Partnership made a valid election into the BBA procedures

Because a limited liability company (LLC) made a valid early election into the audit and examination regime of the Bipartisan Budget Act (BBA), P.L. 114-74, the IRS’s final partnership administrative adjustment (FPAA) it issued to the taxpayer under the procedures of the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), P.L. 97-248, was invalid, the Tax Court held.

Facts: In 2017, SN Worthington Holdings LLC (Worthington), which was classified for federal income tax purposes as a partnership, timely filed its 2016 Form 1065, U.S. Return of Partnership Income. In October 2018, the IRS notified Worthington that the Service had selected Worthington’s 2016 partnership return for examination. The letter also informed the company that it could elect within 30 days from the date of the letter to be examined under the BBA partnership audit procedures pursuant to Regs. Sec. 301.9100-22(b)(1).

Worthington submitted to the IRS Form 7036, Election Under Section 1101(g)(4) of the Bipartisan Budget Act of 2015. In completing it, the company had to make certain representations, one of which was that it had “sufficient assets, and reasonably anticipates having sufficient assets, to pay the potential imputed underpayment that may be determined during the partnership examination” (Regs. Sec. 301.9100-22(b)(2)(ii)(E)(4)).

After receiving the election, the IRS sent a letter to Worthington stating that “[a]fter reviewing the tax return it appears that you do not meet the requirements” of the regulations because the company would not be able to pay an imputed underpayment. The letter gave the company 30 days to respond with any supporting documentation, which it failed to do. In a follow-up letter, the IRS reiterated why, in its view, the election was invalid, claiming that “[p]roof of sufficient available assets to pay the potential imputed tax lability was never provided” and “[t]he election was not signed by the Tax Matters Partner or an individual authorized to sign the partnership return for the taxable year under examination.”

Worthington again failed to respond, although it had subsequent communications with the IRS, signing documents referring to the TEFRA procedures.

In 2020, Worthington argued to the IRS that the examination should have occurred under the BBA, not TEFRA, procedures, asserting that “there is no requirement [under the BBA] that a taxpayer provide proof of sufficient assets to pay an imputed tax liability.” The LLC’s representative also requested, in a fax to the IRS, to be a part of the Small Business/Self-Employed Fast Track Settlement program. The IRS denied the fast-track request but did not address the fact that the taxpayer’s 2016 return was being examined under the allegedly wrong procedures.

On Aug. 24, 2020, the IRS issued the FPAA to Worthington. After filing a timely petition with the Tax Court, the company on Aug. 4, 2023, filed a motion to dismiss, arguing that the court lacked jurisdiction to hear the case because the FPAA was invalid.

Issues: The Tax Court generally has jurisdiction over TEFRA partnership cases if a valid FPAA was issued by the IRS and a petition was timely filed with the Tax Court by a proper party (Wise Guys Holdings, LLC, 140 T. C. 193 (2013)).

When TEFRA was first enacted in 1982, it significantly altered the procedures by which the IRS determined deficiencies for certain partnerships. Prior to TEFRA, the IRS adjusted flowthrough items at the partner, not partnership, level. TEFRA changed that by establishing unified audit and litigation procedures by which the IRS could make adjustments at the partnership level (Sec. 6221 (as enacted by TEFRA)). Under TEFRA, adjustments were determined at the partnership level, but the assessment and collection of the tax attributable to the partnership item was made at the partner level (Secs. 6221, 6230(a)(2), and 6231(a)(6) (as enacted by TEFRA)).

The BBA established a new framework for auditing, adjusting, assessing, and collecting tax with respect to partnerships. It streamlined the audit process by allowing audits, adjustments, and payments to all take place at the partnership level (Sec. 6221(a) (as amended by the BBA)). The BBA procedures also included a delayed effective date, generally applying to partnership tax returns for tax years beginning after Dec. 31, 2017 (BBA, §1101(g)(1)). Thus, under this default rule, any partnership return with a tax year beginning before Jan. 1, 2018, remained subject to TEFRA (BBA, §1101(g)(1))(id.).

Even though it had a delayed effective date, the BBA allowed partnerships to elect into the BBA procedures for partnership tax years beginning after Nov. 2, 2015, and before Jan. 1, 2018 (BBA, §1101(g)(4)). The IRS and Treasury adopted a regulation setting forth the form and manner for making the election (Regs. Sec. 301.9100-22). Specifically, the election must be in writing (Regs. Sec. 301.9100-22(b)(2)). The partnership also must make representations, including that it “has sufficient assets, and reasonably anticipates having sufficient assets, to pay a potential imputed underpayment” with respect to the partnership tax year (Regs. Sec. 301.9100-22(b)(2)(ii)(E)(4)).

Worthington argued that its election was valid because it complied with the plain text of the regulation and that the IRS did not have the authority to request additional information that “was not stated in or required by the regulation.”

