Tax Avoidance Transactions

AGENCY:

Internal Revenue Service (IRS), Treasury.

ACTION:

Notice of proposed rulemaking and notice of public hearing.

SUMMARY:

This document contains proposed regulations under section 6231 of the Internal Revenue Code that allow the IRS to convert partnership items to nonpartnership items when the application of the unified partnership audit and litigation procedures of sections 6221 through 6234 (TEFRA partnership procedures) with respect to certain tax avoidance transactions interferes with the effective and efficient enforcement of the internal revenue laws. The regulations affect taxpayers who have engaged in a listed transaction through an entity subject to the TEFRA partnership procedures. This document also provides notice of a public hearing on these proposed regulations.

DATES:

Written or electronic comments must be received by May 14, 2009. Outlines of topics to be discussed at the public hearing scheduled for June 4, 2009, at 10 a.m. must be received by May 15, 2009.

ADDRESSES:

Send submissions to: CC:PA:LPD:PR (REG-138326-07), room 5205, Internal Revenue Service, PO Box 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be hand delivered Monday through Friday between the hours of 8 a.m. and 4 p.m. to: CC:PA:LPD:PR (REG-138326-07), Courier's Desk, Internal Revenue Service, 1111 Constitution Avenue, NW., Washington, DC 20224, or sent electronically via the Federal eRulemaking Portal at http://www.regulations.gov (IRS REG-138326-07). The public hearing will be held in the Auditorium, Internal Revenue Service Building, 1111 Constitution Avenue, NW., Washington, DC.

FOR FURTHER INFORMATION CONTACT:

Concerning the proposed regulations, Robert T. Wearing at (202) 622-4570; concerning submissions of comments, the hearing, or to be placed on the building access list to attend the hearing, Richard.A.Hurst@irscounsel.treas.gov of the Publications and Regulations Branch at (202) 622-7180 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

This document contains proposed amendments to the Procedure and Administration Regulations (26 CFR Part 301) under section 6231(c) of the Internal Revenue Code. Section 402 of the Tax Equity and Fiscal Responsibility Act of 1982, Public Law 97-248 (96 Stat. 324) added sections 6221 through 6231 to the Internal Revenue Code to provide unified audit and litigation procedures for determining the tax treatment of partnership items at the partnership level rather than at the partner level. Sections 6233 and 6234 were subsequently added by section 714(p)(1) of the Tax Reform Act of 1984, Public Law 98-369 (98 Stat. 494) and section 1231(a) of the Taxpayer Relief Act of 1997, Public Law 105-34 (11 Stat. 788), respectively.

Ordinarily, under the TEFRA partnership procedures, the IRS must adjust a partner's treatment of partnership items only through partnership-level proceedings. There are several exceptions that allow adjustments to be made through partner-level proceedings. The small partnership exception set forth in section 6231(a)(1)(B) provides that partnerships having ten or fewer partners, each of whom is an individual, a C corporation, or an estate, are not subject to the TEFRA partnership procedures. Section 6231(b) provides that items cease to be partnership items subject to the TEFRA partnership procedures in several different situations. Section 6231(c) allows the Treasury Department and the IRS to determine and provide by regulations that treating items as partnership items in areas that present special enforcement considerations will interfere with the effective and efficient enforcement of the internal revenue laws and that, consequently, the items shall be treated as nonpartnership items. Section 6231(c) also allows the Treasury Department and the IRS to prescribe by regulations rules necessary to achieve the purposes of the TEFRA partnership procedures with respect to special enforcement areas. Section 6231(c) lists several specific special enforcement areas, including criminal investigations and indirect methods of proof of income, and provides that the Treasury Department and the IRS may determine others. The Treasury Department and the IRS previously have determined and provided by regulations that bankruptcy, receivership, and prompt assessment requests interfere with the effective and efficient enforcement of the internal revenue laws and designated them as special enforcement areas. See §§ 301.6231(c)-7 and -8 of the Procedure and Administration Regulations.

Explanation of Provisions

One of the principal purposes behind the enactment of the TEFRA partnership procedures was to provide for the more efficient use of the IRS's resources by reducing multiple proceedings with respect to partnership items. The abusive tax shelters of the 1970s often used a single partnership to generate tax benefits for dozens, if not hundreds, of investors. Before the enactment of the TEFRA partnership procedures, the partnership items of each investor were subject to separate partner-level proceedings. The TEFRA partnership procedures effectively brought the partnership item components of these proceedings together in a single proceeding. Unlike the tax shelters of the 1970s, however, the recent generation of tax avoidance transactions often uses combinations of trusts, S corporations, limited liability companies, partnerships, and other entities, many times arranged in tiers, for the tax benefit of a single investor or a small group of investors. The application of the TEFRA partnership procedures to these tax avoidance transactions often results in multiple proceedings that complicate the ultimate determination of the investors' tax liabilities and consume significant administrative resources.

