4.31.5 Investor Level Statute Control (ILSC) Examinations - Field Office Procedures

Manual Transmittal

April 5, 2019

Purpose

(1) This transmits a revision of IRM 4.31.5, Pass-Through Entity Handbook, Investor Level Statute Control (ILSC) Examinations - Field Office Procedures.

Material Changes

(1) Many references to nonTEFRA returns were changed to Investor Level Statute Control (ILSC) returns. This generic term is used for nonTEFRA, BBA elect out partnerships and S corporation returns and their investors.

(2) Section title changed to replace NonTEFRA with ILSC.

(3) Changed Campus TEFRA Function (CTF) to Campus Pass-through Function (CPF).

(4) IRM 4.31.5.1 - Program Scope and Objectives. New section.

(5) IRM 4.31.5.1.1 - Background. New section.

(6) IRM 4.31.5.1.2 - Authority. New section.

(7) IRM 4.31.5.1.3 - Roles and Responsibilities. New section.

(8) IRM 4.31.5.1.4 - Program Management and Review. New section.

(9) IRM 4.31.5.1.5 - Program Controls. New section.

(10) IRM 4.31.5.1.6 - Terms/Definitions/Acronyms. New section.

(11) IRM 4.31.5.1.7 - Related Sources. New section.

(12) IRM 4.31.5.2 - Introduction. Added paragraph (2) to explain that the IRC sections referenced in this IRM are reflective of TEFRA only, and do not reflect the changes made by the Bipartisan Budget Act (BBA) of 2015.

(13) IRM 4.31.5.3 - ILSC Pass-through Entities Defined. Added changes through this section to more clearly reflect S corporations and BBA elect out partnerships.

(14) IRM 4.31.5.4 - Identification of ILSC Key Case Returns. Paragraph (1), (2) and (4), added changes relative to the BBA 2015.

(15) IRM 4.31.5.4.1 - Special Considerations for Limited Liability Companies (LLC’s). Paragraph (1), added reference to partnerships that elect out of BBA 2015.

(16) IRM 4.31.5.4.2 - Election by a Small Partnership to be Included Under the TEFRA Provisions. Added paragraph (1) to reflect the repeal of TEFRA.

(17) IRM 4.31.5.5 - Identification of Partnerships Electing out of BBA. New section.

(18) IRM 4.31.5.5.1 - Determining and Identifying the Number of Investors for Purposes of BBA. New section.

(19) IRM 4.31.5.5.2 - Election by a Small Partnership to be Included Under the TEFRA Provisions. Add an introductory sentence to explain that this section only applies to partnerships.

(20) IRM 4.31.5.6 - S Corporations. Paragraph (1), removed detailed TEFRA related information.

(21) IRM 4.31.5.6.1 - S Corporation Statute Considerations. Reworded section to align with change to Statute IRM that no longer requires the statutes of all investors to be protected if there will be no adjustments to them or the adjustments will be immaterial.

(22) IRM 4.31.5.8.1 - Rules and Guidelines for Linking ILSC Entities on PCS. Paragraph (2), added language to explain that linkage does not mean the campus has to control the investors. Linked investors may still be controlled by the examiner.

(23) IRM 4.31.5.8.2 - Advantages of Using PCS. Paragraph (1), added clarification that PCS will establish returns on AIMS, unless they are already on AIMS.

(24) IRM 4.31.5.8.4 - When to Link the Key Case on PCS. Paragraph (3), updated the section to change "partners" to "investors" as these rules apply to shareholders as well as partners.

(25) IRM 4.31.5.9.1 - Initiating Timely PCS Controls on ILSC Pass-Through Entities. Added new paragraph (3).

(26) IRM 4.31.5.9.2 - Limited Linkage and Form 15041. New section.

(27) IRM 4.31.5.10.2 - Notice to Investors of Examination of Key Case Entity. Updated to reflect a change to the letter.

(28) IRM 4.31.5.10.4 - Control of Cases Established on PCS. Updated section to reflect nonTEFRA LB&I key case control moving back to Ogden.

(29) IRM 4.31.5.10.6 - ILSC Key Case Statute Control. Changed title by changing NonTEFRA to ILSC.

(30) IRM 4.31.5.10.6.2 - Entity Statute Extension. Removed paragraph (2) which discussed the now obsolete Form 872-S.

(31) IRM 4.31.5.11.1 - ILSC Examination Results. Changed title by changing NonTEFRA to ILSC.

(32) IRM 4.31.5.11.3 - Key Cases with Adjustments and Investors Not Linked on PCS. Paragraph (6), added a 15 day time line for getting a perfected protest to Appeals to align with Technical Service’s processing time frames and in order to ensure taxpayer rights are protected and expedited.

(33) IRM 4.31.5.11.4 - Key Case With Investor Linked on PCS. Updated note under paragraph (1) to reflect LB&I key cases being sent to Brookhaven.

(34) IRM 4.31.5.12.1 - Processing ILSC Pass-Through Adjustments. Section updated to reflect a revision to the Form 3198.

(35) IRM 4.31.5.12.1.1 - Special Computation for Non-Oversheltered Returns (Munro Decision). Added new paragraph (1) to better explain Munro.

(36) IRM 4.31.5.15.2 - Key Case Closure Procedures. Updated note under paragraph (1)(h) to reflect LB&I key cases being sent to Brookhaven.

(37) Various editorial changes made throughout the IRM.

Effect on Other Documents

IRM 4.31.5, Pass-Through Entity Handbook, Investor Level Statute Control (ILSC) Examinations - Field Office Procedures, dated 4-21-2017 is superseded

Audience

Field and Technical Services personnel working pass-through entities that are not subject to TEFRA or have a valid election out of BBA and/or their investors. LB&I plans to develop a separate IRM. Until that occurs, LB&I personnel should check with their manager to see if the particular IRM section applies or if there is other guidance to follow.

Effective Date

(04-05-2019)

Daniel R. Lauer,
Acting Director, Examination - Field and Campus Policy
Small Business/Self-Employed Division (SB/SE)

Program Scope and Objectives

  1. This Internal Revenue Manual (IRM) section provides guidance on field office procedures related to examinations of partnerships not subject to provisions of the Tax Equity and Fiscal Responsibility Act (TEFRA) of 1982 or those partnerships that elect out of the Bipartisan Budget Act of 2015 (BBA) , and S corporations.

  2. Purpose: This handbook describes:

    • Investor Level Statute Control (ILSC) Pass-Through Entity Defined;

    • Identification of ILSC key case returns;

    • Identification of Partnerships Electing out of BBA;

    • S Corporations;

    • Examination Returns Control Systems (ERCS) TEFRA Indicator;

    • Pass-through Control System (PCS) (formerly Partnership Control System);

    • Linking the Key Case and Investors on PCS;

    • Examination Process;

    • Post Exam Process;

    • Field ILSC Investor Procedures;

    • Requesting Investor Returns From the Campus Pass-through Function (CPF); and

    • Technical Services PCS Coordinator Duties for ILSC Entities.

  3. Audience: Field examination Revenue Agents (RAs) and campus RAs, Tax Compliance Officers (TCOs), Tax Examiners (TEs) and Clerks working pass-through entities and/or their investors linked on the PCS.

  4. Policy Owner: Director, Small Business/ Self Employed (SB/SE), Headquarters, Examination (SE:S:E:HQ).

  5. Program Owner: Program Manager, Campus Examination and Field Support (SE:S:E:HQ:EFCP:CEFS).

  6. Primary Stakeholders: SB/SE, Large Business and International (LB&I), and Appeals.

  7. Program Goals: Establish an electronic linkage between the pass-through entities being examined and their underlying investors in order to generate notices, monitor and control statutes, and gather closing information.

  8. Contact Information: To recommend changes or make any other suggestions related to this IRM section, see IRM 1.11.6.6I, Providing Feedback About an IRM Section -Outside of Clearance.

Background

  1. TEFRA was passed in 1982 to allow examinations and statutes to be controlled at the partnership level. TEFRA was replaced by the centralized partnership audit regime in the BBA for tax years beginning January 1, 2018. Certain small partnerships and S corporations are not subject to TEFRA. The period to assess investors of entities not subject to TEFRA or BBA is determined at the investor level.

  2. BBA applies to all partnerships, but allows some eligible partnerships to elect out. Those partnerships that elect out will be processed similarly to nonTEFRA partnerships. Partnership returns filed after November 2, 2015 and before January 1, 2018 may elect into BBA. BBA does not impact S corporation entity examinations.

  3. As a result there are four possible partnership regimes:

    1. TEFRA for partnerships whose tax year ended prior to December 31, 2017 and which did not make an election into the BBA.

    2. BBA for partnerships whose tax year ends after December 31, 2017 or who made a valid election into the BBA for years ending after November 2, 2015 and before January 1, 2018.

    3. NonTEFRA for those partnerships that are not statutorily TEFRA, or did not elect into TEFRA.

    4. Partnerships that elect out of BBA whose tax year ends after December 31, 2017 and who made a valid election out.

  4. The PCS was created to establish an electronic linkage between pass-through entities and their underlying investors. This helps ensure that all investors are noticed and adjusted in a timely manner. PCS linkage allows Business Operation Divisions (BODs) to recognize when a taxpayer is subject to a pass-through examination. If an examiner chooses not to control the investors, it allows the campus to work those investors so the examiner can focus on pass-through examinations. PCS also allows the campus to systemically generate notices, control statutes, and gather closing information.

Authority

  1. Linkage policy was established in response to the partnership provisions of the TEFRA. Similar policies will continue to be needed for S corporations and partnerships that elect out of BBA.

Roles and Responsibilities

  1. The Director, SB/SE, Headquarters Examination (SE:S:E:HQ) is responsible for:

    1. Coordinating and implementing linked pass-through policy changes;

    2. Coordinating resolutions for linked pass-through related problems; and

    3. Updating this Handbook.

  2. The Program Manager, SB/SE Examination - Field and Campus Policy, Campus Exam and Field Support (SE:S:E:HQ:EFCP:CEFS) is responsible for:

    1. Ensuring that linked pass-through procedural changes and computer program changes are implemented and coordinated with area office and campus examination personnel; and

    2. Monitoring and evaluating area office and campus examination PCS quality control procedures.

  3. Field Territory Managers, Field Area Directors, Director over LB&I Ogden and Director, Examination - Brookhaven, are responsible for ensuring that linked pass-through policies and procedures are followed.

  4. Field Examination Managers and Campus Field Support Operations managers are responsible for:

    1. Maintaining an updated copy of IRM 4.29, Pass-through Control System (PCS) Handbook, in their respective functions;

    2. Ensuring the training of technical and clerical employees in linked pass-through procedures; and

    3. Establishing PCS records and acting on PCS reports in a timely manner to assure an accurate PCS database.

  5. The campus TEFRA/Pass-Through Coordinator works with:

    • The other TEFRA/Pass-Through coordinator(s)

    • Their local employees

    • Other campus functional areas to ensure timely processing of linked pass-through related returns

  6. The campus PCS Coordinator is charged with:

    • Identifying and resolving technical problems

    • Identifying and coordinating the resolution of PCS systemic problems

  7. Following are specific campus TEFRA/Pass-Through Coordinator responsibilities:

    1. Coordinate with campus and field pass-through coordinators on case processing issues;

    2. Coordinate with Headquarters on any legal issues that need to be addressed by Chief Counsel;

    3. Review closing packages for completeness;

    4. Provide technical support to employees.

Program Management and Review

  1. Program Reports: Each year an exam plan is created for pass-through examinations.

  2. Program Effectiveness: The exam plan is monitored to ensure the linked pass-through examination objectives are met. Open examinations are monitored to ensure a TEFRA determination is recorded on ERCS.

Program Controls

  1. Technical Services monitors a report to ensure partnership returns are identified being subject to TEFRA in a timely manner. The Audit Inventory Management System (AIMS) provides a statute report, AMS 4.0, that the field monitors to ensure field controlled investor cases are worked timely.

