Tax Court Divided on Equitable Tolling of TEFRA Partnership Adjustments

Under the 1982 Tax Equity and Fiscal Responsibility Act (TEFRA), one partner in a business can face substantial fines and penalties for the poor tax choices of another partner. A recent United States Tax Court case, North Wall Holdings, LLC v IRS, asked whether equitable tolling could extend the deadline to challenge TEFRA partnership adjustments. The answer split the Tax Court, resulting in three separate opinions. Given this divide, and the different rulings by Circuit Courts on similar issues, it is likely equitable tolling will remain a topic of frequent litigation in the near future.

What is TEFRA?

The Tax Equity and Fiscal Responsibility Act (TEFRA), passed in 1982, created a unified audit procedure that allowed the IRS to determine the tax treatment of “partnership items” at the level of the partnership itself, rather than performing separate audits for each individual partner. While portions of the TEFRA were repealed as of tax year 2018, its replacement law, the Bipartisan Budget Act of 2015 (BBA) still allows the IRS to make administrative adjustments to the way various partners within the partnership report their taxes and claim deductions, and convert certain items from “nonpartnership items” to “partnership items” assessing taxes and penalties related to the change. The goal of TEFRA was to streamline the audit process for large partnerships, closing loopholes that allowed partner companies to shift items around and avoid paying taxes on them.

Here, the company in question is North Wall Holdings, LLC, an Alabama limited liability company. One of its partner entities is Schuler Investments, LLC (Schuler), another Georgia company. The IRS exercised its authority to readjust partnership administrative deductions for North Wall by sending a Notice of Final Partnership Administrative Adjustment (FPAA) to the tax matters partner of the business in May 2021. It said that the partnership had wrongfully claimed a non-cash charitable contribution deduction of $45.8 million and assessed a variety of penalties based on that determination. In June 2021, the IRS sent the same notice to North Wall Holdings, LLC’s other partners, including Schuler Investments LLC, as non-tax-matter partners.

Deadlines to Challenge TEFRA Partnership Adjustments

When the IRS issues an FPAA to a tax matters partner, that partner has 90 days to challenge the TEFRA partnership adjustments, and ask that the taxes be readjusted. Non-tax partners (the ones who are not believed to have done anything wrong), have 60 days to file their own petition if the tax matters partner does not exercise their right during those first 90 days. In total, the deadline to challenge TEFRA partnership adjustments is 150 days after the FPAA notice is sent to the first partner in the business. Historically, if a non-tax-matters-partner filed a challenge too early (within the first 90 days) or too late (after 150 days), it would result in the challenge being dismissed.

In North Wall, the tax matters partner didn’t challenge the FPAA. Once the 90 days to do so expired, Schuler had 60 days more to file its own challenge to the TEFRA partnership agreement. However, the company did not file until October 2021, a total of 18 days beyond the 150 limit on such challenges.

Can Equitable Tolling Stop the Clock for TEFRA Partnership Adjustments?

In defending against the IRS’s motion to dismiss its challenge to the TEFRA partnership agreement, Schuler asserted that the petition was timely filed 142 days after the FPAA notice was sent to the non-tax-matter partners. It argued the IRS’s delay in sending out the notice entitled it to equitable tolling of the deadline to file its challenge to the TEFRA partnership adjustment. The IRS disagreed and argued that the deadline was “jurisdictional” and that meant it could not be extended, even on a showing of good cause.

As this blog has explained before, in 2022 in Boechler PC v Commissioner, the United States Supreme Court changed the way federal courts decide whether filing deadlines are jurisdictional, or simply administrative. The difference is that a jurisdictional deadline cuts off the courts’ authority to even consider the case after it has passed. If a deadline is merely administrative, equitable tolling can stop the clock temporarily if the petitioner had good cause to file late (such as delayed notice of the IRS determinations).

Since Boechler, different Circuit Courts have taken different positions on whether portions of the Internal Revenue Code are truly “jurisdictional” or if their deadlines can be tolled. In Oquendo v IRS, the Sixth Circuit allowed an individual’s tax deficiency challenge to be tolled, saying that the section of the statute that applied in that case did not include directives to the courts, but instead described what the taxpayers must do. Similarly, in Culp v Commissioner, the Third Circuit called a different deadline a “claims-processing rule” and allowed the deadline to be tolled for equitable reasons.

Tax Court Split Over Whether Equitable Tolling Applies to TEFRA

Judge Buch of the Tax Court said this time is different. In his majority decision, Judge Buch argued that TEFRA would “become unworkable” if the deadline was not jurisdictional. Relying on 40 years of prior court decisions, Jude Buch held that the deadline to challenge TEFRA partnership adjustments was firm. This, together with Congress’s amendments to the law relating to premature petitions by non-tax-matter partners, demonstrated that the Legislature intended the deadline for challenging TEFRA partnership adjustments to be jurisdictional, the majority said.

To support this conclusion, Judge Buch pointed to the complexity of the TERFA challenge procedure. All partners are considered parties to a single TERFA action, with very narrow exceptions. That means they are bound by the outcome of the case even if it was litigated by a different partner. At the same time, the IRS is prohibited from assessing taxes against any partners resulting from its adjustments until the litigation is over. Judge Buche argued that applying equitable tolling in this situation would create “serious administrative problems” and disrupt the assessment process by forcing the IRS to respond to multiple late claims by different partners. If one partner were allowed to exercise equitable tolling, it could result in there being multiple petitions for the same TEFRA partnership adjustment, requiring the Trial Court to dismiss all the subsequent filings. He said there was good reason to believe Congress did not want the equitable tolling doctrine to apply in TEFRA cases.

But not everyone on the Tax Court agreed. Judges Weiler and Marshall wrote separately, disagreeing with how the majority reached its conclusion. While all the judges agreed the petition for TEFRA partnership adjustment should be dismissed, Judges Weiler and Marshall said it should be on the merits of the equitable tolling argument, rather than the jurisdictional question. Judge Wieler said "Petitioner has presented no evidence - and is utterly silent - as to why it would be eligible for [equitable tolling] relief in this case.” In other words, equitable tolling should have been available, but did not apply in this specific case.

The Tax Court has been reversed on questions of equitable tolling before. Given the divided opinions in this case, North Wall may well be headed for another appeal. As the split between the courts widens on interpreting and applying Boechler, there may even be another Supreme Court case in the future. Until then, partners should work with experienced tax attorneys to make certain their challenges to TEFRA partnership adjustments are filed on time. A missed deadline could be the end of their case.

Attorney Joseph R. Viola is a tax attorney in Philadelphia, Pennsylvania with over 35 years experience. If the IRS has issued a TEFRA partnership adjustment notice for your business or your clients, contact Joe Viola to schedule a free consultation.