Issuu

PROCEDURALLY TAXING tax notes federal Here We Go Again: What Is a Partnership Item? Part 2

Jenni Black is a managing director in Citrin Cooperman’s national tax office and the practice leader of the tax procedure and controversy practice. She is also a contributing author for Procedurally Taxing. In this post, Black examines the courts’ approach to what qualifies as a partnership item. This post reflects the author’s personal views and not necessarily those of Citrin Cooperman. As mentioned in part 1 of this post, there has been recent attention on what it takes to be a partnership item, specifically in the case of net earnings from self-employment (NESE) reported on the partnership return. And there have been questions about whether certain factors are determinative of whether something is a partnership item. We don’t have to walk alone. Courts have considered what it takes to be a partnership item for decades. Here in part 2, I look at how the courts have viewed factors such as whether an item must impact more than one partner or not be based (in part) on partner-level facts and circumstances to be a partnership item. Here we go again. Going down the only road I’ve ever known, let’s talk Tax Equity and Fiscal Responsibility Act of 1982. TEFRA uses a bifurcated system. First, the tax treatment of partnership items is determined at the partnership level. Second, after the partnership-level proceeding is over, how those partnership items impact the partners’ tax is determined. Partnership items cannot be

determined in a subsequent partner-level proceeding. That’s why everything that can be determined at the partnership level must be 1 determined prior to the partner-level proceeding. Keep in mind that the partnership’s determination of NESE, just like the applicability of penalties at 2 the partnership level, is provisional. It is income that may be subject to self-employment tax. The actual amount of any self-employment taxes on that amount is determined in a later partner-level proceeding based on partner-level facts and circumstances3 — just like the penalties the Supreme Court held were determined at the 4 partnership level in Woods. What about partner-level facts and circumstances? If you need to inquire into partnerlevel facts and circumstances to determine an item, does that impact whether an item is a

See, e.g., NCF Energy Partners v. Commissioner, 89 T.C. 741, 743-744 (1987); Maxwell v. Commissioner, 87 T.C. 783, 792 (1986) (because the tax treatment of affected items depends on partnership level determinations, affected items cannot be tried as part of a partner’s personal tax case until the completion of the partnership level proceeding). 2

See United States v. Woods, 571 U.S. 31, 40 (2013). If you want to get super technical (and who doesn’t?) you could probably argue all items on the partnership return are “provisional” as the actual tax impact is not determined at the partnership level. 3

In Olsen-Smith Ltd. v. Commissioner, T.C. Memo. 2005-174, the Tax Court correctly held that the “net earnings from self-employment” reported on the partnership return is a partnership item but the ultimate amount the partners pay self-employment tax on is an affected item. This opinion is hard to read so it can be confusing. The court uses the term “net earnings from self-employment” to refer to both the amount reported by the partnership and the amount the partners ultimately pay tax on. The court ruled in favor of respondent and held that partnership must determine, and report, NESE based on the characteristics of its direct partners (e.g., what type of entities they were and whether they are limited partners) and its income and that whether any ultimate taxpayer would pay self-employment and on what amount is an affected item and does not affect the partnership’s reporting. The odd thing about this case is that the partnership reported NESE and the IRS conceded any adjustment to it, so I guess petitioner was challenging how the partnership reported it on the partnership return. 4

The Supreme Court correctly did not hold that the applicability of penalties is a partnership item, but rather is an item required to be determined at the partnership level under section 6221. Both the tax treatment of partnership items and the applicability of penalties to any adjustment to those partnership items must be determined at the partnership level under TEFRA.

TAX NOTES FEDERAL, VOLUME 192, AUGUST 24, 2026 For more Tax Notes Federal content, visit www.taxnotes.com.

1497

by Jenni Black