Terms/Definitions/Acronyms

  1. There are several terms unique to PCS linked returns. Examples of these words:

    Defined Terms and Acronyms

    Word Definition
    Affected Item Any item that requires adjustment as a result of an adjustment made to a partnership item. There are two types of affected items: computational and factual. Factual affected items are those that require a determination at the partner level.
    AIMS Audit Information Management System (AIMS) provides inventory and activity controls of active Examination cases. It uses linkage to Integrated Data Retrieval System (IDRS) to input status changes, adjustments, and case closing actions.
    BBA Bipartisan Budget Act of 2015. The centralized partnership audit regime affects all partnerships filed with tax years beginning on or after January 1, 2018.
    BEO BBA Elect Out. Partnerships that elect out of the centralized partnership audit regime (BBA).
    Campus TEFRA/Pass-Through Coordinator Acts as a liaison between the CPF and the field offices, Appeals and counsel for both TEFRA and ILSC cases. They also provide technical support for the CPF.
    CC Command Code
    CCP Centralized Case Processing - This function processes assessments and abatements and closes or transfers cases from the area to the campus or to files.
    CPF (Formally CTF) Campus Pass-through Function - The CPF is the suspense unit for investor returns located in the Brookhaven campus and Pass-through Entities (PTE) Ogden. The two CPFs will be maintained to obtain and control, through the AIMS and PCS, any partner, shareholder or investor returns related to key cases within their jurisdiction. For details see Campus Pass-through Function (CPF) IRM 4.31.3 and IRM 4.31.6.
    EIN Employer Identification Number (EIN).
    ILSC Investor Level Statute Control - Proceedings related to Pass-through entities where the assessment periods are controlled at the investor level. Proceedings involve investors in partnerships that are not subject to TEFRA, elect out of BBA, and S corporations.
    IRC Internal Revenue Code (IRC).
    Investor Partner, Shareholder, or Beneficiary - An investor return that reflects pass-through items from a pass-through entity return, which is controlled (via PCS and AIMS). Examples of investor returns includes, but is not limited to, Form 1040, Form 1041, Form 1120, Form 1120-S and Form 1065.
    Key Case A pass-through return established on PCS, usually a Form 1065, U. S. Return of Partnership Income or a Form 1120S, U. S. Income Tax Return for an S Corporation, that results in pass-through items to partners, shareholders, or investors (individual returns or another pass-through entity).
    LB&I Large Business and International (LB&I). Serves corporations, subchapter S corporations, and partnerships with assets greater than $10 million.
    LIN LB&I Imaging Network (LIN) is a system used by LB&I to store images of returns.
    Linkage The electronic relationship between a pass-through entity and its investor.
    NonTEFRA Partnership returns that are statutorily excluded from TEFRA procedures. Impacts partnership returns with tax years beginning September 3, 1982 until December 31, 2017.
    Pass-through Control System (PCS) Database used to establish an electronic linkage between a key case pass-through entity and it's underlying investors. The database is used to manage inventory, systemically generate notices, and control statutes.
    RA Revenue Agent (RA)
    Record Information stored on the PCS database for a key case or an investor.
    SB/SE Small Business and Self-Employed. Serves taxpayers who file Form 1040, Schedules C, E, F or Form 2106, as well as small businesses with assets under $10 million.
    TCO Tax Compliance Officer (TCO)
    TE Tax Examiner (TE)
    TMP Tax Matters Partner (TMP). The designated partner to whom the Service looks as the primary representative of the partnership that is subject to a TEFRA proceeding.
    TS Technical Services (TS) is the field review staff.
    Technical Services TEFRA/Pass-Through Coordinator The Technical Services TEFRA/Pass-Through Coordinator in Technical Services acts as a liaison between the area and the CPFs for both TEFRA and linked ILSC cases. The field examiner can locate their Technical Services TEFRA/Pass-Through Coordinator by searching their geographical area on the TEFRA web site's TEFRA Coord Locator tab.
    TEFRA Tax Equity and Fiscal Responsibility Act (TEFRA) of 1982. The act did many things, but one of them was to unify audit and litigation procedures for partnerships. We use TEFRA to refer to these procedures, and the affected returns. Partnerships are subject to TEFRA procedures by statute, or those excluded by statute may elect into TEFRA. Impacts partnership returns with tax years beginning September 3, 1982 until December 31, 2017.
    Tier A pass-through entity that is a partner of a pass-through entity. An S-corporation would be a tier partner of a partnership.

     

Related Resources

  1. The following IRM cross-references may be helpful:

    1. Management of Interrelated and Related Cases: IRM 4.31, Pass-Through Entity Handbook

    2. AIMS: AIMS/Processing Handbook, IRM 4.4

    3. Statute IRM 25.6.23, Examination Process-Assessment Statute of Limitations Controls

    4. TEFRA website. http://tefra.web.irs.gov/m1/1a_home.asp

Introduction

  1. The purpose of this chapter is to define ILSC pass-through entities and to outline and explain how to use the Service's available resources to process these types of cases. Technical issues will not be found in this part of the IRM. Audit techniques for partnerships, both TEFRA and nonTEFRA, and S corporations are found in IRM 4.10, Examination of Returns.

  2. The Internal Revenue Code (IRC) references in this IRM are reflective of the TEFRA law, and not the BBA law passed in 2015 that used the same code sections (6221 through 6248) unless proceeded by BBA. BBA examination procedures will be in a yet to be developed IRM.

Contact with Potentially Dangerous Taxpayers (PDT) or Caution Upon Contact (CAU) Taxpayers

  1. If you need to contact a taxpayer designated as Potentially Dangerous Taxpayers (PDT) or Caution Upon Contact (CAU), please refer to IRM 25.4, Employee Protection, for the most current guidance.

ILSC Pass-Through Entity Defined

  1. An ILSC pass-through entity is any S corporation, or partnership that does not fall under the provisions of TEFRA or elects out of the BBA provisions. They are usually the types of entities described below. The completion of the Partnership Procedures Check Sheet is mandatory for every partnership examined. The Form 13813, Partnership Procedures Check Sheet, must be completed to ensure a proper determination is made. The completed check sheet will be included in the audit file to document that the partnership is or is not subject to the TEFRA or BBA procedures. SB/SE examiners will file this check sheet and other TEFRA work papers under a separate line item in Section 600 on the Form 4318. LB&I Industry Case examiners will file the TEFRA check sheets and work papers under SAIN number 724 on Issue Management System (IMS) and Form 4764-B. The examiner’s manager is to review the Partnership Procedures Check Sheet and work papers to ensure that the correct audit regime is used. The manager’s signature on the Form 13813, Partnership Procedures Check Sheet, indicates that the various audit regimes were reviewed and correctly considered.

  2. A ILSC pass-through entity:

    1. In general, has no tax liability for itself, but passes the tax consequences to its partners, shareholders, beneficiaries, or investors. An S corporation is a pass-through entity but can also pay tax at the entity level. S corporations occasionally pay tax at the entity level.

    2. Might not file a tax return and may not even be required to file a return (For example, a Schedule C or F syndication or promotion reported directly on each investor's Form 1040).

    3. There is no unified proceeding as in TEFRA or BBA. There is also no Notice of Beginning of Administrative Proceeding (NBAP), Notice of Administrative Proceeding (NAP), Summary Report, Notice of Final Partnership Administrative Adjustment (FPAA) or Final Partnership Adjustment (FPA). However, there are similar letters that are used to keep taxpayers informed and similar procedures for linking cases on PCS.

  3. ILSC pass-through entities may be one of three types of entities.

S corporations

  1. A small business corporation for which an election under IRC 1362(a) is in effect.

NonTEFRA Partnerships

  1. A partnership or an LLC (limited liability company)*, which meets the small partnership exception to TEFRA partnership rules and has not elected to be included under TEFRA rules as provided in IRC 6231(a)(1)(B). TEFRA covers partnerships returns with tax years beginning on or after September 3, 1982 through December 31, 2017.

    Note:

    * An LLC, which has more than one member and has not elected to be classified as a corporation under Treas. Reg. 301.7701-3 (effective January 1, 1997), will have filed Form 1065.

    Note:

    An LLC that has only one member and has not elected to be classified as a corporation will be treated as a disregarded entity for income tax purposes.

BBA Elect Out (BEO) Partnerships

  1. BBA IRC 6221 allows certain partnerships and LLCs to elect out of the provisions of BBA each tax year. BBA covers tax years beginning on or after January 1, 2018. In order to make an election out of BBA under BBA IRC 6221(b):

    1. An election must be made with a timely filed partnership return.

    2. The partnership must have 100 or fewer partners for the taxable year, determined by counting the number of statements required to be furnished under BBA IRC 6031(b) with respect to its partners.

    3. The election must include the name, taxpayer ID, and other information for each partner.

    4. Each of the partners of such partnership is an individual, a C corporation, any foreign entity that would be treated as a C corporation were it domestic, an S corporation, or an estate of a deceased partner.

    5. If an S corporation is a partner, it must meet the provisions of (c) for each shareholder, and the S corporation’s shareholder statements count toward the 100 partner limit.

Identification of ILSC Key Case Returns

  1. Identification of returns as TEFRA vs. ILSC is necessary in order to have a valid assessment of tax because the TEFRA and BBA partnership rules and the deficiency procedures that ILSC entities fall under differ. If the Service applies the wrong procedures, e.g., erroneously proceeds as TEFRA at the partnership level rather than deficiency procedures at the investor or partner level, or vice versa, barred deficiencies and/or refunds can result.

  2. Form 1120S returns are not subject to TEFRA by statute.

  3. For Form 1065, the examiner must determine, for each taxable year, whether TEFRA, BBA, or ILSC procedures apply. Comments on Form 4318, Examination Workpapers Index, are required from the examiner as to whether the pass-through return is TEFRA or ILSC, and the reasons supporting this conclusion. The Form 13813, Partnership Procedures Check Sheet, which is required to be completed will assist the examiner in making the determination.

  4. IRC 6231(a)(1) provides that TEFRA rules apply to all partnerships required to file tax returns under IRC 6031(a) whose tax years end between 9-3-82 and 12-31-17, except for small partnerships.

  5. The small partnership exception applies to partnerships or LLCs treated as a partnership, consisting of 10 or fewer partners or members, each of whom is an individual (other than a nonresident alien), a C corporation, or an estate of a deceased partner.

    Note:

    A partner that is a trust (including grantor trusts) or a single member LLC that it is treated as a disregarded entity, does not meet the definition "each of whom is an individual (other than a nonresident alien), a C corporation, or an estate of a deceased partner" . Thus, a Form 1065 with a trust or a single member LLC as a partner/member can not be nonTEFRA, except possibly when the pass-through partner is not identified on the partnership return. See IRC 6231(g).

  6. Generally, most S corporation income is allocated to individual shareholders. It is possible for an LLC, owned by a single individual member, and certain trust to be an S corporation shareholder. The Schedule K-1 may reflect the LLC or trust name and identification number rather than the individual to which the income is reported. In order to properly link the case, it is extremely important that the true shareholder is identified; the individual, trust (in the case of an Electing Small Business Trust) or estate to which the income should be reported. If you cannot look at the Schedule K-1 and determine who is reporting the pass-through items, the Campus will not be able to determine it either.

Special Considerations for Limited Liability Companies (LLCs)

  1. If the type of entity on the investor's Schedule K-1 is "Limited Liability Company" , the agent should always check for MFT 02 on a BMFOL or check on INOLET to see if the type of return required is Form 1120, as it would be if the LLC partner has elected to be treated as a C corporation. If it has elected to be treated as a C corporation for Federal tax purposes, it will be treated as a C corporation for purposes of making an election out of BBA, and for the small partnership exception under TEFRA partnership rules.

Election by a Small Partnership to be Included Under the TEFRA Provisions

  1. This section is only valid for partnerships with tax years beginning before January 1, 2018.

  2. A partnership eligible to be excluded under the rules outlined above may elect to be included under the TEFRA provisions (IRC 6231(a)(1)(B)(ii)). The election is binding for the year for which it is made and all subsequent years unless revoked with IRS consent. Since the TEFRA election is binding for the year for which it is made, as well as all subsequent years, examiners should inquire about prior year elections. The Form 8893 or an equivalent statement should be attached to the partnership return in the year the election is made.

  3. Per the regulations, a partnership shall make the election by attaching a statement to the partnership return for the first taxable year that the election is to be effective. The statement shall be identified as an election under IRC 6231(a)(1)(B)(ii), shall be signed by all persons who were partners of that partnership at any time during the taxable year to which the return relates, and shall be filed at the time (determined with regard to any extension of time for filing) and place prescribed for filing the partnership return. The partnership may make this election on Form 8893. (Under certain circumstances they may file retroactively. Contact the Technical Services Pass-Through Coordinator if the issue is raised.) Treas. Reg. 301.6231(a)(1)-1(b)(2).

  4. The Command Code (CC) MFTRA, CC ACTRA, and CFOL CC BMFOL 'E' indicate whether the partnership return may be a TEFRA return. However, the facts and circumstances, as to whether or not the partnership elected to be covered by the TEFRA procedures, are controlling.

  5. If the examiner determines that a valid election has been filed, the procedures for TEFRA will be followed.

    Note:

    Simply checking a box on the Form 1065 and/or completing the line for the tax matters partner (TMP) on the return is not a proper election. The agent must determine if the partnership has actually filed the proper election.

Determining and Identifying the Number of Partners or Members for Purposes of TEFRA

  1. Except for a transfer of interest by a partner, if at any time during the taxable year the number of partners exceeds the small partnership exception of ten partners, the return will fall under the TEFRA provisions. A partnership may have more than 10 partners during the year, but still fall within the small partnership exception, because it never had more than 10 partners at any point in time (as when sales of partnership interests cause more than 10 Schedules K-1 to be filed).

  2. The small partnership exception does not apply to a partnership for the taxable year if any partner in the partnership during the taxable year is a pass-through partner. (Treas. Reg. 301.6231(a)(1)-1(a)(2).) For example, a partnership consisting of three partners; two individuals plus a partnership, an S corporation or trust will not meet the small partnership exception.

  3. IRC 6231(a)(1)(B)(i) provides that for the purposes of the small partnership exception "a husband and wife (and their estates) will be treated as one partner" . This provision is unqualified and thus should apply to a husband and wife regardless of the manner in which they hold their interests or file their returns.

  4. A partner must have a proprietary interest in profits or capital. Therefore, if a Schedule K-1 indicates no ownership interest, no distribution of any partnership items, and no capital account balance, the person in question may not be a partner for the taxable year involved. Consult Area Counsel, Federal law controls.

Identification of Partnerships Electing out of BBA

  1. All partnership tax years beginning on or after January 1, 2018 are subject to BBA unless an election is made with the timely filed partnership return.

  2. Identification of returns as BBA as opposed to BBA Elect Out (BEO) is necessary in order to have a valid assessment of tax. If the Service applies the wrong procedures, e.g., erroneously proceeds as BBA at the partnership level rather than deficiency procedures at the investor or partner level, or vice versa, barred deficiencies and/or refunds can result.

  3. To be eligible to elect out of BBA, the partnership must file 100 or fewer partners for the taxable year, determined by counting the number of Schedules K-1 required to be furnished under BBA IRC 6031(b) with respect to its partners. If the partnership has an S corporation as a partner, the Schedules K-1 required to be furnished to the shareholders of the S corporation count as Schedule K-1 required to be furnished by the partnership for purposes of the 100 partner limit. Each Schedule K-1 must include the name and taxpayer ID of each partner.

  4. Each of the partners of such partnership must be an individual, a C corporation, any foreign entity that would be treated as a C corporation were it domestic, an S corporation, or an estate of a deceased partner.

  5. The partnership must make its election each year with a timely filed partnership return. The election must include a disclosure of the name, taxpayer ID number, Federal tax classification, and an affirmative statement that each partner is an eligible partner as well as any other information required by forms, instructions, and other guidance for each partner. If the partnership has any S corporation partners, the election must also include the name, taxpayer ID number, Federal tax classification, and any other information required by forms, instructions, and other guidance for each S corporation shareholder.