The IRS countered that a partnership allowed to thus elect into the BBA without providing such additional information as it had requested would frustrate the purpose of the BBA procedures, citing Regs. Sec. 301.9100-22(a), which provides that an election into the BBA procedures is invalid if it frustrates the purposes of Section 1101 of the BBA. The Service also claimed that Worthington should be equitably estopped from arguing that it made a valid election under the BBA “based on its misleading silence and later statements regarding the applicability of TEFRA,” which the IRS claimed it relied on to its detriment.

The Tax Court stated that, in general, taxpayers make valid elections when they comply with “the plain text of the election requirements,” which can be set forth in various ways, including by statute or regulations. Once established, the IRS “may not add ad hoc additional requirements.” Also, in determining if an election is valid, the IRS may not require the taxpayer to satisfy more stringent requirements than those of the provision that authorizes the election. However, the court noted that elections have been held to be invalid “when they fail to comply with the essential requirements of making the election.”

The Tax Court found that Worthington satisfied the election requirements under the BBA procedures by timely submitting a signed Form 7036 representing that it had sufficient assets to pay the potential imputed underpayment that may be determined during a partnership examination. In the court’s view, by submitting this form containing the specific text designed by the IRS, Worthington complied with the plain text of Regs. Sec. 301. 9100-22(b)(2)(ii)(E)(4).

The Tax Court also refuted the IRS’s contention that the partnership must establish (and not merely represent) that it has sufficient assets to satisfy an imputed underpayment. The court found that the BBA procedures were not frustrated because the IRS still could assess and collect any imputed underpayment from the partners themselves if the partnership did not promptly pay (Sec. 6232(f)(1)(B) (as amended by the BBA)). The court further stated that any ambiguity in the meaning of a regulation is interpreted against the drafter. It is presumed that the “drafter of the regulation … said what it means and means what it said” (Sklar, Greenstein & Scheer, P.C., 113 T.C. 135 (1999)). Therefore, the court determined that Worthington satisfied all the requirements in Regs. Sec. 301.9100-22(b)(2), making the FPAA notice invalid.

In its response to Worthington’s motion to dismiss, the IRS did not address its contention that the election was not signed by the LLC’s tax matters partner or individual authorized to sign the return (which Worthington had denied), leaving the court to infer that the issue was no longer in dispute and conclude that Worthington had satisfied that requirement.

Having established that the BBA procedures were properly elected, the court was asked to determine if the taxpayer should be equitably estopped from applying the BBA procedures. For equitable estoppel to apply, all of the following elements must be satisfied:

(1) There must be false representation or wrongful misleading silence by the party against whom the estoppel is claimed; (2) the error must originate in a statement of material fact, not in opinion or a statement of law; (3) the party claiming the benefits of estoppel must not know the facts; (4) the party claiming the benefits of the estoppel must have actually, and reasonably, relied on the acts or statement of the party against whom the estoppel is claimed; and (5) as a consequence of that reliance, the party claiming the benefits of the estoppel must be adversely affected by the acts or statements of the party against whom the estoppel is claimed [quoting Steiner, T.C. Memo. 1995-122].

The Tax Court found that the first factor regarding misleading silence was met. After the IRS denied the LLC’s election out of the BBA procedures, while Worthington continued to communicate with the IRS about the audit and sign documents referencing the TEFRA procedures, the LLC did not inform the IRS that the Service had made an incorrect determination regarding the election until 2020, after the period of limitation to make adjustments for Worthington’s 2016 tax year had expired under the BBA procedures.

“This is misleading silence,” the Tax Court stated.

The Tax Court found the second factor required the IRS to prove that the misleading silence originated in a statement of fact and not in a statement of law. While the determination of whether Worthington made a valid election into the BBA procedures was a mixed question of fact and law, the facts necessary to make that determination were in the IRS’s possession. The only question was how the law applied to those facts, and thus the LLC’s misleading silence went to a question of law, not of fact. Therefore, the second factor was not met.

The third factor required the IRS to prove it did not have all the material facts needed to make the correct determination. The Tax Court found, as it had already determined, that the IRS had all the material facts, regardless of when Worthington informed the IRS that it disagreed with the IRS’s interpretation of the law (i.e., that the LLC’s election into the BBA was invalid). Thus, the IRS had all the information in its possession to apply its own regulation. Consequently, the third factor was not met.

Having concluded that the IRS had not met two of the five elements needed to invoke equitable estoppel, the court determined it need not address the final two elements and held that Worthington was not equitably estopped from arguing that the BBA procedures applied.

Holding: The court held that Worthington made a valid election into the BBA procedures for 2016. Therefore, since the IRS followed TEFRA in issuing the FPAA, the court concluded that the notice was invalid since a valid FPAA is a jurisdictional prerequisite for the court to decide the case. Further, the IRS failed to establish that the elements of equitable estoppel were satisfied.

■ SN Worthington Holdings LLC, 162 T.C. No. 10 (2024) .

— John McKinley, CPA, CGMA, J.D., LL.M., is a professor of the practice in accounting and taxation in the SC Johnson College of Business, and Matthew Geiszler, Ph.D., is a lecturer in accounting in the Brooks School of Public Policy, both at Cornell University in Ithaca, N.Y. To comment on this column, contact Paul Bonner, the JofA’s tax editor.