Accessibility Skip to Top Navigation Skip to Main Content Home  |  Change Text Size  |  Contact IRS  |  About IRS  |  Site Map  |  Español  |  Help  

Part 4. Examining Process

Chapter 31. Pass-Through Entity Handbook

Section 1. Introduction

4.31.1  Introduction

This Handbook will explain the procedures for conducting a coordinated pass through examination from both the field and campus perspective. The Handbook is broken down into sections to allow the user to more easily find answers to questions. Check sheets are provided as a job aid, and to ensure consistency is maintained.

4.31.1.1  (06-01-2004)
Overview

  1. The examiner of a pass-through entity must understand the different types of entities, and how they are examined.

  2. The key case examiner must also know how the tax returns of the related investors are eventually adjusted.

4.31.1.2  (08-01-2006)
Terminology

  1. The terminology used in these sections to describe certain returns is provided below:

    1. Key Case - A pass-through return, usually a Form 1065, U. S. Return of Partnership Income, a Form 1120S, U. S. Income Tax Return for an S Corporation, a Form 1041, U. S. Income Tax Return for Estates and Trusts, or other entity (an agency or promoter examination) that results in pass-through items to partners, shareholders, or investors (individual returns or another pass-through entity).

    2. Tier - A pass-through entity that passes through items for partners, shareholders, or beneficiaries that is itself a partner, a shareholder, or a beneficiary of a pass-through entity. This return appears on the PCS database as a key case record (PS) and an investor record (PN).

    3. 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). The investor return is usually a Form 1040, U.S. Individual Income Tax Return.

    4. AAR - Administrative Adjustment Request - Notification to the IRS of any subsequent change by a TMP or partner, of the treatment of a partnership item. The AAR is filed on Form 8082, Notice of Inconsistent Treatment or Administrative Adjustment Request (AAR), and is filed with a claim for refund, an amended return, or a substitute for return. AAR procedures are in IRM 4.31.4.

    5. 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.

    6. FPAA - Notice of Final Partnership Administrative Adjustment - The statutory notice of adjustments (as distinguished from a statutory notice of deficiency) in a partnership proceeding that is subject to judicial review in the Tax Court, the Court of Federal Claims, or the district court where the partnerships principle place of business is located. Only partnership adjustments are identified. For partnership tax years ending after August 5, 1997, an FPAA may also include penalties that are determined at the partnership level.

    7. NBAP - Notice of Beginning of Administrative Proceeding - The required notice sent at the start of an examination of a TEFRA partnership to the TMP, and the copies of that letter sent to each notice partner.

    8. TMP - Tax Matters Partner - The designated partner to whom the Service looks as the primary representative of the partnership that is subject to a TEFRA proceeding.

    9. 60-Day Letter Package - Contains the letter sent to the TMP and notice partners proposing adjustments to partnership items, notifying them of their right to file a protest to Appeals, the schedule of adjustments, and a Form 870-PT or a Form 870-LT. (Form 870-P and Form 870-L are used for partnership tax years ending before August 6, 1997.)

    10. Campus TEFRA Function (CTF; formerly ESU) - The CTF is the suspense unit for investor returns located in the Brookhaven and Ogden campuses. The two CTFs will be maintained to obtain and control, through the AIMS and Partnership Control System (PCS), any partner, shareholder or investor returns related to key cases within their jurisdiction. For details see Campus TEFRA Function (CTF) IRM Sections 4.31.3 and 4.31.6

    11. Technical Services (TS) - This is the former review staff, QMS.

    12. Field TEFRA Coordinator - The TEFRA coordinator in the TS acts as a liaison between the area and the CTF's for both TEFRA and nonTEFRA cases for their SB/SE area and LMSB in the geographical area.

    13. Centralized Case Processing (CCP) - This function processes assessments and abatements and closes or transfers cases from the area to the campus or to files.

