dissenting:
I must disagree with the majority’s approach here and consequently dissent. The majority notes the logic of assuming that the reference to a partner’s share in section 6231(a)(1)(B) is to the partner’s distributive share as determined in the partnership provisions of the Code. The Code provisions should logically be used to interpret the partnership agreement. However, the majority moves away from this more natural and logical interpretation when they suggest that the “same share” test is to be based solely upon the distributive share reflected by the partners on the partnership tax return.
I submit that the small partnership exception under section 6231 was meant to be limited to simple partnerships with 10 or fewer partners and in which distributive shares of the partnership items are determined under the partnership agreement pro rata in accordance with a partner’s interest or capital account. When complicated provisions Eire inserted into the agreement to enable a capital or other recovery by some partners before others or to flip-flop allocations, I suggest that such a partnership is not a small partnership under section 6231, because each partner’s distributive share of each partnership item may not be the same as his distributive share of every other partnership item.
Section 6231(a)(l)(B)(i) states that, for purposes of the partnership audit and litigation provisions,
The term “partnership” shall not include any partnership if—
(I) such partnership has 10 or fewer partners each of whom is a natural person (other than a nonresident alien) or an estate, and
(II) each partner’s share of each partnership item is the same as his share of every other item.
In interpreting this language, many commentators have noted the problem which now faces this Court.1 To resolve this quandary, I first find it appropriate to note that prior to the passage of the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), the Code provided no efficient means to audit many tax shelters organized as partnerships. Instead, the auditing of these partnerships and their partners was done in a fragmented and confusing fashion and resulted in a myriad of problems.2 To overcome the problems associated with the pre-TEFRA auditing of partnerships, Congress enacted the partnership audit and litigation provisions contained within TEFRA.3 By enacting these audit provisions, Congress cast a large net, excepting from the new provisions only those section 6031(a) partnerships which qualify as “small partnerships.” Sec. 6231(a)(1)(A) and (B).
Most of the problems associated with the pre-TEFRA system had arisen in connection with syndicated partnerships. However, problems of separate proceedings and potentially inconsistent results can arise even within the context of very small partnerships. Federal Income Tax Project Subchapter K - Proposals on the Taxation of Partners, American Law Institute 411 (adopted May 20, 1982; published 1984); see also Tax Compliance Act of 1982 and Related Legislation: Hearing on H.R. 6300 Before the House Comm. on Ways and Means, 97th Cong., 2d Sess. 256 (1982); cf. 111 West 16 Street Owners, Inc., Alan Silverman, Tax Matters Person v. Commissioner, 90 T.C. 1243 (1988) (focusing on the small S corporation exception to the S corporation audit and litigation procedures and suggesting that the exception’s parameters should be considered in light of whether a unified proceeding would prove futile or useless). Because these audit problems can arise within the context of small partnerships, a narrow construction of any exception to the partnership audit provisions is mandated. An examination of language found in the Conference report accompanying TEFRA and mentioned in the majority’s opinion supports this narrow construction.
The TEFRA conferees stated that the “small partnership” rules “do not apply to partnerships consisting of 10 or fewer partners each of whom is a natural person * * * , provided that every partner’s share of any partnership item is the same as his distributive share of every other partnership item. (H. Rept. 97-760 (Conf.), at 608 (1982), 1982-2 C.B. 600, 667; emphasis added.) This language clearly links a small partnership determination to a careful examination of each partner’s distributive share. Section 704(a) establishes the process by which a partner’s distributive share is determined and provides that the partnership agreement controls unless a specific exception exists.4
The language from the Conference report also refers to “any partnership item” and “every other partnership item.” As noted by the majority, partnership items are:
(i) Items of income, gain, loss, deduction, or credit of the partnership;
(ii) Expenditures by the partnership not deductible in computing its taxable income (for example, charitable contributions);
(iii) Items of the partnership which may be tax preference items under section 57(a) for any partner; [and]
(iv) Income of the partnership exempt from tax; * * *
[Sec. 301.6231(a)(3)-lT(a)(l), Temporary Proced. & Admin. Regs., 51 Fed. Reg. 13214 (Apr. 18, 1986).]
