a taxpayer or propose adjustments. Even if a taxpayer made a mistake on a previous year’s tax return, the IRS is generally barred from opening an audit once the applicable statute of limitations has expired. This principle underscores the importance of understanding and adhering to procedural requirements in tax disputes.

The Bipartisan Budget Act (BBA) of 2015 introduced new rules specifically for partnerships, which have added complexity to the already intricate landscape of tax procedure. These rules, which became effective for the 2018 tax year, were designed to streamline the process of auditing and assessing taxes on partnerships. However, as with any new regulatory framework, the BBA partnership rules contain pitfalls that can trap even the most vigilant taxpayers and practitioners. A recent IRS Chief Counsel memorandum highlights how these rules can sometimes ensnare not just taxpayers, but also the IRS itself.

The Bipartisan Budget Act (BBA): An Overview

Enacted in 2015, the BBA introduced significant changes to the way partnerships are taxed and audited. These changes apply to partnership tax returns filed for the 2018 tax year and later. Under the BBA, partnerships are now required to pay income tax on any underpayment of taxes, referred to as an “imputed underpayment,” unless the partnership makes a timely election to push these adjustments out to its partners. This provision aims to simplify the process by holding the partnership directly responsible for any tax liabilities arising from an audit.

In addition to the imputed underpayment rules, the BBA introduced the concept of a “partnership representative” (PR). The PR is an individual or entity designated by the partnership to act on its behalf in tax matters, including executing extension agreements for the statute of limitations and handling IRS examinations. The PR is granted sole authority to make decisions related to the partnership’s tax affairs, and this designation continues until the PR resigns, the partnership revokes the designation, or the IRS determines that the designation is no longer effective. This centralized authority is intended to streamline communication and decision-making during audits.

The BBA’s Statute of Limitations Rules

The BBA also established specific statute of limitations rules for partnerships, which differ from the general rules applicable to individual taxpayers. Under the BBA, the IRS is required to issue three key notices during the course of an examination: a notice of administrative proceeding, a notice of proposed partnership adjustment (NOPPA), and a notice of final partnership adjustment (FPA). These notices are designed to provide clear communication and ensure that the partnership is informed at each stage of the audit process.

The general statute of limitations under the BBA is three years, during which the IRS must propose any adjustments to a partnership’s tax return. This three-year period begins on the later of the date the partnership files its tax return (Form 1065), the partnership’s return filing deadline, or the date on which the partnership files an administrative adjustment request (AAR). However, there are exceptions and extensions that can prolong this period. For instance, the IRS has 330 days from the issuance of a NOPPA to make a partnership adjustment, provided the NOPPA is issued within the initial three-year period. Additionally, the PR and the IRS can mutually agree to extend the statute of limitations by signing a written waiver.

There are also exceptions to the statute of limitations period, such as in cases where a fraudulent return is submitted. These exceptions allow the IRS to revive an otherwise expired statute of limitations, ensuring that taxpayers who engage in fraudulent activities cannot evade accountability by relying on procedural technicalities.

The Role of the Partnership Representative

The partnership representative (PR) plays a critical role in navigating the complexities of the BBA’s procedural rules. The PR is not only responsible for handling communications with the IRS but also for making key decisions that can significantly impact the partnership’s tax liability. One of the most important responsibilities of the PR is the authority to extend the statute of limitations. This authority is exclusive to the PR, meaning that no other individual or entity, including other partners or managers, can bind the partnership to an extension of the audit period.

This exclusivity was underscored in a recent IRS Chief Counsel memorandum (CCA 202505027), which addressed a situation where the IRS sought to extend the statute of limitations for a partnership’s 2018 and 2019 tax years. In this case, the IRS obtained signed extensions (Forms 872-M) from the partnership’s managers, including its CFO/Treasurer. However, these individuals were not designated as the PR under the BBA rules. The IRS Chief Counsel concluded that these extensions were invalid because only the PR had the authority to extend the statute of limitations. As a result, the IRS was barred from proposing adjustments to the partnership’s tax returns for the 2018 and 2019 tax years, despite having initiated the audit within the applicable time frame.

This memorandum highlights the importance of understanding and adhering to the BBA’s procedural requirements. It also serves as a cautionary tale for taxpayers and practitioners, emphasizing that even minor oversights in procedural matters can have significant consequences.

Lessons from the IRS Chief Counsel Memorandum

The memorandum issued by the IRS Chief Counsel in CCA 202505027 provides valuable insights into the practical implications of the BBA’s procedural rules. In this case, the IRS commenced an examination of a partnership’s tax returns for the 2018 and 2019 tax years. The partnership had filed its 2018 return on September 13, 2019, and its 2019 return on September 14, 2020. Under the general three-year rule, the IRS had until September 13, 2022, and September 14, 2023, respectively, to propose adjustments for these tax years.

When the IRS examiner needed additional time to complete the examination, the agency sought and obtained signed statute of limitations extensions from the partnership’s managers, including its CFO/Treasurer. However, these individuals were not the designated PR for the partnership. The IRS Chief Counsel ultimately determined that the extensions were invalid because only the PR had the authority to bind the partnership to an extension of the statute of limitations. This ruling effectively barred the IRS from proposing adjustments to the partnership’s tax returns for the 2018 and 2019 tax years.

This case illustrates the critical importance of procedural compliance in tax audits. The IRS’s failure to obtain the necessary extensions from the PR, despite acting in good faith and within the applicable time frame, rendered the entire audit invalid. This outcome underscores the need for taxpayers and practitioners to carefully navigate the procedural requirements of the BBA to avoid unintended consequences.

Conclusion: The Interplay of Procedure and Substance in Tax Disputes

The BBA’s partnership rules and the accompanying statute of limitations provisions demonstrate the intricate interplay between procedure and substance in tax disputes. While the substantive merits of a case are undeniably important, procedural rules often dictate the outcome of tax controversies. As highlighted by the IRS Chief Counsel memorandum, even minor procedural oversights can result in significant consequences, including the dismissal of an otherwise valid audit.

Tax professionals and taxpayers must remain vigilant in ensuring compliance with the BBA’s procedural requirements, particularly with regard to the designation of a partnership representative and the execution of statute of limitations extensions. The BBA’s rules are still relatively new, and the IRS is continuing to work through the challenges of implementing these provisions. As such, staying informed about developments and seeking expert guidance are essential for navigating this complex landscape.

In conclusion, the BBA’s procedural rules serve as a reminder that tax procedure is not merely a technicality but a critical component of tax dispute resolution. Understanding and adhering to these rules can mean the difference between a favorable outcome and an unfavorable one. As the IRS continues to grapple with the nuances of the BBA, taxpayers and practitioners must remain proactive in ensuring compliance and advocating for their rights throughout the audit and litigation process.