Duty of Consistency Applied to Partnership and Settlement Fund Where Receiver Controlled Returns of Both

The receiver appointed to handle the assets of a partnership that was found to have been involved in a Ponzi scheme ended up with a bit of a tax issue that is discussed in Chief Counsel Advice 201052004.  The receiver established a settlement fund consisting of income generated from the partnership’s remaining legitimate business activities and interest earned on that income.

The receiver also prepared and filed the income tax returns for the partnership.  Those returns contained deductions for expenses incurred by the receiver in gathering and conserving the partnership’s assets.  However the returns did not contain the interest income on the settlement fund, apparently believing it should issue Forms 1099 to the investors who would receive settlement payments.   Such 1099s were not actually ever issued so that that interest on the settlement fund was never reported to the IRS.

The receiver began making payments out of the settlement fund to investors.  In the year following the start of payments to the investors, the receiver noticed the problem with the Form 1099s and contacted the IRS.

It was determined that, in fact, the receiver should have been filing Form 1120-SF (U.S. Income Tax Return for Settlement Funds) for each year the fund was in existence and the interest reported there.  Such returns should have reported the interest income on the settlement fund and, had the returns be filed timely, a deduction would have been allowed for the expenses incurred by the receiver in gathering and conserving the partnership assets.

Complicating matters was the fact that the statute of limitations for assessing tax on the partnership returns for the years those expenses were incurred had expired—returns on which these same expenses had been deducted.

The IRS concluded that the duty of consistency doctrine applied in this case to prevent the deduction of those expenses on the 1120-SF for the years in question.  The doctrine generally applies when the following three elements are present:

1. A representation has been made by the taxpayer in one year
2. The IRS has relied on that representation and
3. The taxpayer now seeks to change that representation at a later time when the statute of limitations bars an adjustment to the return for the earlier year

The receiver protested that denying those deductions would harm the investors, as the settlement fund would bear the entire burden, and, in any event, the partnership and the settlement fund were not the same taxpayer.

While agreeing these entities were two separate tax entities, the IRS pointed out that the duty of consistency doctrine can apply to related taxpayers.  The IRS concluded that the fact that the receiver had control over both taxpayers was sufficient to cause the duty of consistency to apply.

 

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