Report of the American Bar Association Tax Section Task Force on the Tax Recommendations of the National Bankruptcy Review Commission

THE TRUSTEE AS TAX MATTERS PARTNER

(COMMISSION TRACK NUMBER 415B)

Present Law

Prior to the adoption of Subchapter C of Chapter 63 of the Internal Revenue Code in 1982, controversies involving the proper treatment of items of taxable income or loss realized by a partnership and allocated to the individual partners became unwieldy, especially where there were a large number of partners with inconsistent positions and, frequently, filing their individual tax returns in different states or Internal Revenue districts. This problem was largely solved by providing that such controversies would be determined in proceedings between the partnership and the IRS or, if the matter went to litigation, by providing that the partnership was a party to the litigation. As part of this process, one of the general partners is designated the "Tax Matters Partner," and is the person who represents the partnership in its dealings with the IRS or in court (fn. 164).

For example, the start of a tax examination is normally commenced by notifying the taxpayer that the IRS intends to conduct the examination. In the case of a partnership, the IRS normally sends that notice to the Tax Matters Partner and, depending upon the number of partners, the size of their interests and, in certain cases, other factors, to other partners. IRC Section 6223. It is the obligation of the Tax Matters Partner to make sure that all of the partners are kept advised of all important developments, such as proposed settlements or other final determinations. In certain situations, the Tax Matters Partner may bind the other partners by his actions. IRC Section 6224(c)(3).

The 150 day period during which the IRS is barred from assessing any deficiency relating to a partnership item begins to run from the time a notice of a final partnership administrative adjustment (which is analogous to the 90 day letter or notice of deficiency in cases involving other types of taxpayers) is mailed to the Tax Matters Partner. IRC Section 6225

Within 90 days after the notice of a final partnership administrative adjustment is mailed to the Tax Matters Partner, the Tax Matters Partner may file a petition for a readjustment either with the Tax Court or the Claims Court or the U.S. district court in which the principal office of the partnership is located. While certain of the other partners also may file petitions for readjustment in one of those courts, their actions will be preempted by any petition filed by the Tax Matters Partner. Moreover, if the Tax Matters Partner has not filed his or her own petition, he or she may intervene in a proceeding commenced by any other partner. IRC Section 6226.

The mailing to the Tax Matters Partner by the IRS of its notice of final partnership administrative adjustment cuts off the right of other partners to file requests for administrative adjustments of partnership items (i.e., refund claims or amended returns). IRC Section 6227. The Tax Matters Partner may commence a suit for refund in the Tax Court, the Claims Court or the U.S. District Court in which the partnership's principal office is located. Other partners may also file refund suits, but their right to do so is substantially restricted, and subordinated to the decisions made by the Tax Matters Partner.

Any partner may enter into an agreement to extend the period for assessing taxes, but such agreement will be binding on the other partners only if the agreement is executed by the Tax Matters Partner. IRC Section 6229(b)

The Tax Matters Partner also has a number of special obligations, such as the duty to notify other partners of the existence and outcome of the IRS examination. The Tax Matters Partner must also supply the IRS if it so requests with the names, addresses, profits interests, taxpayer identifications numbers and other data with respect to each person who was a partner in the partnership at any time during the taxable year. IRC Section 6230(e).

The net result of all of the above is that, generally, the only persons authorized to deal with the IRS or to appear in court to litigate a tax issue are the Tax Matters Partner and, in limited circumstances, certain other partners of the partnership, and only the Tax Matters Partner may bind the partnership as a whole or be required to perform certain of the administrative tasks.

Section 6231(a)(7) defines the Tax Matters Partner as a general partner designated by the partnership (in the manner specified by regulations) or, in default of such a designation, as the general partner with the largest profits interest in the partnership at the close of the taxable year involved. If more than one partner has the largest profits interest, then the partner whose name appears first on an alphabetical listing becomes the Tax Matters Partner. If this method of designating a Tax Matters Partner is impractical, the IRS may select the Tax Matters Partner.

In the context of a chapter 7 proceeding and, often, in the context of a chapter 11 proceeding, the last thing one could get the partners to agree on is the designation of one of the general partners to serve as a Tax Matters Partner. First, at this point, the interests of the general partners are not likely to be the same (assuming that they ever were). Most of the general partners probably aren't on speaking terms with each other; more likely, they are closer to suing each other than breaking bread. There is little reason to believe that any one of them could or would act in the neutral fashion contemplated by the statute for the role played by a Tax Matters Partner, or that any other general partner would trust him to do so.

In addition, no general partner is likely to be willing to serve as the Tax Matters Partner, because the Tax Matters Partner will incur significant expenses in fulfilling his or her obligations as such and at the same time run a substantial risk of being sued by his former partners as his thanks for acting in that role. It is unlikely that the partners would agree to reimburse the Tax Matters Partner for his expenses, let alone compensate him for his time and efforts (as they would probably do were the partnership still a viable and continuing business entity). Add to this the likelihood that if one of the other general partners disagreed with the actions of the Tax Matters Partner, he or she might well commence an action against the Tax Matters Partner. Under these circumstances, serving as the Tax Matters Partner would be extremely burdensome and no sane general partner would agree to act as the Tax Matters Partner.