For example, in a typical transaction described in Notice 2000-44 (2000-2 CB 255) (September 5, 2000), see § 601.601(d)(2)(ii)(b), in which the ultimate noneconomic loss or deduction is taken at the partner level by a single individual, the IRS first needs to initiate timely partnership-level proceedings to determine, among other things, whether the partnership is a sham and the amount and character of contributions and partnership liabilities. Following the partnership-level proceedings, the IRS often still must issue an affected items notice of deficiency to disallow the noneconomic loss or deduction at the partner level. Conducting both entity-level and partner-level proceedings in these cases to determine the tax liabilities of only a single individual or small group of related persons places an unnecessary burden on taxpayers, the IRS, and the federal courts.

Other tax avoidance transactions use multiple tiers of partnerships making coordinated partnership elections for the benefit of a single individual. Two or more separate partnership proceedings, as well as a partner-level proceeding, may need to take place before an assessment can be made against the individual. Again, conducting entity-level proceedings in these and similar cases in which a single individual or small group of related persons control multiple entities and receive all the tax benefits is inefficient and imposes a significant administrative burden.

The need to conduct partnership-level proceedings to determine the tax liabilities of a single individual or small group of related persons also generates complex and burdensome procedural issues that do not contribute to the determination of the individuals' tax liabilities. For example, the application of the TEFRA partnership procedures may raise complicated issues concerning the segregation and aggregation of partnership items, affected items, and nonpartnership items. Often, the TEFRA partnership procedures make the identification and examination of the transactions more complicated and difficult. As a result, the Treasury Department and the IRS have determined that special enforcement considerations, within the meaning of section 6231(c)(1)(E), are present in the case of transactions that the Treasury Department and the IRS have publicly identified as tax avoidance transactions. Specifically, the Treasury Department and the IRS have determined that treating items related to listed transactions within the meaning of § 1.6011-4(b)(2) of the Income Tax Regulations as partnership items interferes with the effective and efficient enforcement of the internal revenue laws.

The proposed regulations are limited to tax avoidance transactions that are publicly identified by the Treasury Department and the IRS as listed transactions under § 1.6011-4(b)(2) of the Income Tax Regulations. Under the proposed regulations, the transaction must be a listed transaction on the date the IRS sends written notification to the partner that the partner's partnership items will be treated as nonpartnership items. Accordingly, the fact that a transaction becomes a listed transaction after the date on which the taxpayer engages in the transaction does not preclude the conversion of items under the proposed regulations. This limitation promotes taxpayer awareness of the transactions that can subject their partnership items to removal from the TEFRA partnership procedures. The Treasury Department and the IRS also have determined that the limitation will provide for the more efficient use of the IRS's resources.

Under the proposed regulations, the IRS will make determinations regarding whether to convert partnership items to nonpartnership items on a partnership-by-partnership and partner-by-partner basis. Thus, if a taxpayer is a partner in two partnerships with partnership items related to listed transactions and a third partnership that has no partnership items related to listed transactions, the IRS could convert the taxpayer's partnership items in either or both of the first two partnerships but could not convert the taxpayer's partnership items in the third partnership. Similarly, if a taxpayer engages in a listed transaction through a tier of TEFRA entities, the IRS could convert the taxpayer's partnership items in any or all of the tier entities with partnership items related to the listed transaction.

Although, consistent with section 6231(c)(2), the Secretary has determined that treating items related to listed transactions as partnership items will interfere with the effective and efficient enforcement of the internal revenue laws and has so provided in the proposed regulations, the proposed regulations further provide that the partnership items related to listed transactions remain subject to the TEFRA partnership procedures unless and until the IRS sends written notification to the partner that the items will be treated as nonpartnership items. In this regard, the proposed regulations are consistent with the rules that are already in place with respect to sending notices under section 301.6231(c)-5 of the Procedure and Administration Regulations relating to partners under criminal investigation. See Phillips v. Commissioner, 272 F.3d 1172, 1176 (9th Cir. 2001). Specifically, the IRS will send written notification under the circumstances described in the proposed regulations using procedures similar to the procedures used under § 301.6231(c)-5 of the Procedure and Administration Regulations, and will make conforming changes to the Internal Revenue Manual and Delegation Order 4-19, as necessary.

If the IRS concludes that a particular partner's partnership items should be treated as nonpartnership items under the circumstances described in the proposed regulations, the IRS will send written notification to the partner identifying each partnership for which the partner's partnership items will be treated as nonpartnership items. In the case of an indirect partner (as defined in section 6231(a)(10)) having an interest in a partnership through one or more pass-thru partners (as defined in section 6231(a)(9)), the IRS may send a written notification to the indirect partner identifying only the lower-tier partnership and not the pass-thru partners. In those circumstances, the partnership items attributable to the lower-tier partnership that flow through to the indirect partners will convert to nonpartnership items of the notified partner, even though the pass-thru partners were not identified in the written notification. Any partnership items originating with the pass-thru partners, that is, partnership items that are not attributable to the lower-tier partnership, will not convert to nonpartnership items unless the IRS identifies the pass-thru partner in the written notification (in which case all the partnership items directly attributable to the pass-thru partner also will convert to nonpartnership items of the notified partner).