    14. Centralized Workload Selection & Delivery (CWSD) - This is the former PSP.

  2. The terminology used in these sections to describe certain agreements or settlement agreements is provided below:

    1. Form 870-PT, Agreement for Partnership Items and Partnership Level Determinations as to Penalties, Additions to Tax, and Additional Amounts. This agreement form allows the partner to agree to adjustments proposed to partnership items. Penalties are determined at the partnership level for partnership years ending after 8/5/1997. (See IRC section 6221.) Use this agreement form if only proposing adjustments to partnership items and partnership level penalties, but not to affected items.

    2. Form 870-LT, Agreement for Partnership Items and Partnership Level Determinations as to Penalties, Additions to Tax, and Additional Amounts and Agreement for Affected Items. This form permits the partner to agree to both partnership adjustments and affected items or only partnership adjustments.

    3. Form 870-PT(AD), Settlement Agreement for Partnership Items and Partnership Level Determinations as to Penalties, Additions to Tax, and Additional Amounts. This is the appeals version of the Form 870-PT.

    4. Form 870-LT(AD), Settlement Agreement for Partnership Items and Partnership Level Determinations as to Penalties, Additions to Tax, and Additional Amounts and Agreement for Affected Items. This is the appeals version of the Form 870-LT.

      Note:

      For partnership tax years ending before August 6, 1997, other settlement agreement forms are required to be used. These are the Forms 870-P, 870-L, 870-P(AD) and the 870-L(AD). If more information is needed on when to use these forms, contact your local TEFRA Coordinator.

  3. Signing an agreement or settlement agreement:

    1. Allows the TMP or any notice partner to agree with the treatment in the investor's return of the examination (or settlement) results of the key case.

    2. Removes the investor from any further partnership proceeding.

    3. The TMP or notice partner will be agreeing to all proposed adjustments unless partial agreement language has been included on the settlement agreement form signed.

    4. No subsequent claim may be filed.

    5. The TMP can also agree for non-notice partners (partners holding less than a one percent profits interest in a partnership with more than 100 partners) if the Form 870-PT is modified to specifically state that the TMP is binding non-notice partners.

    6. All notice partners must sign their own separate agreements.

    7. A settlement by a pass-through partner binds indirect partners to adjustments to partnership items and partnership level penalties, but not to affected items.

    8. Non-notice partners may elect NOT to be covered by an agreement that may be entered into by the TMP, where the Form 870-PT may be modified to allow the TMP to agree for the non-notice partners. This election is made by filing a statement with the Service denying the TMP the right to enter into such a settlement.

    9. The TMP cannot agree to affected item adjustments requiring deficiency proceedings for non-notice partners. Similarly, a pass-through partner cannot bind indirect partners to affected items.

      Note:

      All settlement agreements signed by a taxpayer must be properly executed by the Service before an agreement is binding.

  4. Guidelines in these sections address the handling of suspensed related returns by either a field office or the CTF.

4.31.1.3  (05-31-2005)
PCS Overview

  1. The PCS is a computer system designed to control and monitor pass-through entity 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 and meet the legal requirements of TEFRA. The PCS is described in depth in IRM 4.29, the Partnership Control System (PCS) Handbook including information on special features, the various user reports, letters, input documents, and indicators. IRM 2.2 covers information related to the specific command codes.

4.31.1.4  (02-15-2008)
TEFRA

  1. Before TEFRA was enacted in 1982, partnership items appearing on individual and corporate taxpayer returns were determined by individual audits and notices of deficiency which included both partnership and nonpartnership items. Thus, multiple partners in the same partnership would be adjusted through separate proceedings unique to each partner.

    Statutory Notice - Partner A
    Statutory Notice - Partner B
    Statutory Notice - Partner C

    Each notice suspended only the period for assessment for one partner and began a petition period for only that partner. Alternatively, the partner could allow the notice of deficiency to default, pay the tax, and file a claim/suit for refund. Inconsistent results were possible.

  2. The Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) changed the way the Internal Revenue Service conducts the examinations of those entities to which the TEFRA sections of the Internal Revenue Code apply. Along with the changes to the examination process, specific time frames and notice requirements were created. If these time frames and notice requirements are not properly adhered to, no assessments are allowable against any investor returns.