  6. If the election is invalid, the partnership must be examined as a BBA partnership.

Determining and Identifying the Number of Investors for Purposes of an Election Out of BBA

  1. Partnerships electing out must issue Schedules K-1 to 100 or fewer partners for the taxable year, determined by counting the number of Schedules K-1 required to be furnished under IRC 6031(b) with respect to its partners..

  2. Partnerships electing out of BBA may have as partners an individual, C corporation, any foreign entity that would be treated as a C corporation were it domestic, an S corporation as a partner, or an estate of a deceased partner.

  3. If the partnership has an S corporation as a partner, the Schedules K-1 issued by the S corporation count toward the 100 partner limit.

  4. Example 1, a partnership has two partners, an individual and an S corporation. The S corporation has 90 shareholders. The total number of partners for the taxable year would be 92 which is the total of the number of Schedules K-1 required to be furnished by the partnership to its two partners (the S corporation and the individual) plus the 90 Schedules K-1 required to be furnished by its S corporation partner.

  5. Example 2, a partnership has two partners, both S corporations. One S corporation has 90 partners, and the other has 10. The total number of Schedules K-1 required to be furnished by the partnership is 102. The two Schedules K-1 issued to the S corporations, plus the 100 Schedules K-1 issued to the S corporations’ shareholders put the partnership over the limit and it is not eligible to elect out of BBA.

  6. Example 3, a partnership has two partners, an individual and an S corporation. The S corporation has 90 shareholders. One of the S corporation shareholders is a trust with one beneficiary. The total number of Schedules K-1 required to be furnished by the partnership for purposes of determining the number of partners the partnership has for purposes of its eligibility to elect out of BBA is 92. Any Schedules K-1 issued by shareholders of an S corporation partner are not counted towards the 100 partner limit.

    Note:

    Family attribution rules do not apply with regard to the 100 partner limit. BBA requires that all Schedules K-1 required to be issued by the partnership and any S corporation partner be counted. Although family attribution rules allow a shareholder and up to six generations of family members to be counted as one shareholder, the S corporation is required to issue each a Schedule K-1. Because the S corporation is required to issue a Schedule K-1 to each family member, BBA requires those Schedules K-1 to be counted.

S Corporations

  1. S corporations are not partnerships subject to TEFRA or BBA. S corporations that are partners in a partnership may be subject to those regimes as a partner.

  2. In determining whether the corporate statute needs to be protected, in addition to the shareholder level statutes, examiners should first determine whether the entity is a C corporation or is a taxable S corporation. A corporation elects S corporation status by properly completing Form 2553, Election by a Small Business Corporation. When an election is filed and accepted by the Campus, transaction code (TC) 090 is assigned on Integrated Data Retrieval System (IDRS) and the entity's "1120 filing requirement" changes from "01" (indicating an 1120 return is due) to "02" , (indicating that it has an S corporation filing requirement).

  3. If the taxpayer files an S corporation return and the entity does not have a TC 090, the Campus can not process the return as an S corporation and the return rejects in normal processing. The Campus will then assign an audit code "4" and correspond with the corporation in an attempt to correct the problem. If the corporation does not respond back or is unable to substantiate a valid election (or a retroactive valid election), the Campus converts the Form 1120S to a Form 1120, but assesses no tax.

    Note:

    The Campus accepting the S election does not automatically verify that the corporation qualifies to elect S corporation status. As such, this must be confirmed during the examination.

  4. In addition to investor statutes, an S corporation may be a taxable entity and need its statute protected. For example, an S corporation that is subject to the built-in gains tax (IRC 1374) or the Excess Net Passive Investment Income Tax (IRC 1375) is a taxable entity. Additionally, if the S corporation election is terminated, either voluntarily or involuntarily, or if the corporation never had a valid S election, the corporation is a C corporation. As such, the entity’s statute will need to be protected.

S Corporation Statute Considerations

  1. As with any taxpayer, the statute of limitations should be verified. The AIMS database will generally reflect a statute based on 3 years from the date the S corporation’s return was filed. S corporation examinations are not subject to the TEFRA or BBA audit regimes, so statutes are generally controlled at the shareholder level.

  2. Generally, when auditing an S corporation it is the examiner’s responsibility to protect the statute which includes all shareholders’ statutes. If adjustments result in the S corporation examination, the examiner will need to control the shareholder(s) return(s) or have the corporation’s shareholders linked to the corporate return. If the shareholder(s) are linked and controlled in the campus, then the campus is responsible for protecting the statutes of shareholders they control.

    Note:

    To link the case you need to have a year on the statute of the corporation and all shareholder returns that will be subject to adjustments. When the corporation first shows up on the Statute Expiration Report it is generally too late to link the case unless statute extensions have been secured on all of the shareholder returns that will be subject to adjustment. See IRM 4.31.5.11, Linking the Key Case and Investors on PCS, and IRM 4.31.5.10.2, Limited Linkage and Form 15041, for linkage procedures.

  3. In Bufferd v Commissioner 506 U.S. 523, 113 S.Ct. 927 the Supreme Court held that the limitation period for assessing the tax liability of a shareholder in a Subchapter S corporation who claimed pass-through items, began to run from the filing date of the individual return and not the filing date of the corporate return.

  4. The S corporation may be a taxable entity and have its own statute which needs to be protected. An example of when an S corporation would be a taxable entity is when it is subject to the Built-in Gains Tax of IRC 1374 or the Excess Net Passive Income Tax of IRC 1375.

  5. If the S corporation has the potential of being a taxable entity, protect the corporate statute. Form 872, Consent to Extend the Time to Assess Tax, is used to control the corporate statute – whether it is an S corporation or C corporation.

  6. PCS does not preclude the examiner from controlling one or more of the investors in the group. PCS simply identifies that the return is linked to the pass-through entity. However, if the examiner controls an investor return, then they are responsible for controlling the statute for that investor.

  7. Often the entity will have a different statute from its investors. If the investor statutes are shorter than the entity statute, steps should be taken to ensure the investor statutes are protected. Investor statutes may be protected by the examiner (establish group control on AIMS) or by the Campus (secure PCS linkage).

Examination Returns Control System (ERCS) TEFRA Indicator

  1. There is a TEFRA indicator on ERCS that must be entered for allForm 1065. The return cannot be updated beyond status 12 until the TEFRA indicator is entered.

  2. The TEFRA indicator should be entered on the system as soon as the TEFRA determination is made, but no later than 60 days after the case is updated to status 12.

  3. The RA should request that the manager and/or secretary set the TEFRA indicator through the "correct and display" screen on ERCS. The TEFRA indicator can be set or changed on this screen. See IRM 4.7, Examination Returns Control System (ERCS), for further information.

  4. The TEFRA indicator is required on all partnership tax years beginning before January 1, 2018 with a Master File Transaction (MFT) Code of 06 or a Non Master File Transaction (NMFT) Code of 35. The Field Values are as follows:

    1. Y (Yes) = Subject to TEFRA procedures;

    2. N (No) = Not subject to TEFRA procedures; and

    3. S (Survey) = Surveyed without determining if subject to TEFRA procedures.

      Note:

      S can be used on status 12 returns because the RA may charge time and survey after assignment without making a TEFRA determination.

  5. The Election Out Indicator is required on all partnership tax years beginning after December 31, 2017, with MFT Code 06 or a NMFT of 35. The Field Values are as follows:

    1. 0 = BBA (no elect out)

    2. 1 = Elect out

    3. 2 = Revocation of elect out (Whether taxpayer revokes or we determined they were never eligible to elect out.)

  6. Timely linkage of a pass-through return is important in that it maximizes the time the campus has to secure and perfect the investor returns. This becomes even more important when the partnerships electing out of BBA have tier partners.

Pass-through Control System (PCS)

  1. The PCS is a database designed to control and monitor pass-through entities and linked investor returns. It does not replace AIMS inventory control, but it provides the additional information needed to control investor and pass-through returns. It Interfaces with AIMS to establish returns, access information, and provide mass updates to AIMS.

  2. PCS allows an unlimited number of investors to be linked to each key case or tier and allows an investor to be linked to an unlimited number of pass-through entities. The linkage charges the returns to the appropriate area office or CPF. In addition, it places the pass-through entity Partnership Investor Control File (PICF) Code 2 on the key case on AIMS and ERCS databases. It also places an investor PICF Code of 6 on AIMS and ERCS databases so that any other part of the service can see that an entity related to the investor return is under examination. This prevents premature closure of an investor return until all key case issues are resolved. It should also prevent improperly restricted statute extensions.

  3. The campus will input an H freeze on the partnership as part of the linkage process. The H freeze will appear on the key case AIMS transcript when PCS is established for TEFRA or ILSC cases.

  4. The PCS is described in the text of IRM 4.29, Pass-through Control System (PCS) Handbook.

    Note:

    Refer to IRM 4.29 for in-depth information on special features, the various user reports, letters, input documents, and indicators.

Rules and Guidelines for Linking ILSC Entities on PCS

  1. The decision to use or not to use PCS must be made as early in the examination as possible. In some cases the use of PCS is highly recommended, while in others it is optional. The number of investors and/or their geographic location will be the factors to consider for required linkage. For entities with less than 5 investors, efficient use of the Service's resources is the important factor. In either case, the examiner should understand that using PCS will not prevent them from following package audit requirements nor interfere with the examination of any related investor. If as a result of the package audit you determine that an investor(s) should be examined and others should not, the examiner should place on AIMS the appropriate investor(s) prior to linking the case.

  2. Linking does not mean the campus must take control of the investors. An examiner may establish their pass-through return on PCS but retain control of some or all of the investors that are linked. Linkage helps others see the returns under exam, see IRM 4.31.5.10.2, and allows us to gather productivity statistics.

  3. During the compliance checks examiners should review related returns, including investors. If it is determined that one or more of the investors has issues including basis, passive activity losses or those not related to the examination of the pass-through return which warrant examination, they should place the Form 1040 under examination. Examiners should not link a return in lieu of their responsibilities to do compliance checks or to place related returns under examination which have Large, Unusual and Questionable items. If the investor is in another geographical area and warrants examination, you should discuss with your manager. Consideration should be made as to whether you should place the shareholder under examination or work with the other area to get the return worked.

Advantages of using PCS

  1. PCS allows all users to research and see the return under exam and all investors involved. This is important information when an investor is involved in multiple pass-through examinations.

  2. Linkage does not require the campus to control the investors. Examiners can still control all their investor returns. Those investors just need to be established on AIMS by the examiner before they are linked.

  3. Linkage provides awareness of ongoing exams, and prevents the inadvertent issuance of a statutory notice of deficiency that could bar assessments from another exam.

  4. When the key case is linked on PCS (Form 14092 or Form 14093), it establishes the investor returns on AIMS, if not already controlled on AIMS, and generates Form 5546, Examination Return Charge-Out Sheet, for their tax returns. If an investor return is not already in an audit status, the investor returns are sent directly to the CPF. The CPF becomes responsible for protecting the statute on the investor cases, except for cases charged out to Compliance. For cases already charged out to Compliance, the examiner with control of the investor case has the statute responsibility. The CPF will also secure agreements, assess tax and send notices of deficiency, when necessary, on the cases they control.

  5. If during the linkage process the Tax Identifying Number of the investor is incorrectly reported on the Schedule K-1, the CPF unit will identify the problem and take appropriate action. This will include determination of the correct information so that the proper tax return can be secured or notifying the examining agent that additional information is needed. The CPF will contact the examining agent for assistance when they are unable to determine the correct investor.

  6. The CPF is responsible for inspecting the investor returns to determine if the taxpayer reported all pass-through items. If there are differences, the CPF determines the reason. After the determination is made, the CPF will contact the key case examiner, who will decide the action that should be taken. Unlike TEFRA cases, the investor return cannot be conformed to the key case return using a computational adjustment. Statutory Notice procedures must be used.

  7. When the investor returns are received in the CPF, cases with potential non-pass-through audit issues are identified and referred to the examining agent.

  8. The PCS system places a PICF Code of "6" on the AIMS record for the investor. The code alerts personnel to the existence of an ongoing examination of the key case return and prevents its premature closure. For example, an examiner in Peoria may be auditing Investor A's individual income tax return when an examiner in Boston begins the examination of an S Corporation in which Investor A is a shareholder. If Investor A asks for a restricted consent, the Peoria examiner can check the PICF Code and determine whether the restricted consent should include any pass-through entities. Investor A's examination cannot be closed without addressing the PCS linkage.

Agent Responsibilities if PCS is Not Utilized, or PCS is Used But Cases Are Controlled Locally

  1. If the key case return is not linked, the key case examiner assumes total responsibility for statute control for all of the investor returns. The CPF has no responsibility for any statute protection for any investor unless that investor is in the CPF because of a TEFRA or other ILSC linkage. Once the linkage is resolved, the CPF will no longer have responsibility for the statute.

  2. If a decision is made not to link the return, the key case examiner is responsible for:

    1. Establishing AIMS controls, on all investors not already open.

    2. Preparing individual examination reports for all investors open in their group.

    3. Notifying any "investor group" of the entity examination who have an investor return already open with Form 6658, Notice of Special Investor Action.

    4. Informing the investor group on the progress of the entity’s examination and provide them with an interim report when statute considerations require the issuance of a notice of deficiency. This interim report should be prepared and mailed out when the investor has less than 210 days remaining on the statute.

    5. Providing Form 6657, Related Returns Examination Report, and a copy of the entity report to each "investor" group.

    6. Securing the necessary information from the investor's area/territory regarding any other key cases or tier entities in which the out-of-area/territory investor may have an interest. If a pass-through entity has any out-of-area/territory investors, it is strongly recommended that the case be linked.

  3. The key case examiner must reconcile the items reported on the investor Schedule K-1 to the amounts reported on the investor return, and the reason for any differences must be determined. The key case examiner must inspect the investor returns to determine whether non-pass-through issues should be examined.