In the absence of a voluntary designation, the statute indicates that the general partner with the largest profits interest should serve. This is a rather unrealistic test for a chapter 7 case, where there are no profits anticipated. In effect, the profits interests of all the partners have been reduced to zero, and any attempt to assign some sort of ratio in non-existent or extremely remote profits that might occur would probably run afoul of the requirements of Internal Revenue Code Section 704(b) (relating to substantial economic effect of allocations). The only one who really owns the profits interests is the trustee and the creditors (fn. 165).

This leaves the IRS with the task of designating the Tax Matters Partner, but even a brief consideration of the issues raised by this possibility indicates why this is an undesirable solution. Among others, the IRS would be forcing a general partner to serve without compensation or reimbursement and against his own will as well as against the will of his co-partners. That is not likely to achieve an effective representation of the partnership in its dealings with the IRS or, subsequently, in court.

The apparent solution is to let the trustee function as the Tax Matters Partner, or otherwise represent the partnership in any tax proceeding. This would be consistent with the provision in Bankruptcy Code Section 323(a), which states the trustee "is the representative of the estate." However, in practice, the IRS has refused to recognize that the Bankruptcy Code provision overrides the specific provisions of the Internal Revenue Code restricting the IRS to dealing only with partners. Since the trustee is not a partner, he has no standing with the IRS in connection with examinations of the partnership, refund claims, extensions of the statute of limitations on assessments, and similar matters. Even though he may be the most logical person for providing the IRS with information like the names, addresses and taxpayer identification numbers of the partners pursuant to Internal Revenue Code Section 6230(e), he is nearly the only person in the bankruptcy proceeding NOT authorized to do so.

The failure to recognize the trustee as a representative of the estate and the common unwillingness of the partnership to designate a Tax Matters Partner or for any general partner to agree to serve as such creates serious impediments to the efficient resolution of tax issues between the partnership and the IRS.

Proposals Before the Commission

Commission Track Number 415B. This proposal.

Task Force Position

Amend Section 6231(a)(7) by adding a provision authorizing a bankruptcy court to designate the trustee in a chapter 7 or chapter 11 proceeding to serve as the Tax Matters Partner (fn. 166).

Reasons for Position

As a practical matter, the trustee is the only party with the knowledge and ability to represent the partnership in resolving controversies with the IRS.

In the absence of this authority, the trustee would not be authorized to file amended returns for prepetition years, to extend the statute of limitations for assessments or to enter into closing agreements with the IRS. In fact, while he may be required to file the initial return of the partnership for years ending after the commencement of the case (fn. 167), he is not authorized to file an amendment of those returns or to discuss with the IRS any adjustments of items on the returns he filed.

Designating the trustee as the Tax Matters Partner is consistent with section 323 of the Bankruptcy Code and will facilitate the administration of the bankruptcy estate.

The proposed provision would not authorize the IRS to make this decision. It would be made only by the bankruptcy court. The request to the court can be submitted by any interested person, including the trustee, the IRS, any partner and any creditor. Similarly, any interested person, including a partner, a creditor, the trustee or the IRS, who believes that the trustee would not be an appropriate selection in the particular proceeding can present his or her objections to the bankruptcy court. The court can weigh the arguments for or against the selection, and make its decision in the best interests of all parties, including the IRS and the partners of the partnership (fn. 168). For good reason, the court could even act on its own initiative, although it is contemplated that the appointment without an opportunity for all parties to be heard would be extremely unusual.

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fn. 164: Technically, the Tax Matters Partner or another partner may actually be the party in court or with whom the IRS deals, but the effect is the same as though the partnership were the party.

fn. 165: Technically, a partner could be deemed to own a share of profits equal to his share of the responsibility for the partnership debts. For purposes of allocating the tax liability under section 704(b) for income used to satisfy parntership debts, this is the ration that may be applicable. See Rev. Rul. 92-97, 1992-2 C.B. 224. However, the shares of the respective partners for liabilkities to third parties is an issue often subject to dispute in these types of proceedings and, from a realistic or true economic viewpoint, may be affected more by the creditors' perceptions as to which partners have the deepest pockets than by the true economic interests in profits and losses contemplaed in the written partnership agreement. The determination of this ration is further complicted by the probability that former partners, who would not be deemed partners for any current years for tax purposes, may be forced to satisfy some of the liabilitites to thid parties. Accordingly, even if it were possible to determine with some degree of certainty what that ration was in a particular case, it would not seem to be an appropriate or reliable measure of the economic interests that Congress intended to use as a basis for selecting the Tax Matters Partner in default of a designation by the partnership itself.

fn. 166: Consideration should be given to including chapter 12 in this list.

fn. 167: The current law on the obligation of a trustee to file a return for a partnership is currently unclear and is the subject of a separate proposal. See Commission Track Number 414.

fn. 168: It is expected that the court would recognize that facilitating the resolution of the tax controversies will normally benefit everyone, including the unsecured creditors. In addition, the legislative history should make it clear that, in deciding whether to grant the request, teh court should keepin mind that Congress is concerned that courts assert reasonable efforts to maintain the integrity of the tax system even in the context of bankruptcy procedings.

Questions, comments or suggestions? kbercik@taxcounsellor.com