  3. After the enactment of the unified partnership audit and litigation procedures of IRC Sections 6221 through 6234 (TEFRA), one partnership audit, notice and judicial proceeding binds all partners:

    1. One Notice of Beginning of Administrative Proceeding (NBAP) is sent to the Tax Matters Partner (TMP) to signify the beginning of an audit. Notice partners are sent copies.

    2. One Notice of Final Partnership Administrative Adjustment (FPAA) is sent to the Tax Matters Partner (TMP) informing him/her of the Service’s adjustment to partnership items. Notice partners are sent copies, if their partnership items have not converted to nonpartnership items.

    3. Only the FPAA notice to the TMP suspends the statute of limitations for all partners and begins the petition period for a unified judicial proceeding.

    4. Only one petition based on the FPAA to the TMP may be filed on behalf of all partners in either the Tax Court, District Court or Court of Federal Claims; duplicate petitions will be dismissed.

    5. If the TMP does not file a petition within the first 90 days after the FPAA was mailed, a petition may be filed within 60 days from the close of the 90 day period by any notice partner or 5 percent group.

    6. The single petition that goes forward will bind all remaining partners regardless of whether they participate or intervene. If no petition is filed, the defaulted FPAA will bind all partners remaining in the partnership proceedings.

    7. Once an FPAA is defaulted, no separate refund action is allowed. (IRC sections 6511(g) and 7422(h)) Thus, all adjustments that may result in a refund must be raised in a petition to the FPAA since this will be the sole opportunity to file a petition resulting in a refund.

    8. The Service computes the resulting assessments and refunds following the default of the FPAA or the final decision of the Tax Court. Petitions to District Court or the Court of Federal Claims are treated as defaulted FPAA’s for assessment and collection purposes in order to preserve the status of those forums as refund courts. (IRC section 6225.)

    9. Penalties are assessed using notice of deficiency procedures following the partnership proceeding. For partnership years ending after August 5, 1997, however, they may be determined at the partnership level and directly assessed following the partnership proceeding even if the amount they are computed on are affected items subject to deficiency procedures.

  4. The unified audit and litigation procedures (IRC sections 6221 - 6234) unified the procedures in three respects:

    1. All partners are governed by one administrative proceeding and one docketed proceeding (if applicable).

    2. All deficiencies and refunds are determined based on the single unified proceeding.

    3. IRC section 6229 sets forth a minimum assessment period for all partners running from the date the partnership return is filed or due to be filed, whichever is later.

  5. The existence of the Campus TEFRA Function (CTF) is to provide administrative assistance to the area offices. The CTF ensures the TEFRA requirements are met in accordance with the applicable sections of the Internal Revenue Code.

  6. If the examiner elects not to utilize the PCS and the CTF, then the examiner assumes all of the responsibilities of the CTF including administrative functions, issuances of all notices, the recognition of and the actions required within the proper time frames and the proper resolution of all of the related investor cases. The examiner must secure all of those returns for resolution. If an investor in a pass-through entity is itself another pass-through entity (a pass-through entity, also called a tier), then the examiner must also secure all investor returns of the pass-through entity. As long as this tiering situation exists, the examiner must continue to secure and control all of the related returns.

  7. If the examiner utilizes the CTF, substantially all of the burdens of administrative duties, time frames, notice requirements, investor examination report writing and tiering situations are shifted from the examiner to the CTF. The examiner is free to conduct the examination of the key case and the CTF will complete all of the required administrative functions. If the examiner wants to avoid the CTF initially, but then decides later to transfer responsibilities to the CTF, all of the actions that would have been completed by the CTF to that point must be completed by the examiner prior to any shifting of responsibilities. Anything less requires total and complete cooperation and approval between the area TEFRA Coordinator and the CTF TEFRA Coordinator.

4.31.1.5  (06-01-2004)
NonTEFRA

  1. If the examiner elects not to use the PCS and the CTF for a nonTEFRA case, the examiner assumes responsibility for substantially all of the same functions as for TEFRA cases. NonTEFRA cases do not have the same notice requirements or time frames, but the tiering, case control and report preparation requirements still exist for the examiner. With nonTEFRA cases, if the examiner does not utilize the CTF, the examiner assumes complete and total statute control for all related investors. Unlike TEFRA cases where the statute for all related investors is controlled at the key case level, the statute control for all related investors of a nonTEFRA case is controlled at the ultimate investor level. The examiner must secure all investor returns (including pass-through entities) and secure statute extensions for all entities required.