  4. If the key case is not linked on PCS, there is no Form 5546, Examination Return Charge-Out Sheet, to be associated with the investor case, and there is no PICF code on AIMS. A person, other than the key case examiner, holding the investor return may be unaware of the need to include the ILSC pass-through in any proposed adjustments, statute extensions, or statutory notices of deficiency. If the key case is not linked, the person holding the investor return (CPF, examiner, appeals officer, etc.) is not responsible for statute control on unlinked issues for which there is no notification. For example, if the investor requests a restricted consent, the person holding the investor return will not know to include the non-linked entity in the consent.

When to Link the Key Case on PCS

  1. The decision to use the PCS should be considered and made as early in the examination as possible. If the examiner waits until there is less than one year on investor statutes, they may not be able to use PCS. The examiner should make the decision within 120 days of the initial interview.

  2. It is strongly recommended that the area/territory link all ILSC key cases that meet the following criteria:

    1. The entity has more than five investors, or

    2. There is at least one out-of-area/territory investor, or

    3. There is at least one out-of-operating unit investor, or

    4. There is a investor which is a pass-through entity, or

    5. There is an investor with an open TEFRA linkage.

  3. Linkage is mandatory when:

    1. An ILSC pass-through is linked to a TEFRA partnership already under examination. In that case, a ILSC linkage package must be sent to the campus. Even though the investors may already be linked on PCS, the ILSC linkage package is needed to change the designation of the investor returns from TEFRA to dual status on PCS. This ensures the campus knows that they have to protect the investor's individual statute for the ILSC exam. If a linkage package is not submitted, the campus will not protect the individual statute which could result in barred statutes. Barred statutes in such instances will be returned to the field for failing to notify the campus, or

    2. One of the investors in the ILSC partnership has an open TEFRA linkage. Submitting the ILSC linkage package is needed to change the designation of the investor on PCS from TEFRA to dual status. Adding the ILSC link will alert the campus that the individual investor statute must be protected. With TEFRA, the statute is controlled at the partnership level and not at the partner level. Failing to submit the ILSC linkage package may result in barred statutes. Barred statutes in such instances will be returned to the field for failing to notify the campus.

  4. If the key case is not linked on PCS, Appeals will only accept protesting investors cases if both of the following are met:

    1. The entity has five or fewer investors, and

    2. None of the investors is a pass-through entity.

    Note:

    As a general rule, the key case and one protesting investor will be sent to Appeals. However, Appeals will accept protesting investors with different representatives, protesting investors without representation and protesting investors with unagreed non-pass-through issues. The key case examiner must either link the key case on PCS or hold the investor returns until the key case entity issues are resolved in Appeals.

  5. Also, all pass-through returns in which you do not control 100% of the investors (For example, if another agent in a different state has control of one of the investors) should be linked. This will prevent the investor’s return closing without considering the results from the pass-through entity examination.

Linking the Key Case and Investors on PCS

  1. If the examiner has not determined that the examination will result in a No-Change within 120 days of the initial interview they should prepare the package described above and submit it to his/her manager. The group manager will review the package for timeliness and accuracy. The group manager will indicate approval by signing the Form 14092 or Form 14093.

  2. The examiner should make every effort to have the linkage package in the hands of the campus before the last 12 months of the shortest investor statute is to expire.

    Note:

    It is a best practice to request linkage as soon as adjustments are known, but no longer than 120 days. Delays in linkage create a bigger burden for the campus. Older returns take longer to retrieve from the Federal Records Center. This impacts the campuses’ ability to secure investor returns and have them ready for report writing. It also can leave them with little time to secure statute extensions.

  3. It is important to remember that when a key case is linked, all the investors will be linked no matter where they are controlled.

Initiating Timely PCS Controls on ILSC Pass-Through Entities

  1. ILSC linkage package must be received by the CPF with at least 12 months on all investor statutes. If less than 12 months remain on an investor statute, examiners must coordinate with the Technical Services TEFRA/Pass-Through Coordinator and/or the CPF Pass-Though Coordinator - ILSC. The campus may accept a package if there is less than 12 months, but more than 9 months, if their workload allows.

  2. If the ILSC pass-through entity is already linked on PCS to a TEFRA case, ILSC linkage must be established as well. If the agent does not establish ILSC linkage, the campus controlling the investor returns will not know to protect the partner level statute. The campus does not control the partner level statute if there is only a TEFRA linkage. Not establishing the ILSC linkage may result in barred statutes.

  3. If the BEO pass-through entity is already linked on PCS to a BEO key case, linkage must be established as well. If the agent does not establish linkage, the campus controlling the investor returns will not know to protect the partner level statute. Not establishing the BEO linkage may result in barred statutes. The BEO pass-through entity must be linked as a key case and as an investor.

  4. In those instances where there are less than 12 months remaining on the statutory period of limitations for assessment of the tax for any investor, the key case area is responsible for securing extensions of the statutory period of limitations on all related investor returns, including tier returns and their related investors. When extensions cannot be secured, the agent is also responsible for all 30-day letters or notices of deficiency. The CPF will only link if the field has established AIMS controls for all investors.

    Caution:

    In situations where the campus agreed to accept the case and the 9 month time limitation lapses during mailing of the package, the CPF should be notified of the package prior to mailing. If the CPF is not notified, and there are less than 9 months remaining on the statute, then the CPF may reject the package.

  5. The key case examiner is responsible for securing the necessary information from any investor areas regarding any other key cases or tier entities in which the investor may have an interest so as to not exclude them from any restricted consents.

  6. When a return is properly linked, the responsibility to make adjustments from the ILSC pass-through audit that pass to the individual returns shifts to the campus for all investors the campus controls. This does not negate the examiner’s responsibility to conduct the compliance examination and evaluate related returns during the examination process.

  7. In auditing an S corporation, there are a number of issues which are related to the S corporation but are non pass-through issues. These include basis, at-risk, passive activity losses, gain on loan repayment and taxable distributions which can all be identified and developed as part of the corporate audit. In addition, there could be non-S corporation issues identified through inspection of the shareholder’s returns which need to be addressed which are not related to the S corporation examination. These non-S corporation issues will generally require the examiner to place the individual shareholder under examination regardless of the S corporation examination results.

  8. If you determine that you have some investors which you will need to place under examination due to 1040 issues, these cannot be controlled by the Campus. The Campus will only make adjustments for pass-through adjustments. It is recommended that the examiner first control those returns which have non pass-through issues and then link the key case return which will protect all other shareholders.

Form 15041 and Limited Linkage

  1. Generally, all ILSC pass-through investors must have their statutes secured. However, there are times when it is clear that not all investors will be affected by an adjustment. When this occurs, Form 15041, NonTEFRA Pass-Through Entity Intent Not to Pursue Investor - Statute Protection, may be used to secure approval to let an investor statute expire. No investors will be linked on PCS if their statutes are allowed to expire.

  2. The examining agent or the campus may identify investors that may not be subject to adjustment and may not require statute protection. When this occurs, Form 15041, NonTEFRA Pass-Through Entity Intent Not to Pursue Investor - Statute Protection, will be used to

    1. identify the investor return(s) where the statute will not be protected,

    2. the reason(s) for not protecting the statute, and

    3. for manager approval.

  3. Approval must be secured prior to the expiration of the investor’s statute, and ideally at least 12 months prior. See 25.6.23.4.5.1, Inconsistent Application of Investor Returns - NonTEFRA.

  4. The initiator of the Form 15041 must not only have their manager sign in agreement with the decision to not protect the statute, but must also have their Department Manager or Territory Manager sign the agreement as well. The high level of approval is necessary since the statute will be allowed to expire.

  5. Allowing an investor’s statute to expire may make sense if it is highly likely the investor will not be adjusted. This will save resources and reduce taxpayer burden. Protecting such an investor will result in unnecessarily contacting them, and potentially requesting statute extensions or other communication.

  6. The campus should contact the examining agent to gain their concurrence if they think an investor’s statute doesn’t need to be protected. The examining agent may have other information that would require the statute of a investor to be protected that not might not otherwise appear to need protecting.

Field Control of Investors

  1. The examiner is responsible for reviewing the investor returns related to Non TEFRA pass-through audits for large, unusual or questionable items. If it is determined that the investor return warrants further examination, then AIMS controls should be requested.

  2. PCS linkage is recommended on all ILSC pass-through entities within 120 days of the initial interview. When there is one out of area investor, greater than 5 investors or if any investor is a pass-through entity the examiner must submit PCS controls for the pass-through entity.

  3. If AIMS controls exist on any investor prior to linking the pass-through entity on PCS then it is important that the investor returns remain in the group until linkage is fully established. The investor return can be closed after PCS linkage is established and also when the NON pass-through entity adjustments are resolved before the pass-through entity examination is complete. A TSUMYP secured through AIMS will indicate if PCS linkage does exist along with a listing of investors linked. Once linkage does exist the case can be closed from the group.

    Note:

    Returns that are CIC corporation, Joint Committee, or other corporate specialty cases (Forms 1120 with letters after the 1120 other than A, S, or X) must be held in the field.

  4. Do not close the investor returns off AIMS if a key case linkage package is being submitted. This creates added work for the campus as they have to reopen those partner returns before a linkage can be established.

  5. Once linkage has established, investor returns can be transferred to the campus through Tech Service and updated to Status 21. In addition to the normal case information, the Form 3198 should be completed as follows:

    1. On page one, in the Special Features Box, check the other box on page 1 and write suspense case with unresolved pass-through issues, non pass-through issues are being surveyed/no changed/agreed/unagreed, please forward to Brookhaven if linked to a SB/SE key case or to Ogden if linked to an LB&I key case.

    2. Check Forward to Tech Services.

ILSC Linkage Package

  1. To initiate a linkage, the agent must complete Form 14092 (for an SB/SE key case) or Form 14093 (for an LB&I key case) and submit the linkage package to the CPF within 120 days of the initial interview.

  2. The examiner should make every effort to have the linkage package in the hands of the CPF before the last 12 months of the shortest investor statute is to expire.

    Note:

    It is a best practice to request linkage as soon as possible. Delays in linkage create a bigger burden for the campus. Older returns take longer to retrieve from the Federal Records Center. This impacts the campuses’ ability to secure investor returns and have them ready for report writing. It also can leave them with little time to secure statute extensions.

  3. For LB&I key cases, the agent must also include the LIN link.

  4. If the return is not imaged, the return can be scanned or faxed.

  5. If faxed, the check sheet and attachments should be sent via secure E-mail at the same time. Attachments include:

    1. A spreadsheet with a reconciliation of the Schedules K-1. All attempts should be made to secure any missing Schedules K-1.

    2. The agent must answer the questions on the check sheet.

      Note:

      Director of Field Operations (DFO)/Area Director concurrence is still required but does not need to be included in the package. The memo must be included in the case file.

  6. The copying of tax returns and Schedules K-1 are no longer required at the field level when the return is imaged or scanned.

  7. Schedules K-1 filed electronically can be accessed via the Employee User Portal (EUP) or via a TRPRT print.

  8. The group manager must review the package and electronically sign the Form 14092 or Form 14093 before submission to the CPF. Once signed, the agent can forward the package via secured E-mail to the CPF. The E-mail address is provided on the appropriate form. The manager’s signature on the TEFRA Electronic Linkage Check Sheet indicates that the linkage package has been reviewed, is accurate and complete.

  9. A copy of the electronic check sheet must be included in the audit file.

  10. The Technical Services PCS coordinator is no longer used. The packages are sent directly to the CPF via secure E-mail.

  11. If the return is too big to email or fax, the information can be uploaded to a shared drive. If the information cannot be sent electronically, coordinate the mailing of the return with the Campus Pass-Through Coordinator - ILSC. All information should be sent electronically except for that which must be mailed.

Transferring Work to the Campus Using a Share Drive

  1. Large files cannot be emailed. As a result, a shared drive was created to allow these large files to be transferred electronically.

  2. In order to transfer files via the shared drive, a network pathway must be established.

  3. To map to the drive:

    1. Right click the My Network Places icon on the desktop

    2. Left click Map Network Drive

    3. A window will open with two fill in boxes. One for Drive and one for Folder.

    4. The Drive box displays the first available drive letter for the connection. You can click on the arrow and scroll down until you see the drive letter that you want to use or you can use the drive letter listed.

    5. ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡

    6. Also, make sure to check the box Reconnect at Login. This will ensure your computer reconnects to the drive each time you log on.

  4. Check to see if the mapping was successful. Right click on the Start button on the lower left hand corner of your computer. Left click on Explore. The newly mapped drive will appear in the list. You should see the specified drive, followed by EX TEFRA Elect Notice followed by the drive name.

  5. Left click on that drive and there will be two folders. One folder entitled LB&I OSC Notices and the other entitled SBSE BSC Notices.

    Note:

    All ILSC related documents need to be loaded in the SBSE BSC Notices folder.

  6. Once you have mapped the drive, you will then be able to double click to the folders that you have access to. You can also create a shortcut to put on your desktop.

  7. A new folder needs to be created to send to the campus. To create a new folder in your case folder, left click on the appropriate folder. Left click on "File" in the top menu. Left click on "New" in the drop down menu, and then on "Folder" . A new folder icon with highlighted name "New Folder" will appear in your data folder.

  8. With the name of the folder highlighted, left click on the folder and enter a name. If the name of the folder is no longer highlighted, then right click on the folder and left click on "Rename" .

  9. The folder should be named:


    XXXX = Type of Package-FL.
    (Where XXXX = Last four digits of the Taxpayer Identification Number (TIN)
    Type of Package = e.g., NBAP, and
    FL = First and last name of sender)
  10. Save all taxpayer files to be sent to the campus in the file folder named above.

  11. To add the folder to the shared drive, right click on the folder being sent. Bring the cursor to the WinZip option and left click on "Add to foldername.zip" in the submenu. This will create a WinZip folder.

  12. Right click on the .zip folder and left click on cut. Left click on the short cut folder on your desktop for the campus, or go through the network drive (long way).

  13. Left click to open the campus folder where the package will be attached.

  14. Right click on paste to attach the folder. When you click paste, an error message will appear to alert you that encrypted data cannot be copied or moved. Click ignore all.

