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IRS Says TEFRA Hearing Required if Nature of Guaranteed Payments Not Identified on K-1

- by Roger McEowen

Since their enactment as part of the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) provisions, the TEFRA partnership audit procedures have presented difficulties combining concept with reality.  IRS had long sought the rules as a means to bring procedural order to the chaos that resulted from the tax shelter boom in the late 1970s and 1980s.  Even though many of these tax shelters were implemented through partnerships with many partners, the IRS was required to make determinations and monitor the statute of limitations for each partner individually.  That led to different partners having different statute of limitations and often resulted in different outcomes.  The TEFRA procedures were designed to consolidate the determination of “partnership items” in a unified TEFRA partnership proceeding subject to a single statute of limitations. 

An issue has been whether a TEFRA proceeding is required when a guaranteed payment is not specifically identified on the Schedule K-1 as being for services.  IRS says that it is.  Guaranteed payments that are for services are earned income.  As such, they are subject to self-employment tax.  So, IRS reasons that if a partnership reports guaranteed payments on the partner’s Schedule K-1, but doesn’t include it in the partner’s share of self-employment income, a TEFRA proceeding is required to determine the source of the activity that generated the guaranteed payment.  Otherwise, IRS would simply have to accept the partnership’s characterization that the payment was not subject to self-employment tax.  Partially redacted e-mail advice from IRS Chief Counsel’s Office, Oct. 28, 2005, released under court order.