  2. If the examiner utilizes the CTF in the nonTEFRA examination, then substantially all of the burdens of case control, statute protection and tiering are shifted to the CTF. As in TEFRA examinations, if the examiner starts out controlling the case but decides later to shift much of the responsibilities to the CTF, the examiner must have completed all necessary actions the CTF would have completed up to that time. The requirements for shifting responsibilities for nonTEFRA cases are much more stringent than the requirements for TEFRA cases. Before any transfers can take place, it requires complete and total agreement and cooperation between the field NonTEFRA Coordinator and the campus NonTEFRA Coordinator

4.31.1.5.1  (06-01-2004)
Appeals Considerations

  1. 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.

  2. If a nonTEFRA key case is unagreed, the key case is not linked, and the case does not meet the criteria for sending multiple investor cases to Appeals, 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. IRM 4.31.6, NonTEFRA Examinations-CTF (formerly ESU) Procedures describes the statute requirements for linking cases. The CTF will make no exceptions.

4.31.1.6  (06-01-2004)
Responsibilities

  1. The following subsections contain the core responsibilities of each group. There may be other locally directed responsibilities in addition to these core responsibilities.

4.31.1.6.1  (06-01-2004)
General

  1. Each designated Campus will maintain a Campus TEFRA Function (CTF) to obtain and control, through the AIMS and Partnership Control System (PCS), any partner or shareholder returns related to key cases within its jurisdiction. The PCS will also be used to identify and establish linkage on second and subsequent tier entities. AIMS and PCS are also used to identify and control indirect investors and/or pass-through entities.

  2. The CTF is responsible for maintaining centralized RAR files. The files should be maintained at least two years after closure.

  3. Coordination between the key case CTF and the key case field division (Examination and/or Appeals) is critical to ensure that all notices are timely issued.

  4. Each CTF will request and complete an AIMS IVL at least annually, or more often if necessary.

4.31.1.6.2  (02-15-2008)
National Headquarters

  1. The Director, SB/SE Campus Compliance Services, Campus Reporting Compliance, is responsible for:

    1. Coordinating and staffing CTF operations;

    2. Selecting the campus(es) for the CTF;

    3. Ensuring that TEFRA procedural changes are promptly implemented through coordination with CTF personnel and with Compliance, in the field offices, area offices and territories of both the SB/SE and LMSB operating divisions;

    4. Monitoring and evaluating CTF operations and quality control procedures;

    5. Coordinating the resolution of CTF technical and operational problems;

    6. Initiating the development of training modules for all levels of CTF employees; and

    7. Updating Internal Revenue Manuals 4.31 and 4.29.

    8. The establishment of assessment and refund tolerances used by the Campus TEFRA Functions.

4.31.1.6.3  (06-01-2004)
Campus Examination Operations Manager

  1. The campus Examination Operations Manager, or equivalent, who has a CTF is responsible for ensuring:

    1. The establishment and maintenance of TEFRA suspense files;

    2. The establishment of correct PCS and AIMS data bases;

    3. The effective use of PCS reports;

    4. The correction of data base rejects;

    5. The timely processing of TEFRA notices;

    6. The development of appropriate controls to ensure timely and accurate return and linkage establishment;

    7. Timely report writing;

    8. Timely assessments;

    9. The training of all employees in CTF procedures; and

    10. The timely notification to the field and the other CTF of significant events.

4.31.1.6.4  (06-01-2004)
CTF Managers

  1. The CTF manager is responsible for:

    1. Maintaining updated copies of the Pass-Through Entity Handbook in their respective functions;

    2. Ensuring the training of their employees in CTF procedures;

    3. Establishing investor returns on PCS and AIMS;

    4. Maintaining correct data bases;

    5. Maintaining complete and accurate case files;

    6. Timely report writing and assessment of TEFRA deficiencies or overassessments within the one-year assessment statute date; and

    7. Coordinating with other functions and the other CTF, as necessary.

4.31.1.6.5  (02-15-2008)
CTF Technical Employees

  1. Revenue Agents (GS-512) and Tax Compliance Officers (GS-526), Tax Auditors (GS-501) and Tax Examiner (592) Report Writers assigned or detailed to the CTF will perform all technical duties including coordinating with and assisting other units within the campus, the other CTF, and field offices nationwide.