  15. The folder will be posted to the campus folder. No password is needed because special access is required for the shared drive.

  16. Each TEFRA campus will have an employee assigned to monitor the shared drive who will copy and save the package externally and then delete it from the shared drive. The campus will acknowledge the package within 24 hours via email stating "your linkage package has been received for XXXX (last four digits) on MMDDYY" .

  17. The agent should also monitor the shared drive to confirm that the package was deleted.

Requesting "Dummy" Taxpayer Identification Numbers
  1. A dummy TIN is required to link any key case that did not file, or is not required to file, a tax return.

  2. The field office is responsible for acquiring a dummy TIN when:

    1. It is needed for a key case. Identification of a Schedule C or F type promotion is one example of an occasion where a dummy TIN is needed.

    2. The field chooses to work investors that did not file, or were not required to file, a return.

  3. The campus is responsible for acquiring a dummy TIN when the campus will control the linked investor(s).

  4. A dummy TIN is created by using two CCs. First, AMTIN7 is used to generate a dummy number. CC AMNON is then used to establish the dummy number on AIMS.

    Note:

    Field personnel should work with the AIMS Coordinator in acquiring a dummy TIN.

  5. Once the entity is established, the agent can submit the Form 8341 to control all investor returns that are identified. Before the Form 8341 is input, the key case examiner must insure that the NMF TIN, MFT code, tax period and Employee Group Code (EGC) shown on AIMS are consistent with the input information on the Form 8341.

  6. The NMF AIMS for any investor should be established before the key case is linked. That will eliminate any rejects that would occur when linking the NMF investor.

  7. As additional investors are identified, use Form 8341 to add controls for the additional investors. All existing instructions for PCS are then applicable including case closing instructions.

Entities Acting as Agents for Investors
  1. Examiners may encounter situations where an entity such as a corporation is acting as an agent for investors. The agent-investor arrangement may be identified as a result of the examination of the agent-promoter or the examination of the investor. In either instance, the examiner will determine whether it should be controlled using the PCS or manual procedures.

  2. If the agent-investor arrangement is identified as a result of the examination of the agent-promoter and there is an adjustment affecting the investors, or a determination is made to control the arrangement, the PCS procedures should be used to control the investor returns. A copy of the substitute Schedule K-1 or other similar document provided by the agent to the investors showing distributive shares of income, loss, etc., will be used in lieu of Schedule K-1.

  3. If the agent-investor arrangement is identified as a result of the examination of an investor, nominee, etc., and it is determined that controlling the arrangement would be beneficial, the examiner of the investor's return will prepare and submit a collateral examination request to the agent's area. The procedures discussed in (2) above for controlling the investor's returns will be followed.

  4. If it is determined, as a result of the examination by the agent, that a partnership return should have been filed, the return will be secured from a responsible party. The procedures in this Handbook, including the use of the PCS, will then be followed.

  5. When a promoter of a Schedule C or F type promotion is identified, obtain a dummy TIN for the specific shelter by using the procedures outlined in IRM 4.4, AIMS/Processing Handbook. Create the dummy entity on AIMS as a NMF entity. Input Form 8341 to control all investor returns that are identified. As additional investors are identified, use Form 8341 to control the additional investors. All existing instructions for PCS are then applicable including case closing instructions. Before the Form 8341 is input, the key area examiner must insure that the non-Master File (NMF) TIN, MFT Code, tax period, and Primary Business Code (PBC) code shown on AIMS are consistent with the input information on the Form 8341.

Verification of Linkage

  1. The examiner should verify linkages using a TSUMYP print. No Form 886-Z is generated for ILSC investors. If the examiner notices any discrepancies between the TSUMYI print and the return, the CPF Pass-Through Coordinator - ILSC should be contacted. The CPF Pass-Through Coordinator - ILSC will help rectify any linkage problems. The campus may not link all investors if they determine some will not have a material adjustment.

  2. Additionally, an AMDISA can be secured for each investor. The PICF code 6 indicates linkage with at least one ILSC key case, though it will not state the ILSC key case. The AMDISA will also show the investor’s statute. If the case is in status 33, it is controlled by the ILSC unit in the Campus. Be aware there may be more than one ILSC key case or also TEFRA key case linkage and an AMDISA will not show the key case, so a TSUMYP is the safest method to verify linkage.

  3. Although S corporations are no longer subject to TEFRA they could be an investor in a partnership thereby causing the partnership to be subject to TEFRA proceedings. As such, examiners should be checking PCS to see if their 1120S taxpayer is linked to any open TEFRA key case. ILSC issues can be partially assessed and the return can then be sent to the campus for suspense to await the TEFRA results. Multiple ILSC linkages need to be resolved together, as only one stat notice may be sent to investors for ILSC issues.

  4. Once the key case has been properly linked, the Campus is responsible for protecting investor statutes on cases they control and making pass-through adjustments as a result of the examination.

    Note:

    The campus may not link all tier investors. For example, if a grantor trust is a shareholder in an S-Corp, the campus may opt to link the beneficiary only. Tax exempt investors are also not linked, however any tax changes will be shared with Tax Exempt/Government Entity (TE/GE). If the agent is concerned about a tax exempt partner being subject to tax, they should submit a referral to TE/GE.

Examination Process

  1. The following subsections cover the examination process.

Starting the Examination

  1. The examiner will issue a regular appointment letter confirming the initiation of an examination with an accompanying Information Document Request (IDR). If, within 120 days, the examiner and their manager have determined that PCS linkage will not be used, the investor returns not already controlled by the examiner will be requested. Any returns already open outside the group will be notified that an entity, in which their taxpayer is an investor, is under examination. Use the Form 6658 to notify other offices of the exam and send with a Form 3210, Document Transmittal. Make sure an acknowledgment copy is received to ensure the examining agent is aware of the key case examination. A copy of each investor Schedule K-1 should be included with the notification for the investor's file.

  2. The partnership return cannot be surveyed once the examination has started. The investors are sent notification of the examination when they are linked. There should be no reason to survey a return since linkage is not needed until 60 days after the examination has started.

Notice to Investors of Examination of Key Case Entity

  1. When the examiner has secured the investor returns but is not examining issues other than the pass-through, the examiner should use one of the Letter 3457, Pass-Through Audit Notification Letter, to inform the investors of the examination. This assures that the taxpayers first contact is not a request for a statute extension, a 30-day letter or a notice of deficiency. Separate notices should be considered for taxpayers filing joint returns.

  2. If it is clear the shareholders are aware of the S corporation audit, it is not necessary to issue the above letter. If the corporation is linked, the Campus will notify the shareholders of the examination.

  3. Do not contact the taxpayer if there is "Z" Freeze or a TC 914 on the taxpayer account. If there is a "Z" Freeze or a TC 914 on the taxpayer account, give the investor information to the Pass-Through Coordinator - ILSC for immediate, appropriate action.

Control of Investor Returns Related to Key Case Entities

  1. The examiner of the unlinked entity is responsible for controlling statutes and applying examination results to investors open in his/her group. The examiner must also keep any other investor groups updated on the progress of the entity's examination and provide them with an interim report when statute considerations require the issuance of a notice of deficiency. This interim report should be prepared and mailed out when any investor has less than 210 days remaining on the statute.

Control of Cases Established on PCS

  1. The AIMS databases and the tax returns for the investors of a key case will establish in the campus PBC (295) or (398), EGC 5400 and be delivered to the key case CPF, unless the investors are already established on AIMS.

  2. When tier investor returns are received in the key case CPF, the tax returns of the tier investors will also be requisitioned. This procedure will be followed through the significant layers of the tiering arrangement.

  3. If a TC 420 already exists on the module when a TC424 request posts, the function with the return will be notified as explained below.

Notification of Examination of the Key Case Entity

  1. Internally, notice of a key case examination is provided by Form 5546, Examination Return Charge-Out, which is produced by AIMS.

  2. The Form 5546, Examination Return Charge-Out, delivers the investor return to the key case CPF or delivers an acknowledgment to the location of the return if it was previously charged-out to another campus function or area. The Form 5546, Examination Return Charge-Out, shows the identifying information of the entity under examination.

ILSC Key Case Statute Control

  1. In general, no statute control is necessary for ILSC key case entities as they are considered information returns. The statute of limitations of each investor return controls the pass-through entity issues on the investor's return.

  2. Alpha statute "GG" – ILSC Pass-through can be used to update the corporate statute if it is determined that no entity level statute of limitation exists. Caution should be exercised before assigning any alpha statute code; once an alpha code is assigned, the statute will not be reflected as imminent on Statute Expiration Reports. Alpha statute "GG" should only be used on an ILSC entity if all the following items are confirmed:

    1. The entity is not liable for entity level tax. For S corporations that includes the Built-in Gains Tax (IRC 1374), Excess Net Passive Investment Income Tax (IRC 1375), LIFO Recapture Tax (IRC 1363(d)), recapture of prior years investment credit, tax paid on fuels, or application of penalties under IRC 6707A and IRC 6699. For S corporations and partnerships it can also include application of penalties under IRC 6707A, IRC 6698 and IRC 6699.

    2. The S corporation election is valid and has not had a terminating event (including, but not limited to, an invalid shareholder, three years of excessive net passive income, or a revocation).

    3. A final determination has been made that the partnership does not come within the BBA or TEFRA provisions.

    4. All of the investor statutes are protected by being controlled on AIMS or properly linked at the Campus.

  3. Generally Form 5348, AIMS/ERCS Update, is used to update the statute date by adding the alpha code "GG" . Both AIMS and ERCS may need to be updated. As an example, if the 3 year corporate statute was to expire 3-15-09, the statute date on the Form 5348 would be 03GG2009.

  4. TheILSC pass-through alpha code "GG" should only be used when all investor statutes are protected.

    Note:

    Caution should be exercised in updating the statute to any alpha code; if it is not used properly it may result in a barred statute. The ILSC pass-through alpha code "GG" should only be used when all investor statutes are protected. Any time you receive a case with an alpha statute, you should take steps to confirm that it is proper.

S corporation or Partnership Penalties
  1. The entity level statute may also need to be protected for penalty purposes. Applicable penalties include IRC 6707, Failure to furnish information regarding reportable transactions, IRC 6698, Failure to file partnership return, and IRC 6699, Failure to file S corporation return. The failure to file penalty is normally assessed by the Campus during processing but occasionally it will need to be assessed by an examiner, see discussion below.

Entity Statute Extension
  1. If the entity has the potential of being a taxable entity, protect the entity statute. Secure a consent for the S corporation or Partnership, for entity level taxes or penalties, on Form 872, Consent to Extend the Time to Assess Tax. Please note if the IRC 6707A penalty is applicable, there may be special language required.

  2. The "kind of tax" line on Form 872 will be "income" when the entity is taxed as a C corporation, subject to built-in gains tax, excessive net passive income tax or the Income Tax Credit claimed for Fuels. If the entity is subject to a penalty, then the specific penalty will also be specified on the "kind of tax" line.

  3. When the corporation is taxed as a C corporation because the S election is not valid or has terminated, or if the S corporation statute is being extended to assert the built-in gains tax, the net passive investment income tax, the LIFO recapture tax or the recapture of prior C corporation credits, the kind of tax on the Form 872 should be Income Tax.

Extension of Investor Statute for ILSC Items

  1. The examiner charged with the investor return is responsible for the IRC 6501 statute for all ILSC issues on the investor return. All regular statute extension request procedures must be followed when soliciting Form 872, Consent to Extend the Time to Assess Tax, including requests for restricted consents. If the examiner receives a return letter with a signed consent that places conditions on the extension, the examiner should include these terms in a revised Form 872, after the conditions are reviewed by Counsel, and re-mail to the taxpayer for signature.

  2. The case file must be documented that managerial approval has been obtained to solicit a consent to extend the statute of limitations from the taxpayer 210 days prior to the statute expiration date.

  3. It is recommended that all investor statutes be listed and attached to the Form 895. The attachment should indicate that the statutes are being controlled at the investor level. A statement should be included that indicates if any entity level penalties exist. The Form 895 should be initialed and dated by both the examiner and the manager.

  4. The Restructuring and Reform Act of 1998 (RRA '98), section 3461(b), imposed provisions that must be followed in soliciting a consent to extend the statute of limitations. The provision requires the IRS to provide the taxpayer(s) or their authorized representative(s) with an explanation of their rights to decline to extend the assessment statute of limitations, or to request that any extension be limited to a specific period of time or to specific examination issues.

  5. In order to meet the provisions of RRA '98, the IRS has established the following procedures whenever an extension to the statute of limitations is solicited:

    1. Letter 907, and Publication 1035, Extending the Tax Assessment Period, must be provided to both the taxpayer and any authorized representative. In the case of a joint return, both spouses must be separately notified. A copy of Letter 907 must be attached to the Form 872 in the file, and its mailing documented in the case activity record.

    2. Examiners should ensure that the proper extension form is transmitted to the taxpayer and representative.

    3. Upon receipt of the executed copy from the taxpayer or authorized representative, the consent should be date stamped received and processed to the manager for execution. All requests for restricted consents must be considered. If the examiner receives a return letter with a signed consent that places conditions on the extension, the examiner should include these terms in a revised Form 872, after the conditions are reviewed by Counsel, and re-mail to the taxpayer for signature. A copy of the executed consent must be returned to the taxpayer and/or authorized representative(s) with the original attached to the tax return. The team should ensure that both the AIMS and ERCS databases are properly updated to reflect the new statute of limitations date.

  6. If the taxpayer or authorized representative does not wish to execute a consent, they should be notified that the case will be evaluated to determine whether a Statutory Notice of Deficiency should be issued.

  7. Further guidance on the control of statutes can be found at IRM 25.6, Statute of Limitations Handbook.

  8. If any investor statute of limitations expires, the responsible agent will follow the statute expiration procedures as outlined in IRM 25.6.1.13, Barred Assessments/Barred Statute Cases.

