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TAX NEWS - January 2010

FPAA proposing adjustments "directly attributable" to flow-through items considered timely

Recently, a U.S. District Court held that a Final Partnership Administrative Adjustment (FPAA) was not time barred because the adjustments were directly attributable to flow-through items of the partnership whose partners' returns were subject to an extension agreement. Candyce Martin 1999 Irrevocable Trust v. U.S., 2009 U.S. Dist. LEXIS 115456 (N.D. CA 12/11/09).


This case involved a three-tier entity structure composed of trusts and limited liability companies (LLCs). The Martin family established fourteen trusts (the "Martin Family Trusts"), which are the first-tier entities. The trusts subsequently created First Ship, a second-tier LLC, and 2000-A, a third-tier LLC. First Ship was subject to the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), which simplifies the treatment of partnership items via a single partnership-level audit and litigation procedure, the results of which are binding on all partners. Both First Ship and 2000-A timely filed their 2000 federal income tax returns on March 22, 2001. As a result of 2000-A's liquidation on December 28, 2000, First Ship reported a loss of $318,018,377 on Schedule D of its federal income tax return.

Statute of limitations on assessment

Generally, the statute of limitations on assessment expires either three years from the date the partnership filed its return under IRC Section 6229(a) or three years from the date the partners filed their returns under Section 6501(a). The IRS and a taxpayer, however, may agree to extend the statute of limitations. In this case, the Martin Family Trusts and the individual Martin family members agreed to extend the statute of limitations by executing an extension agreement, Form 872-I, Consent to Extend the Time to Assess Tax as Well as Tax Attributable to Items of a Partnership. The extension agreement stated that it was limited to "…any adjustment directly or indirectly (through one or more intermediate entities) attributable to partnership flow-through items of First Ship..." and extended the statutory period to June 30, 2008.

Adjustments "directly attributable" to flow-through items

On June 19, 2008, the IRS issued an FPAA to 2000-A for the 2000 tax year, with a determination that certain items on that return should be disallowed, reversed, or abated. The taxpayer argued that the FPAA was barred by the statute of limitations, because the extension agreements extended the statute of limitations solely for First Ship, and not for 2000-A.

The IRS took the position that the proposed adjustments in the FPAA issued to 2000-A are "directly attributable" to items reported on First Ship's tax returns and thus covered by the extension agreements.

The Court found that the FPAA attempted to adjust liabilities claimed by 2000-A, which resulted in the losses claimed by First Ship on its return. Based on the fact that First Ship reported losses as a result of 2000-A's liabilities, the Court concluded that the FPAA issued to 2000-A involved an adjustment "directly attributable" to flow-through items of First Ship.

The Court further explained that if the extension agreement specifically included 2000-A, the scope of the agreement would have been much broader and would allow the IRS to propose adjustments to any item reported by 2000-A, instead of only items directly attributable to First Ship.


The Court held that the FPAA was not time barred because the adjustment proposed by the IRS in the FPAA issued to 2000-A was directly attributable to flow-through items of First Ship, the entity whose flow-through items were specifically included in the restricted consents executed by its direct and indirect partners. This case demonstrates that extension agreements for a partnership subject to the TEFRA provisions signed by some of the partners, both direct and indirect, allow the IRS to issue an FPAA to a flow-through entity, which may affect some partners, but not others, depending on their respective individual limitations periods.
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