  2. Specific technical responsibilities include the following;

    1. Report writing of IMF and BMF reports;

    2. Review of the FPAA, 60-Day, and Form 8340, PCS TEFRA Establish or Add, packages;

    3. Development and securing of statutory notice language;

    4. Classification and screening of returns;

    5. Execution of Forms 870-PT and 870-LT (Forms 870-P and 870-L are still used for partnership tax years ending before August 6th, 1997);

    6. Coordinating the execution of Forms 870-PT(AD) and 870-LT(AD) (Forms 870-P(AD) and 870-L(AD) are still used for partnership years ending before August 6th, 1997) with Appeals;

    7. Review of Form 906, Closing Agreement on Final Determination Covering Specific Matters;

    8. Identification of tier activities, including the determination of whether tax consequences on returns of tier investors warrant linking tier investors, writing tier RARs, and preparation of the appropriate distribution schedules for tiers;

    9. Providing advice on the appropriate statute of limitations;

    10. Preparation of Form(s) 3999, Statute Expiration Report, for barred statutes;

    11. Preparation of Form(s) 3999-T, Statute Expiration Report (for TEFRA key cases): e.g., tier statute expires;

    12. Assisting in bankruptcy cases;

    13. PCS coordination activities;

    14. Compliance Team (C-Team) coordination, where appropriate;

    15. C-Team assistance, where appropriate;

    16. PFN (Pre-Filing Notification) assistance, where appropriate;

    17. Assisting in training; and

    18. Assisting in the determination of the applicability of penalties from the key case RARs.

  3. Technical employees will coordinate with and assist the following other functions:

    1. Report writers;

    2. TAS Cases (Taxpayer Advocate Service);

    3. Clerical units;

    4. Campus Quality Assurance;

    5. Field Quality Measurement;

    6. Other campus operations;

    7. Field office TEFRA coordination;

    8. Criminal Investigation;

    9. Other Customer Service functions;

    10. Area PCS Coordinators;

    11. Centralized Case Processing;

    12. Taxpayers and their authorized representatives;

    13. Appeals Officers; and

    14. Area and Chief Counsels.

4.31.1.6.6  (06-01-2004)
CTF Mail Clerk(s)

  1. The CTF Mail clerk will be responsible for acknowledging Form 3210 (Document Transmittal) within 3 days of receipt.

4.31.1.6.7  (06-01-2004)
Key Case CTF Responsibilities

  1. Generally, key case CTF responsibilities are determined by Operating Division. Large and Mid-Sized Business (LMSB) cases are worked at the Ogden Campus and Small Business and Self Employed (SB/SE) cases are worked at the Brookhaven Campus.

  2. The key case CTF is responsible for:

    1. Linking investors through PCS;

    2. Issuing timely notices to investors;

    3. Receiving and executing agreements and settlement agreements;

    4. Establishing and maintaining the key case administrative file; and

    5. Setting the one-year assessment statute date.

    6. Preparing and mailing closing packages to functions (Compliance and Appeals) that have statute responsibility for investor returns.

4.31.1.6.8  (08-01-2006)
Investor CTF Responsibilities

  1. Generally, the investor CTF services the investors according to the Operating Division of the key case (LMSB for Ogden Campus and SB/SE for Brookhaven Campus).

  2. The investor CTF is responsible for:

    1. Securing investor returns;

    2. Creating and maintaining investor files;

    3. Identifying tiers;

    4. Linking tier investors;

    5. Writing reports of examinations; and

    6. Making TEFRA/nonTEFRA assessments

  3. Generally, the key case CTF and investor CTF are the same. They may not be the same if the investor is linked to key cases or tiers in more than one Operating Division (i.e., LMSB or SB/SE). These are called multi-linked tiers or investors.


More Internal Revenue Manual