Restricted Consents
  1. Restricted consents are not common with TEFRA investor cases. Care must be taken to ensure all restricted issues are covered.

    Note:

    It should be noted that using the standard language included in IRM 25.6.22.8.9, Basic Restrictive Statement, in effect removes the TEFRA language. A statement must be added that the applicable TEFRA paragraphs are still valid. Without that language, the TEFRA issues may be lost.

  2. Research the investor for other linkages. If other linkages exist, contact the examining agent to see if other restrictions exist.

  3. There is a restricted consent indicator on AIMS that signifies if a restricted consent is secured. An "R" will follow the Statute Date if a restricted consent was secured. If an extension was secured with no restriction, an "X" will follow the Statute Date.

  4. More than one restricted consent can be secured for a taxable year.

  5. Once the original IRC 6501 statute is gone, each existing restricted consent must be extended timely to keep the statute open.

  6. No other restricted issues may be added after the original IRC 6501 statute has passed.

    Note:

    The original statute may be, for example, the six-year period for a return with a substantial omission under IRC 6501(e).

Extension of Investor Statute for TEFRA and ILSC Items
  1. In Alan H. Ginsburg v. Commissioner, 127 T.C. 75 (2006), the Tax Court held that a consent that did not reference affected items was not sufficient to extend the statute of affected items of taxpayers with pass-through entity interests subject to TEFRA.

  2. All examiners soliciting consents to extend the statute of limitations should now use Form 872, Consent to Extend the Time to Assess Tax As Well As Tax Attributable to Items of a Partnership, for any taxpayers that are direct or indirect investors in one or more entities that file, or should file, a Form 1065 . This is especially important where the pass-through entity is not under examination; therefore, no Form 872-P has been secured at the partnership level.

  3. Although an S corporation is not subject to TEFRA procedures, it can own an interest in a partnership. Any partnership with an S corporation partner (or other pass-through entity, including a single member LLC) is automatically TEFRA. Therefore if the S corporation is a taxable entity, or has the potential to be a taxable entity, an unrestricted Form 872 (10-2009 revision) should be obtained.

  4. An unrestricted Form 872 is recommended for all cases where the taxpayer is a direct or indirect investor in pass-through entities that file (or should file) a Form 1065. As an example, a large corporate taxpayer may be invested in hundreds of partnerships or limited liability companies subject to the TEFRA partnership administrative and judicial procedures. In this situation, it may not be known which of these pass-through entities are subject to TEFRA. If a significant TEFRA partnership adjustment is picked up during an examination of a taxpayer/investor, the period of assessment will be held open by the executed Form 872. It is very important to note that a TEFRA partnership proceeding is still required in order to make this adjustment even though the taxpayer who has executed the Form 872 consent may be the only partner adjusted as a result of the TEFRA partnership proceeding unless other partners or the TMP have also extended the period for assessing partnership items.

    Note:

    The TEFRA language should not be removed from an extension if the taxpayer is linked either directly or indirectly to a TEFRA key case.

  5. If the taxpayer declines to execute an unrestricted Form 872, the taxpayer should be advised that due to the implications of the Ginsburg decision the Service will take all necessary steps to protect the Government's interest.

  6. In those cases where it is appropriate to solicit a partner level extension, but the partner refuses to sign the consent, the examiner should document the refusal in the case file.

    Note:

    There is no harm in obtaining a Form 872 for an individual or corporation which has no TEFRA entities so it is recommended an unrestricted Form 872 always be used so there will not be an inadvertent problem with an unknown partnership.

  7. Anytime the statute is extended at the partner level, a copy of the extension must be sent to the campus that linked the case.

  8. It is recommended that all investor statutes be listed and attached to the Form 895. The attachment should indicate that the statutes are being controlled at the investor level. A statement should be included that indicates if any entity level penalties exist. The Form 895 should be initialed and dated by both the examiner and the manager.

25% Omission of Income
  1. If it can be shown that a taxpayer understated their gross income by 25%, a special 6-year statute applies per IRC 6501(e). On a non-taxable, ILSC return, the computation of the substantial understatement will be made at the investor level.

  2. The general rule is the investor’s gross income includes the investor's pro rata share of the pass-through entity's gross income. Treas. Reg. 1.1366-1(c)(1). Gross income for a business is the total amount of sales received or accrued prior to the reduction for cost of goods sold.

  3. In determining whether an individual has a substantial understatement of income, you would total the gross income reported on the individual tax return and compare it to the correct total of gross income.

    Note:

    Separately stated income from the pass-through entity should be included on the proper line of the 1040 – interest, dividends, capital gains, etc.

  4. The following items would be totaled in arriving at the investor’s gross income:

    • Wages, Salaries, Tips, etc.,

    • Interest Income (not including tax exempt interest),

    • Dividends,

    • Gross Income from Business or Farm (before cost of sales),

    • Net Gains from the Sales of Property (not the gross sales price),

    • Proportionate Share of Gross S Corporation and Partnership Income,

      • Gross Receipts (before cost of sales)

      • Gross Rents

      • Net Gain from Form 4797

      • Other Income Included in Total Income

      • Gross Income from Farm Included in Total Income

    • Gross Rents or Royalties, and

    • Other Income

  5. In establishing a 25% omission of income case, the burden is on the government. An item other than an overstatement of basis is not considered omitted from gross income if the taxpayer adequately disclosed the item on the return or on an attached statement. The disclosure must adequately apprise the Service of the nature and approximate amount of the item; the actual dollar amount of the omission need not be disclosed. An understatement of gross income caused by an overstatement of basis is an omission from gross income for the tax period for which the assessment statute was open on July 31, 2015 and for returns filed after July 31, 2015.

  6. Due to the requirement to use the proportionate share of gross receipts, it may be difficult to trigger the 25% omission rule where the individual taxpayer reports the distributive share of income or loss of the S corporation or partnership ownership interests.

  7. On the other hand, this gross income test could actually trigger the 6-year statute if the investor failed to report his entire share of the entities pass-through income.

  8. Based on Treas. Reg. 1.1366-1(c)(2), the amount of gross income reported by the investor depends on whether the investor reports all of their pro-rata share of pass-through income. If all of the pass-through income is not reported, then all of the gross income for the 25% omission test has not been reported.


    Example – Six Year Statute
    • Ann owns 25% of S, Inc., an S corporation with gross income of $200,000 and ordinary income of $20,000.

    • This means that Ann’s gross income from the S corporation is $50,000. Also, her share of the ordinary income is $5,000.

    • If Ann only reports $3,000 of ordinary income, and failed to report $2,000 of ordinary income, she would also fail to report $20,000 of gross income (2,000/5,000 of $50,000).

    • Assume Ann's only other income is $25,000 of W-2 income. Her total gross income is $75,000 ($25,000 W-2 income plus $50,000 S corp. income).

    • She has omitted $20,000 of the $75,000 of income which is a 26.67% omission. This triggers the 6-year statute.

  9. Be careful when computing substantial understatement of income, especially relating to pass-through entities. The pass-through entity’s gross income versus pass-through taxable income should be used in the calculation. Situations where an individual fails to include their entire share of S corporation or partnership income can result in a 25% omission of income.

    Note:

    Be sure not to double up counting gross income on the investors return. If you have a 25% shareholder, the shareholder would get allocated 25% of the gross receipts. Do not include the ordinary income reflected on the shareholder’s Form 1040.

Receipt of Amended Returns and Claims

  1. The agent should review and process all amended returns and claims received per IRM 4.10.8.9, Claims.

  2. ILSC partnership amended returns have no statute of limitations and are information returns like their originally filed Form 1065. An examination of the amended ILSC partnership is conducted in the same manner as any other nonTEFRA partnership examination. ILSC examinations can be linked on PCS, see IRM 4.31.5.8, Pass-through Control System (PCS). Since the partnership is ILSC, all statutes are controlled by the partners’ IRC 6501 statutes.

  3. Generally S corporation returns are non-taxable entities. If an amended return is filed, it does not extend the statute of the non-taxable corporation or the shareholders. On occasion an amended S corporation return statute is improperly updated to "AA" indicating a claim statute. When the S corporation is a non-taxable entity it cannot be a claim.

  4. The individual investor’s 1040s should have timely filed amended returns relating to the amended S corporation or partnership return. AIMS should be reviewed for each investor to see if the amended returns were filed and whether the claims were paid.

    1. If an investor claim has not been paid, even though the regular statute has expired, the investor return can be audited and an assessment can be made up to the amount of tax requested in the claim. In other words, the tax refund requested in the claim can be offset by other audit adjustments.

    2. If one, or more, of the investor claims have been paid and the regular statute has expired, there is no statute with respect to that investor. One exception to this is if the refund is an erroneous refund, which is rare. The determination of whether or not an erroneous refund exists would need to be made by the local Counsel attorney.

    Unfortunately claim returns relating to an ILSC pass-through entity and related investors are not currently reviewed together.

  5. Claims and taxable amended returns received for any investor controlled on PCS should be reviewed by the agent for potential examination or statute issues.

  6. If no examination or statute issues exist, the claim should be forwarded to the controlling CPF.

  7. All taxable amended returns should be assessed before forwarding to the campus.

Capital Loss Carryforward Adjustments

  1. A capital loss carryforward is governed by the investor's IRC 6501 statute for the carryforward year. IRC 6501(h) would extend the investor's statute based on the loss year only for carrybacks. If a carryforward adjustment is possible, the investor's statute will need to be protected on all carryforward years.

Post Exam Process

  1. The following subsections cover the post exam process.

ILSC Examination Results

  1. ILSC reports are similar to those for TEFRA partnerships. The agent prepares a Form 4605, a Form 886-A, Explanation of Items, and a Form 886-S, Form 886-X, Form 886-W or Form 886-Z to show the corrected pass-through amounts for each investor. The Form 4605 is used to secure agreement from the entity. All are available on RGS.

  2. There is no summary report letter. Instead, for cases with adjustments, Letter 921, Report Transmittal for a Partnership, Fiduciary or S-corporation, is used for the entity and Letter 950 (30-Day Letter) for each of the investors. When investors do not file a protest to the 30-day letter or when the statute does not allow time for the 30-day letter, a notice of deficiency is issued.

  3. A Letter 992, No-change Letter, is used for the entity when it is no-changed. The examiner will also prepare Form 6657, Related Returns Examination Report, as a cover for the reports for investors not under their control.

  4. These forms and letters are used for both PCS linked and unlinked cases. Letter 992 and Form 6657, whether or not case is PCS linked, will be issued by the agent.

  5. The unified proceeding with NBAP's, a Summary Report and FPAA's used under TEFRA are not available for these entities. The subsections below discuss the procedures for processing the results of the key case examination.

Key Cases With No Adjustments and Investors Not Linked on PCS

  1. The examiner will immediately issue a Form 4605 indicating no adjustments and mailed to the entity along with Letter 992. A copy will be issued to the POA as required. There is no requirement for the pass-through entity to sign the forms. IRM 4.10.8, Examination of Returns, describes the report writing requirements if no changes are proposed for the pass-through entity.

  2. The examiner will prepare a Form 6657 indicating a no-change. The Form 6657 and a copy of the report must be associated with any investor files that are open. The Form 6657 must be sent with the report for all investors not under the control of the examining entity agent. Any investors that have been contacted will need to be notified of the no-change. Letter 3401, Preliminary No-Change Report Transmittal Letter, will be used to notify the investors when all issues are no-changed. Letter 590, No Change Letter, is checked off on Form 3198, and is issued when the case is officially closed.

  3. An examination is not considered a no-change with adjustments case merely because there is no tax at the entity level.

  4. It may be important to notify the taxpayer of, or secure agreement to, audit adjustments to basis, passive/non-passive activity or recourse/non-recourse type items so that the items will be properly reflected in subsequent returns of the taxpayer. If so, a report on Form 4605 (with explanatory pages) should be prepared and given to the pass-through entity at the conclusion of the examination.

  5. If the taxpayer raises affirmative issues, they should be considered by the agent as part of the examination. If adjustments are made in the taxpayer's favor, the adjustments should be made by the examiner on the key case and the investor returns. It would no longer be considered a no-change. The agent will issue Letter 950, 30-Day Letter, to each of the investors.

  6. If the examiner determines that the affirmative issues are not allowable, a no-change report will be issued. The fact that the issues were considered but not allowed will be noted in the remarks section of the Form 4605 and explained on Form 886-A. This report should be associated with the investor files for future reference. There are no entity level claim procedures similar to the Administrative Adjustment Request (AAR) procedures under TEFRA or BBA for ILSC entities. Investors will have to file claims for any further consideration.

  7. Unless there are other issues to be determined for the investor returns, the key case and investor returns case will be closed to Centralized Case Processing (CCP). There is no special handling needed in TS.

Key Cases With Adjustments and Investors Not Linked on PCS

  1. The examiner will furnish a copy of the examination report to the responsible individual for the entity. A copy of the examination report should be transmitted to the pass-through entity by Letter 921. A copy will be provided to the POA as required. This letter informs the responsible person in the entity that the investors will receive a 30-day letter reflecting their share of the adjustments made at the entity level. Only the investors will be able to request a hearing with Appeals because there is no "deficiency" at the entity level.

  2. The examiner will discuss any proposed adjustment(s) with a responsible individual for the entity at the conclusion of the examination. This provides an opportunity to secure from the responsible person at the entity level an agreement with respect to the treatment of any key case adjustments. The examination report will contain a complete explanation of adjustments including any penalty items.

  3. The responsible individual should sign in the space provided on Form 4605, Examination Changes-Partnerships, Fiduciaries, S Corporations, and Interest Charge Domestic International Sales Corporations. While the Form 4605 is not binding, the fact that a responsible person at the entity level has agreed to the adjustments may help secure agreements from investors.

  4. The examiner will prepare a Form 6657 indicating agreed or unagreed (at entity level). The Form 6657 and a copy of the entity report must be associated with any investor files that are not under their control.

  5. Whether a responsible person at the entity level agrees or does not agree, the examiner must still solicit agreements from investors under their control. A Letter 950, 30-Day Letter, will be used to propose adjustments to each of the investors.

  6. If an investor does not agree to the proposed key case adjustments and files a protest, both the key case and generally one protesting investor return will be sent to the Appeals Office for the area/territory that examined the key case return. The campus will forward the perfected protest to Appeals within 15 days. Appeals requires at least one year remaining on the statutes of the investor returns. The examiner should allow at least an additional 30 days of processing time for the returns to reach Appeals. See Appeals IRM 8.19.9.2.1.2, Protest.

    Note:

    If a ILSC key case is unagreed, not linked, and has more than five investors, Appeals will not accept all the investors returns. Appeals will accept protesting investors with different representatives, protesting investors without representation and protesting investors with unagreed non-pass-through issues. The key case examiner must either link the key case on PCS or hold the investor returns until the key case entity issues are resolved in Appeals.

  7. When no investors file a protest to the 30-day letter or when the statute does not allow time for the 30-day letter, a notice of deficiency is issued.

  8. When all investor cases are agreed, the key case and investor returns will be closed to CCP. There is no special handling needed in TS.

Key Cases With Investors Linked on PCS

  1. Except for the closure of the key case, key cases with PCS linkages are worked in the same manner as those without linkages. There is no difference in the reports or cover letters issued to the entity. The reports issued to any investors under the examiner’s control are also the same. The main difference is that the key case must be closed to Technical Services for special handling. This is true even when an in-area investor has requested an Appeals hearing. The examiner will check the TEFRA or non-TEFRA Key Case box on the Form 3198, Special Handling Notice. In the Technical Services the case will be assigned to the TEFRA/Pass-Through Coordinator for a procedural review before closing the case to the CPF responsible for servicing the examiner's operating division.

    Note:

    The ILSC key case will be closed to the appropriate CCP. While Brookhaven is processing their remaining LB&I ILSC investors, the Ogden CPF will suspense ILSC LB&I key cases until full closure. Ogden will forward the closing package on to Brookhaven to process the investors they control.

  2. Adjustments to the pass-through items from the key case entity should be proposed in the examinations of the income tax returns of all investors open in the area. A copy of the key case Revenue Agents Report (RAR) must be included in the investor files. If any of the investors do not agree, the procedures in IRM 4.10.8, Examination of Returns, should be followed.

  3. For all closures the key case examiner should prepare a single Form 6657, and place a copy in the key case file.

  4. There are additional actions that must be taken if the key case examiner has control of any of the investors and the key case is linked.

    1. The examiner will close the investor returns following normal procedures but because of the PCS linkage on the investor (PICF 6) they must initiate a change to the PCS to allow the investor to close. Unagreed investors will not require this action.

    2. The examiner will prepare a Form 8339, PCS Change, for each investor for which it has jurisdiction. The Form 8339 will be included in the investor case file on top of the Form 5344. More than one Form 8339 may need to be prepared if the assessment is the result of adjustment of more than one key case. The Form(s) 8339 will be input before attempting to close the case at the terminal. Box 11, Change(s), will be completed with item number 05, investor one-year assessment statute date field. The entry will be, for a no-change, 22222222$NCT (time in tenths of an hour). For a change/ no-change, it will be 22222222$CNCT). For a deficiency, it will be 22222222$ (enter whole dollars) T. For an overassessment, it will be 22222222$ (enter whole dollars)-T. As an example, a deficiency in the amount of $3,400.00 with 4 hours of time on the pass-through portion of the case would require an entry of 22222222$3400T4.0. AIMS will not allow the investor case to close until the preceding is entered.

      Note:

      The PCS will not allow anything other than 22222222 to be entered in the one year date field. An attempt to enter a real date will result in an error message.

    3. The examiner must also answer yes to the question "TSCLS?" when completing the Form 5344 on RGS. If completed manually, check the TSCLS box in the upper left-hand corner.

  5. When they have received the closed key case from the area Technical Services, the CPF will send the appropriate letters and reports to linked investors in their jurisdiction and will prepare any additional Form 6657 that may be needed to make other offices aware of the pass-through entity results.

CPF Actions After Receipt of Form 6657

  1. The key case CPF will receive the examiner's key case administrative file and one Form 6657, Related Returns Examination Report, properly completed along with a complete copy of the entire examination report when the examination of the key case is completed. In lieu of listing all investors on the Form 6657, a TSUMYP print of the key case may be attached to the form and included with the copy of the report.

    1. The Form 6657 will reflect the closing status (agreed, no-change, unagreed) of the pass-through entity.

    2. The examination report and the Form 6657 should be reproduced and a copy associated with each investor case file.

  2. For agreed or no-change key case examinations, the results (if any) will be included in the investor examination report. No feedback to the key case area is required. If any of the investors do not agree, the procedures in IRM 4.10.8, Examination of Returns, Report Writing will be followed.

  3. For unagreed key case examinations, the Form 6657 will provide guidance for issuing the appropriate letter. The investor area or the investor CPF should take the action indicated as soon as the status of the investor case permits. Adjustments will be proposed to each investor. If any of the investors do not agree, the procedures in IRM 4.10.8, Examination of Returns, Report Writing, will be followed.

Field ILSC Investor Procedures

  1. Field examiners (RAs and TCOs) other than the key case examiner will in some cases be responsible for applying the results of the key case examination. He/she may have been assigned the case before the ILSC entity examination was initiated or received it because it was classified and sent to the field by the CPF after linkage.

  2. If linked on PCS, a Form 5546, Examination Return Charge-Out, should be received labeled "Flow Through Notification" . If classified by the CPF the Form 5546 will be in the file when assigned.

  3. When not linked, a Form 6658, Notice of Special Investor Action, should be received from the key case examiner. The investor examiner should find an attached Schedule K-1 print for the investor.

  4. If the investor examiner has completed the non-pass-through issues and has not received the results of the entity examination, he/she may contact the campus or key case agent depending on whether the case is linked or not.

Processing ILSC Pass-Through Adjustments

  1. The procedures below can be completed with or without the resolution or completion of any TEFRA or BBA issues.

  2. All issues, other than key case issues, should be completed for the investor's return. If the proposed adjustments from the key case examiner are received while the investor's return is still under examination, the adjustments will be incorporated into the report.

  3. Upon receipt of the proposed adjustments from the key case examiner, the CPF will forward the proposed adjustments to the examination group to prepare an examination report if the investor's case is in the field controlled by other than the key case examiner.

  4. If the examination of all other issues is completed prior to the completion of the key case examination, a partial agreement should be obtained for the resolved items using forms prescribed by IRM 4.10.8, Examination of Returns, Report Writing.

    • For RAs, a statement is inserted in the "Other Information" section of the Form 4549, Income Tax Examination Changes, stating that the items contained in the Form 4549 do not include adjustments attributed to the examination of the related key case and that the related adjustments, if any, will be proposed upon completion of the key case examination.

    • For Tax Compliance Officers/Tax Auditors, a similar statement will be on the Form 886-A (Explanation of Items) or the Form 3547, Explanation of Adjustments, and attached to the Form 1902-B, Report of Individual Income Tax Examination Changes.

    Note:

    For all such cases, the examiner will process the partial agreement. Form 3198, Special Handling Notice, is attached to the front of the case file. The "Other" block under the Forward to Technical Services section will be checked. After "Other" the following statement will be made: Partial Agreement. After the assessment is made, the case(s) will be suspensed until the completion of the related key case examination. These cases will be forwarded to TS and updated to status code 21.

  5. Investor returns that are joint committee, CIC corporations, or other corporate specialty cases (Form 1120 with letters after the 1120 other than A, S, or X) are suspended in the field by the examination group charged with the return. The investor return will be suspended in the examination group that has control of that return for that year after the group has had all other ILSC adjustments processed. If the return was never examined (i.e. surveyed), prior to being linked to a ILSC key case, the return will be suspended with the examination group that would have examined the return had it been examined. The return will not be suspended in PSP and under no circumstances will the return be suspended in the CPF. If they are held in the examination group, the case(s) will be updated to status 14.

  6. For unagreed cases, reports are prepared as prescribed by IRM 4.10.8, Examination of Returns. Form 3198 will be attached to the front of the case file. The "Other" block under the Forward to Technical Services section will be checked and the following statement made: "Unagreed Suspense Case with Unresolved Pass-through Entity Issue - forward to CPF (or the examination group)." (See IRM 4.31.5.12.1, Processing ILSC Pass-Through Adjustments.) Normally, no Appeals action will be taken on any items until the resolution of the pass-through entity items.

  7. For no-change cases, Form 3198 is attached to the front of the case file. The "Other" block under the Forward to Technical Services section is checked and the following statement made: "Suspense Case with Unresolved Pass-through Entity Issue - Forward to CPF (or the examination group)." (See IRM 4.31.5.12.1, Processing ILSC Pass-Through Adjustments.)

  8. After the examination of other issues is completed and assessment of the agreed portion, if any, is made, the return is placed in suspense by the CPF pending receipt of the proposed adjustments from the key case examiner.

  9. Statute control for ILSC issues is the primary responsibility of the area that has control of the investor return. If less than 210 days are left on the statute the examiner should solicit an appropriate extension before closing to the CPF. If the examiner is unable to secure an extension, they should ask their Technical Services Pass-Through Coordinator how to proceed.

  10. Any return that the area does not choose to examine should be "Surveyed" and closed through Technical Services. The agent will need to attach Form 3198 to the front of the case file. The Other block in the Forward to Technical Services section is checked and the following statement made: Surveyed Suspense Case with unresolved Pass-through Entity Issue - Forward to CPF. Technical Services will forward to CCP. The CCP will update AIMS to Status Code 33, EGC 5417, and send the return to the CPF via Form 3210. The CPF will acknowledge the Form 3210 within three days of receipt.

    Note:

    If the surveyed return meets the criteria in IRM 4.31.5.12.1, Processing ILSC Pass-Through Adjustments, the return will not be forwarded to the CPF but will remain in the examination group instead.

Special Computation for Non-Oversheltered Returns (Munro Decision)
  1. In Munro v. Commissioner, 92 T.C. 71 (1989), the Court held that the partnership items (whether income, loss, deduction or credits) included on a taxpayer's return should be completely ignored in determining whether a deficiency exists that is attributable to nonpartnership items. Moreover, the Court ruled that the Service may not assume the correctness of its proposed adjustments to partnership items for computational purposes in determining a deficiency, and taxpayers may not offset net partnership losses against their taxable income for purposes of deficiency proceedings.

  2. Non-oversheltered returns (and oversheltered returns related to partnership returns with tax years ending before August 6, 1997) are returns that will have a taxable amount owing after the proposed adjustments (for other than partnership items).

  3. For non-oversheltered returns, Munro computations will continue to be used.

    1. When adjusting a taxpayers return for ILSC pass-through issues and the Form 4549 results in a reduced deficiency because of large TEFRA partnership losses, the examiner will prepare a report without consideration of any TEFRA partnership income or losses.

    2. Prepare a report starting with the original return, or as amended, and remove all TEFRA issues from open TEFRA proceedings. This will establish adjusted "per return" figures without taking the TEFRA losses into consideration. Label this report as: "Information Only – Do Not Process" . Using this report as the starting point, prepare a report making the ILSC pass-through adjustment.

    3. The result is that the taxpayer may be assessed at a higher tax rate by removing the TEFRA losses. If the taxpayer is already filing at the highest tax rate, there is no reason to prepare this computation.

  4. When there is an open TEFRA proceeding, the following paragraph should be used on the statutory notice of deficiency:

    1. In computing the deficiency attributable to the adjustments in this notice, which adjustments are neither partnership items nor affected items, as defined by IRC 6231, all TEFRA partnership items subject to an open TEFRA proceeding, whether income, loss, deduction or credits have been ignored exclusively for the purpose of computing the deficiency which is attributable to the adjustments set forth herein. All TEFRA partnership items subject to an open TEFRA proceeding have been ignored in this notice of deficiency for computational purposes only and this notice is not a substitute for any Notices of Final Partnership Administrative Adjustment (FPAA) which may be issued in regard to the TEFRA partnerships. This computation is being made pursuant to the Tax Court decision in Munro v. Commissioner, 92 T.C. 71 (1989).

  5. The following sample paragraph should be included in the explanation of items:

    1. The following TEFRA partnerships are subject to partnership level proceedings pursuant to the partnership audit and litigation procedures of IRC 6221 through IRC 6234 with respect to the taxable year(s) and accordingly, all partnership items, whether income, loss, deductions or credits, have been disregarded for purposes of computing a deficiency attributable to the adjustments in this notice:

      ABC Partnership $(30,000.00)
      XYZ Partnership (7,000.00)
      HIJ Partnership (27,700.00)
      Total $(64,7000.00)
  6. A Munro computation may result in an inflated deficiency due to a change in tax bracket until treatment of the TEFRA items is finally determined.

Requesting Investor Returns From the CPF

  1. When an examiner determines that a linked (PICF code 6) investor's return is needed to complete an examination due to basis, passive activity, at-risk or other investor level issue, he/she may request it from the controlling campus CPF. The controlling CPF can be found using CC TSINQP which displays the CPF Indicator.

    1. Order IDRS CC TSINQP on each year of the key case

    2. Look in the CPF field for either OSC (Ogden) or BSC (Brookhaven)

    3. If the TSINQP shows OSC, then Ogden is the key case Campus

    4. If the TSINQP shows Brookhaven, then order IDRS CC TXMODC on the TEFRA key case; if there is no data, then Ogden is the key case Campus; if there is data, look in the "Control Base and History Information" section; if the "Assign To" column has numbers that begin with 01, then Brookhaven is the key case Campus; if there are no numbers in the "Assign To" column, then Ogden is the key case Campus.

  2. Both of the CPF's will establish a liaison to respond to area requests for tax returns. The name, address, and telephone number of the CPF PCS/AIMS Coordinator is posted on the TEFRA web site under the TEFRA/PCS Coord. Locator tab. The examiner should consult the TEFRA web site for this information.

  3. The CPF will send the entire investor file to the requestor via a Form 3210. The requestor will acknowledge the Form 3210 within three days of receipt. If the individual who would normally acknowledge the Form 3210 is unavailable, the manager will ensure the Form 3210 will be acknowledged by another employee (or himself/herself) within that three day period. The CPF will ensure that the AIMS data base has been updated to reflect the requesting area's status, PBC, Secondary Business Code (SBC) and EGC, and the correct statute date.

Miscellaneous

  1. This section covers other areas that may be a concern during an examination.

Items Requiring Key Case and Investor Level Determinations

  1. The key case examiner may need to examine both the entity and investors for some issues such as passive loss, at-risk, and basis issues. Determinations at the key case level and the investor level are required to develop the issue factually. Unlike TEFRA, adjustments are made as part of the same report to the investor.

  2. Pass-through level components for basis:

    1. Amount of the initial capital contribution to the pass-through.

    2. Amount of each distribution from the pass-through.

    3. Amount of all subsequent capital contributions to the pass-through.

    4. Amount of investor's share of taxable income, non-taxable income, losses and deductions.

    5. Amount of liabilities used to secure or improve an asset at the pass-through level.

  3. A partner level component for basis is: "Did the partner buy his interest from another partner without the partnership making a IRC 754 election?" In this situation the partnership does not have to know the purchase price because the partnership cannot adjust the basis of partnership without IRC 754 election in effect for the taxable year. In addition, the partnership does not have to take the purchase price into account for its taxable year.

  4. An at-risk issue requires certain determinations at the key case level. In situations where loans or notes appear on the books of an entity, it must be determined in the entity level examination whether the loans or notes are recourse or nonrecourse to the entity. In determining the amount for which a partner is at-risk, several items must be addressed, including situations where:

    1. The loans or notes appear to be recourse, but the pass-through is protected from loss.

    2. The loans or notes are nonrecourse in substance.

    3. The loans or notes are nonrecourse.

    4. The investors cannot use their proportionate share of income, gain, loss, deduction, or credit from the pass-through in determining their at-risk amount for deducting losses.

    Note:

    Not all nonrecourse notes or loans follow the general rule that the investors can use their proportionate share in determining their at-risk amount for deducting losses.

  5. Pass-through level components for at-risk are:

    1. Was a particular loan or note recourse or nonrecourse?

    2. What was the amount of the loan or note?

    3. Whether a partner is a limited or a general partner.

    4. Whether the lender has an interest other than as a creditor.

  6. Investor level components for at-risk are:

    1. Are there third party side agreements (guarantees, stop-loss or assumption agreements)?

    2. Did a partner contribute money borrowed from another partner to the partnership?

    3. Did an investor bear the ultimate economic risk of loss with respect to a particular pass-through liability?

    Note:

    In these situations the pass-through does not have to know, nor does it have to take into account for its taxable year, any of these components because these are investor level components.

  7. A passive activity loss issue requires certain determinations at the entity and investor level as to type(s) of activity.

  8. Pass-through level components for passive loss are:

    1. Whether the pass-through is engaged in a rental activity.

    2. Whether the pass-through is engaged in a trade or business for purposes of IRC 162.

    3. Whether a partner is a limited or a general partner.

    4. Whether income is portfolio income.

  9. An investor level determination for passive activity loss is: "Did the investor materially participate in the business?" In this situation the pass-through may know if the investor materially participates.

Conversion of S Corporation to C Corporation

  1. When a Form 1120S return is filed with an untimely election (Form 2553, Election by a Small Business Corporation), the return is treated as a C corporation. This includes when:

    1. no proper election was filed

    2. the election terminated because the corporation ceased to be a small business corporation (for example, due to an improper shareholder)

    3. in certain circumstances, the corporation has excessive passive investment income, or

    4. the election was revoked.

  2. If a valid election was not filed, the return needs to be reviewed to determine the amount taxable to the C corporation (if any), and provide the basis for an adjustment to the shareholders.

  3. If the campus receives a Form 1120S for which no Form 2553 is on file, and for which the taxpayer has not responded to queries from the campus, then the unprocessed Form 1120S will be processed as a Form 1120 by attaching a blank Form 1120 to the front of the Form 1120S. A TC 150 with an amount of "0" is generated.

  4. If the Form 1120S was processed as an S corporation return, but the examiner subsequently determines that it is a C corporation, the examiner will follow the procedures outlined in IRM 4.4, AIMS/Processing Handbook, and IRM 4.10.8, Examination of Returns, Report Writing. There will be two RAR's. One, using Form 4549 will show the taxable income and any tax due to the C corporation. The other will use Form 4605 and Form 886-X to remove items of income and separately stated items from the shareholder's returns.

  5. The filing of either a Form 1120 or Form 1120S (later determined to be invalid or if the Form 1120S is a taxable entity such as when the built-in gains tax applies), starts the running of the statue of limitations. Remember, Form 1120 (or Form 1120S) is due 21/1 months after the end of the tax year or March 15th for a calendar year return.

Fast Track Settlement or Fast Track Mediation

  1. Fast Track Settlement (FTS) is a service offered by the IRS designed to expedite case resolution. It involves an Appeals Officer who has been trained in mediation techniques acting as a mediator between the Taxpayer and Compliance (Examination/Collection). The purpose is to facilitate communication and to help the parties resolve the issue(s). This service is available for unagreed issues on ILSC key cases and should be considered by the examiner before reports are issued to investors. At the conclusion of an examination/collection determination, if the Taxpayer does not agree to the proposed changes, the examiner will determine whether the case qualifies for FTS using the case criteria set forth in FTS Eligibility. If the case qualifies for FTS, the examiner should offer and explain the benefits of utilizing FTS. If the case does not qualify for FTS, standard procedures for unagreed cases should be followed.

IRC 7602 (c), Third Party Contacts

  1. For ILSC partnerships or S corporations, reasonable advance notice is provided (by issuing any one of Letters 3164 A through 3164 V), as appropriate, to the entity when the examination is being conducted at the entity level. When the examination of the entity is being made as part of the examination of a particular partner/member or shareholder's return, a Letter 3164 should be issued to both the entity and the particular investor. If an entity level examination is being conducted, contacts with the partners/members or shareholders of the entity are not considered IRC 7602(c) contacts. On the other hand, if the examination of the entity is being done as part of the examination of a particular partner or shareholder's return, then contact with any other partner or shareholder (other than the partner or shareholder under exam) should be treated as a third party contact.

    Note:

    Letter 3164 E(DO), Letter 3164 F(DO), and/or Letter 3164 G(DO) will most likely be the ones used for investor cases.

IRC 6404(g), Suspension of Interest and Certain Penalties

  1. The notice date for the purposes of IRC 6404(g) is the date adequate notice is mailed or provided to the individual investor. For ILSC pass-through purposes, it is not the date a report is given to the entity. All other IRC 6404(g) rules apply.

  2. In the case of an individual who files a return on or before the due date for the return (including extensions), the Service has a 36-month period (18 months effective for tax years where the 18 month period ended on or before November 25, 2007) beginning on the later of:

    1. the date on which the return is filed; or

    2. the due date of the return without regard to extensions,

    in which to provide notice to the taxpayer specifically stating the taxpayer's liability.

  3. If notice is not provided to the taxpayer before the close of the 36-month period, then any imposition of interest, penalty, additions to tax or additional amounts that are calculated in reference to the 36 month time frame (18 months effective for tax years whose 18 months end on or before November 25, 2007.) are suspended.

    Note:

    If, as of November 25, 2007, the 18 month period has closed and the Service has not provided notice to the taxpayer, interest and applicable penalties will be suspended beginning on the day after the close of the 18 month period and ending on the date that is 21 days after the notice is provided. In all other cases, interest and applicable penalties will be suspended beginning on the day after the close of the 36 month period and ending on the date that is 21 days after the notice is provided.

  4. The exceptions to the 36 month (18 months effective for tax years where the 18 month period ended on or before November 25, 2007.) notice requirement are:

    1. any penalty imposed by IRC 6651;

    2. any interest, penalty, addition to tax, or additional amount in a case involving fraud;

    3. any interest, penalty, addition to tax, or additional amount with respect to any tax liability shown on the return;

    4. any interest, penalty, addition to tax, or additional amounts with respect to any gross misstatement;

    5. any interest, penalty, additions to tax or additional amounts with respect to any reportable transactions with respect to which the requirement of IRC 6664(d)(2)(4) is not met and any listed transaction (as defined in IRC 6707A(c)); or

    6. any criminal penalty.

  5. The term suspension periods means the period:

    1. beginning on the day after the close of the 36-month period under (1) above and

    2. ending the date which is 21 days after the date on which notice is provided to the taxpayer.

Preparer Penalties

  1. Under Treas. Reg. 301.7701-15(b)(3), a preparer of the key case entity return is considered a preparer of the investor's return if the "pass-through" share of income, credits, deductions, etc. from the key case entity reportable on the investor's return constitutes a "substantial" portion of the investor's return.

    Note:

    For purposes of this section, whether an entry, schedule, or other portion of an investor's return is "substantial" depends on its length, complexity, and the associated tax liability, relative to the return as a whole. A single entry, schedule, or other portion involving amounts of gross income, deduction or basis for computing a credit that is either (i) less than $10,000, or (ii) less than $400,000 and also less than 20% of gross income (or AGI for an individual), shall not, by itself, be "substantial" . If there are several entries, schedules, or other portions, the preceding amounts (and percentage) are applied to the aggregate. See Treas. Reg. 301.7701-15(b)(ii)(3)(A) and (B).

  2. In those situations where a preparer penalty under IRC 6694(a) or IRC 6694(b) may be warranted:

    1. The key case area will alert the investor area or CPF by placing a comment on line 5 of Form 6657, stating that a penalty is being considered;

    2. The investor area or CPF should complete their examination; and

    3. Send a memorandum to the key area with a copy of the RAR, and copies of pertinent sections of the investor's income tax return. This allows the key area to decide whether the pass-through items from the key case entity are, in fact, a substantial part of the investor's return, and whether a penalty should be applied.

Technical Services Pass-Through Coordinator Duties for ILSC Entities

  1. The following subsections cover the duties of the Technical Services Pass-Through Coordinator.

General Responsibilities

  1. The Technical Services Pass-Through Coordinator is the main contact for LB&I and SB/SE field agents and managers to explain and clarify the ILSC audit procedures for linked returns.

  2. The Technical Services Pass-Through Coordinator responsibilities include the following:

    1. Function as the liaison with the CPF functions for PCS linkage and any related linkage problems if requested by the PCS coordinator;

    2. Verifying that the CIC group timely writes the RAR and requests removal of PCS controls and input of the Form 8339 for linked CIC investors;

    3. Coordinate with Counsel on key case technical questions involving TEFRA vs. ILSC issues;

    4. Give advice on the preparation and signing of statute extensions;

    5. Provide on site case visitations/consultations for key cases with procedural problems as necessary;

    6. Complete a procedural review of closed ILSC key case entities and related investors;

    7. Forward closing ILSC key case packages to the CPF; and

    8. Forward PCS reports to examination groups within the area.

Key Case Closure Procedures

  1. Upon receipt in Technical Services of an ILSC key case closed from a group, the Technical Services Pass-Through Coordinator should review the following areas of the case file:

    1. Proper determination as nonTEFRA? See IRM 4.31.5.4, Identification of ILSC Key Case Returns.

    2. If attached, is the Power of Attorney (POA) completed correctly? Two areas of the Form 2848 need to be reviewed. For a Form 1065: Item #3 - Type of Tax - Partnership Proceeding , Tax Form Number - 1065 and Consequential Adjustments. Item #9 - The signature block should be signed by a responsible person including their title, such as general partner. For a Form 1120S: Item #3 - Type of Tax - Income, Tax Form Number - 1120S and Consequential Adjustments. Item #9 - The signature block should be signed by a responsible person including their title. Any corporate officer that can bind the corporation under State law may sign.

    3. Statute Extensions - If statute extensions are part of the package, review any investor consents to determine if they have been prepared and signed correctly. If there are any errors, and the normal statute is still open, a new consent will be secured. If the normal statue is gone, consult with local Counsel on the validity of the consent. An S corporation can need the IRC 6501 statute protected when corporate level tax issues under IRC 1374, IRC 1375, or IRC 55 are to be raised. The agent would solicit a regular, unrestricted Form 872.

    4. The examiner's RAR will be reviewed for required content and accuracy. The Technical Services TEFRA/Pass-Through Coordinator will ensure that all forms required for a ILSC examination are included. If any required items are missing or incorrect, the package may be returned to the originating office or the reviewer may invite the examining agent to appear at the Technical Services office to complete or correct the case there. Minor errors may be corrected by the coordinator.

    5. The Technical Services TEFRA/Pass-Through Coordinator will review the PCS linkage using TSUMY to see that it is complete and correct.

    6. Form 8339 will be prepared and submitted to CCP for any agreed or no-changed field controlled investors in the package.

    7. The coordinator will close all PCS linked key cases through CCP to the SB/SE or LB&I CPF for completion of the investor returns.

    8. When the coordinator has determined that the package is procedurally correct, the administrative file will be closed to the proper CPF. The Form 3198 will be noted to request for SB/SE cases, disposal code 30, and updates to PBC 295 and EGC 5417 (Brookhaven) or for LB&I cases, disposal code 30, and updates to PBC 398 and EGC 5417 (Ogden).

      Note:

      The ILSC key case will be closed to the appropriate CCP. While Brookhaven is processing their remaining LB&I related ILSC investors, the Ogden CPF will still suspense ILSC LB&I key cases until full closure. Ogden will forward the closing package on to Brookhaven to process their remaining investors.

    9. Prepare Form 8339 for the key case, with completion of item 8, pass-through adjustment amount. The amount to enter as the adjustment amount will vary. As a rule, all adjustments should be combined to arrive at one net adjustment. Adjustments to credits will be divided by 30% (credit amount / 30% = credit adjustment amount). This will allow credits and ordinary income/expense adjustments to be combined without skewing the results due to the credits.