TEFRA Tax Matters Partner Consents to Extend the Statute of Limitations

In United States v. Martinez, ___ F.3d ___ (5th Cir. 2009), decided 4/3/09, the Fifth Circuit held that actions taken by the tax matters partner in a TEFRA partnership were not ineffective to toll the statute of limitations because of an alleged disabling conflict between the tax matters partner and the other partners. The specific actions involved executing consents to extend the statute of limitations and filing a Tax Court proceeding. Under the TEFRA scheme, both of these actions result in the extension of the statute of limitations at the partnership level and thus extension of the statute of limitations for the TEFRA partnership adjustments at the individual partner level.

The Fifth Circuit distinguished an earlier Second Circuit case which had found a disqualifying conflict between the tax matters partner and the partners that made it unreasonable and inappropriate for the IRS to rely upon consents given by the tax matters partner. The Fifth Circuit concluded that (i), unlike the facts in Transpac Drilling, the IRS had not sought consents from the partners and been denied the consents, (ii) the IRS did not have a pending criminal investigation against the tax matters partner, (iii) the tax matters partner’s request for a quid pro quo via relief from the preparer penalties was not disabling because the IRS had already determined not to seek the penalty, and (iv), although the IRS believed the tax matters partner was dishonest, that alone did not create a per se conflict between his interests and the limited partners’ interests sufficient to put the IRS' reliance unreasonable under the circumstances.

A Loser on Avoiding the 6 Year Statute for 25% Omissions

Our readers will recall that Section 6501(e)(1)(A) gives the IRS a six year statute for a “substantial omission” – defined as an omission from gross income in an amount exceeding 25% of the amount of gross income stated in the return. An exception to this extended statute of limitations is provided if the omitted income is disclosed on the return even though it is not included in gross income on the return.

Consider this discussion from Benson v. Commissioner, ___ F.3d ___, ___ (9th Cir. 2009) where there was a 25% omission and no disclosure:

The Bensons also argue that Colony can be read to preclude the application of the extended limitations period because the Commissioner was able to discover the unreported income, despite their omissions. For this proposition, the Bensons cite the Court's language stating that the extended limitations period was meant to give the Commissioner additional time to "investigate tax returns in cases where, because of a taxpayer's omission to report some taxable item, the Commissioner is at a special disadvantage in detecting errors." Colony, 357 U.S. at 36. The Bensons argue that the Commissioner was at no such special disadvantage here, as evidenced by the fact that the Commissioner actually detected the errors, and therefore the six-year period should not apply. However, the Supreme Court's gloss on the statutory language does not alter the statute's plain language, which simply provides that the Commissioner is afforded extra time whenever a taxpayer “omits” a certain amount from his or her gross income. 26 U.S.C. § 6501(e)(1)(A). The Bensons omitted the constructive dividends from their tax returns.

The taxpayer’s argument was, of course, circular. If the IRS did not discover the omission, then the statute was six years but would be meaningless because the IRS did not discover the omission even in the six years. If the IRS did discover it in the six year period, then the six year period would not apply because the IRS discovered it.

So the question is Shakespearean - to disclose or not to disclose. For taxpayers who pay close attention to odds (viewing tax reporting like gambling), disclosing solely to avoid a six year limitations period is not generally a recommended option. Providing that the taxpayer is reasonably certain he or she can avoid civil and criminal penalties for the omission, the taxpayer may want to take the risks involved in having a six year rather than a three year statute of limitations. The IRS hardly ever commences audits of returns that are over 2 ½ years old anyway, so that the additional three year risk may not be that great. Thus, for each year during the first three years when the statute is open under the general rule, the odds of an IRS audit of the return are far greater than in the succeeding three years (Years 4 through 6). Nevertheless, even with the decreased odds in the “out years,” the IRS will sometimes stumble upon an out year problem while auditing years within the normal statute of limitations and will seek to invoke § 6501(e). And, of course, a disclosure will likely eliminate the far worse risk than a 6 year statute of limitations – a criminal investigation and prosecution.

Tax Court Invalidates Two Year Rule for Innocent Spouse Relief

In the past the IRS has contended that someone asking for innocent spouse relief under Section 6015(f) of the Internal Revenue Code would have to file for innocent spouse relief within two years of the first collection action taken by the IRS. The IRS has consistently disallowed claims that were not filed within this two year period.

In the case of Lantz v. Commissioner, 132 T.C. No. 8 (Apr. 7, 2009), the Tax Court has held that the two year rule imposed by the Regulation Section 1-6015-5(b)(1) is invalid. If request for innocent spouse relief has been denied by the IRS based on the two year rule, it should be requested again.

Enrolled Agent Suspended

An enrolled agent has been suspended from practice before the Internal Revenue Service by the Office of Professional Responsibility for not performing services related to offers in compromise paid for by taxpayers. In IR 2009-35 the IRS states that the enrolled agent admitted a lack of due diligence in representing the taxpayers. The announcement also states: "The IRS is taking a closer look at tax resolution companies, and is also litigating known OIC abuses to ensure that tax professionals fulfill their legal and ethical obligations to their clients in dealing with IRS tax matters".
It is time more action is taken against those who represent taxpayers before the IRS and do not perform work in a competent and professional manner.