As of the date that the IRS sends written notification of the conversion to the partner, all of the partner's partnership items attributable to the identified partnership will be treated as nonpartnership items for all of the identified partnership's taxable years that (1) ended on or before the date written notification is sent by the IRS to the partner and (2) for which the partner has items attributable to that partnership that are related to the listed transaction. The deficiency procedures in subchapter B of chapter 63 will apply, pursuant to section 6230(a)(2)(A)(ii), as of the date of the notice.

The proposed regulations incorporate existing rules under § 301.6231(c)-3 of the Procedure and Administration Regulations, which provide that the partnership items of a partnership may not be converted if a notice of final partnership administrative adjustment (FPAA) with respect to those partnership items has been mailed to the tax matters partner of the partnership and either (1) the period for bringing an action with respect to the FPAA has expired and no judicial action has been brought or (2) the decision of the court in an action brought with respect to the FPAA has become final. This rule allows the IRS to send notification converting partnership items to nonpartnership items after the commencement of a judicial proceeding related to the converted partnership items. The Treasury Department and the IRS recognize, however, that it is not in the best interest of taxpayers, the Treasury Department, the IRS, or the courts to unnecessarily delay conversion of partnership items to nonpartnership items. Consistent with its existing practices under section 6231(c), the IRS intends to make a decision regarding whether to convert partnership items to nonpartnership items before the commencement of any judicial proceeding, although on isolated and unusual occasions changed circumstances may require the IRS to revisit that decision after the commencement of a judicial proceeding. In addition, judicial doctrines such as collateral estoppel and res judicata may preclude litigating issues in a partner-level proceeding that were previously litigated in a partnership-level proceeding prior to conversion of partnership items to nonpartnership items. Finally, the partnership items of any partners to whom the IRS does not send written notification will not convert to nonpartnership items.

Proposed Effective Date

The regulations, when finalized, are proposed to apply to any taxable period ending on or after the date of publication of these rules as proposed regulations in the Federal Register.

Special Analyses

It has been determined that this notice of proposed rulemaking is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It has also been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations, and, because these regulations do not impose a collection of information on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the Internal Revenue Code, this notice of proposed rulemaking has been submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.

Comments and Public Hearing

Before these proposed regulations are adopted as final regulations, consideration will be given to any written (a signed original and eight (8) copies) or electronic comments that are submitted timely to the IRS. The Treasury Department and the IRS request comments on the clarity of the proposed rules and how they can be made easier to understand. The Treasury Department and the IRS also request comments that identify additional transactions or activities that present appropriate grounds for converting partnership items to nonpartnership items. All comments will be made available for public inspection and copying.

A public hearing has been scheduled for June 4, 2009, beginning at 10 a.m. in the Auditorium of the Internal Revenue Service Building, 1111 Constitution Avenue, NW., Washington, DC. Due to building security procedures, visitors must enter at the Constitution Avenue entrance. In addition, all visitors must present photo identification to enter the building. Because of access restrictions, visitors will not be admitted beyond the immediate entrance area more than 30 minutes before the hearing starts. For information about having your name placed on the building access list to attend the hearing, see the FOR FURTHER INFORMATION CONTACT section of this preamble.

The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons who wish to present oral comments at the hearing must submit written or electronic comments and an outline of the topics to be discussed and the time to be devoted to each topic (signed original and eight (8) copies) by May 15, 2009. A period of 10 minutes will be allotted to each person for making comments. An agenda showing the scheduling of the speakers will be prepared after the deadline for receiving outlines has passed. Copies of the agenda will be available free of charge at the hearing.

Drafting Information

The principal author of these regulations is Robert T. Wearing of the Office of the Associate Chief Counsel (Procedure and Administration).

List of Subjects in 26 CFR Part 301

• Employment taxes
• Estate taxes
• Excise taxes
• Gift taxes
• Income taxes
• Penalties
• Reporting and recordkeeping requirements

Proposed Amendments to the Regulations

Accordingly, 26 CFR Part 301 is proposed to be amended as follows:

PART 301—PROCEDURE AND ADMINISTRATION

Paragraph 1. The authority citation for part 301 is amended by adding the entry in numerical order to read in part as follows:

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

Section 301.6231(c)-9 is also issued under 26 U.S.C. 6230(k) and 6231(c)(1) and (c)(3). * * *

Par. 2. Section 301.6231(c)-3 is amended by revising paragraphs (a) introductory text and (b) to read as follows: