Changing the identified hedge fund partner did not require a separate audit

Plain-English summary

A partnership used contracts with a bank to retain investment exposure to interests in a hedge fund that was also taxed as a partnership. The parties reported the bank as the owner and partner, but the examination team concluded that the taxpayer partnership was the true owner of the hedge fund interests. The proposed adjustments would place on the taxpayer's Form 1065 the items the hedge fund had reported to the bank on Schedule K-1. Chief Counsel advised that identifying the taxpayer instead of the bank as the partner was not a partnership item under the then-applicable TEFRA procedures because the change would not affect the other hedge fund partners' distributive shares. The examination team therefore did not need to open a separate partnership proceeding for the hedge fund.

Ruling snapshot

• Question: Does replacing the reported partner with the person found to be the true owner require a separate TEFRA audit proceeding for the underlying partnership?
• Outcome: advice given (no separate proceeding was required because other partners' allocations would not change)
• Key authorities: TEFRA partnership procedures enacted by Pub. L. 97-248, § 402; Blonien v. Commissioner, 118 T.C. 541 (2002); Hang v. Commissioner, 95 T.C. 74 (1990)

Full text (IRS public release)

ID: CCA_2019101515015932
UILC: 6221.00-00, 9300.98-05

Number: 202019003
Release Date: 5/8/2020
From: --------------------
Sent: Tuesday, October 15, 2019 3:01:59 PM
To: -----------------------------------------
Cc: ----------------------------------
Bcc:
Subject: Adjustments to a taxpayer who is deemed an owner of partnership interests

You have requested advice on whether a change in the identity of a partner in the
partnership described below is a “partnership item” that would require a separate audit
proceeding with respect to that partnership. During the taxable years in issue, the
partnership unified audit and litigation procedures in effect were the procedures enacted
by the Tax Equity and Fiscal Responsibility Act of 1982. Pub. L. 97-248, § 402, 96 Stat.
648 (1982).

The facts are as follows. Taxpayer is a U.S. person that is treated as a partnership for
U.S. federal tax purposes. To retain investment exposure to HF, a hedge fund that is
treated as a partnership for U.S. federal tax purposes and that holds a diversified pool
of other hedge fund interests, Taxpayer entered into contracts (“Contracts”) with a
counterparty bank (“Bank”) referencing partnership interests in HF (“HF
Interests”). Taxpayer and Bank accounted for the transaction as though the Contract
was a derivative and treated Bank as the owner of the HF Interests. As a result, during
the taxable years at issue, Bank treated itself as the partner in HF and reported items of
income, expense, gain, and loss that HF reported to its partners on Schedules K-

1. Exam has concluded that, for tax purposes, Taxpayer owns the HF interests and
   Taxpayer (and not Bank) is the true partner in HF. As a result, exam proposes to make
   adjustments to Taxpayer’s Form 1065 (U.S. Return of Partnership Income) to include
   partnership items that HF reported to Bank on Schedule K-1.

You have asked whether these adjustments require separate partnership unified audit
and litigation procedures with respect to HF. The identity of Taxpayer versus Bank as
the partner in HF is not a partnership item because the determination will not affect the
distributive shares of HF’s other partners. See Blonien v. Commissioner, 118 T.C. 541,
551 fn. 6 (2002) (“determination of who is a partner can be a partner-level item where
resolution of the issue would not affect the allocation of partnership items to the other
partners”); Hang v. Commissioner, 95 T.C. 74, 80 (1990) (considering benefits and
burden of ownership because reallocation of income from S corporation’s shareholders
of record to taxpayer who is not a shareholder of record is not a partnership
item). Accordingly, adjustments to Taxpayer’s Forms 1065 that reflect inclusion of
partnership items from HF’s Schedule K-1 do not require that a separate audit
proceeding be opened with respect to HF.

Please call if you have any additional questions.