In applying the “small partnership” exception, we must then compare each partner’s distributive share of any one of these listed items to his share of every other one of these items. Our comparison is not limited under the language of the report to an analysis of those specific partnership items arising in any one taxable year.5 The report’s language thus places no limitation on our need to compare all partnership items which might represent a portion of each partner’s distributive share.
By focusing on only reported partnership items, the majority reads a limitation into the report’s language and consequently expands the notion of a “small partnership” beyond a narrow construction. By accepting such a limitation, the majority fails to compare any partnership item to every other partnership item; they instead compare only specific items to one smother.
I additionally note that, if the partnership agreement itself controls the issue, the parties can make an up-front determination regarding which procedure to follow. This focus on the agreement eliminates the need to examine operational facts regarding the partnership in order to determine jurisdiction.6 Furthermore, it is important that the determination regarding the applicability of TEFRA’s audit procedures be made at the examination stage based on fixed and knowable facts. The partnership agreement provides this factual basis. Granted, some partnership agreements may well be complex and ambiguous but, even then, the agreement is fixed and unalterable and provides a much firmer basis for determination than potentially disputed facts regarding how the partnership actually operated. 7
A hypothetical situation brings this last comment to bear. Assume individuals A and B establish AB, as cash basis partnership. A and B agree to equally share all partnership tax items, except tax-exempt income which is to be allocated wholly to A. Now suppose that AB receives income which is in actuality tax exempt. AB fails to record this tax-exempt income amount either because of inadvertence or because B disputes the partnership-level characterization of this income as being exempt. Only an in-depth examination by the Service or a court into operational facts reveals that AB does not truly qualify as a small partnership. These true facts and their consequence of nonqualification are in stark contrast to the facts as presented in the returns of the partnership and partners and the consequence of these presented facts that AB does qualify as a small partnership. A first look at the partnership agreement, however, properly reveals that AB is not a small partnership and circumvents any need to fully examine the given situation’s operational facts.
As this hypothetical situation also brings to light, a predominant focus on the facts as presented in the returns of the partnership and partners may well lead to the misreporting of partnership items by these persons in their attempt to have the partnership fall within or without the audit provisions’ exception.
Additionally, section 301.6231(a)(l)-lT(a)(3), Temporary Proced. & Admin. Regs., states that the small partnership requirements must be satisfied “during all periods” of the partnership’s taxable year. To the extent the Schedules K-l in evidence do not reflect individual period adjustments, but instead reflect aggregate allocations over an entire taxable year, a problem may arise in our resting our “small partnership” determination solely on the amounts listed on these tax forms.
I believe the majority places undue reliance on what is “required” to be reported on the partnership returns and Schedules K-l because such returns and schedules can be amended up to the date of the statutory notice of deficiency. However, the partnership agreement in effect at the time of the filing due date of the return for the partnership (or, if there is no partnership agreement, the applicable partnership law in effect at such time) is concrete, and subsequent amendments or modifications do not affect the partners’ distributive shares. See sec. 761(c). Nevertheless, the majority observes that only the partners and partnership should be bound by the partnership agreement in the determination of classification as a small partnership under the statute and that respondent should not be required to be tied to the partnership agreement in making such a determination, for it would be at his peril. However, I respectfully submit that respondent often is required to make determinations “at his peril.” See, e.g., Dellacroce v. Commissioner, 83 T.C. 269 (1984), and Matut v. Commissioner, 88 T.C. 1250 (1987), on appeal (11th Cir., Aug. 20, 1987).
Further, the majority establishes an arbitrary rule to expedite the already makeshift reporting standard which would preclude any petitioner “to claim a result other than that identified in the return and Schedules K-l as filed and amended prior to the date of commencement of the partnership audit” (majority opinion at 246-247; emphasis supplied). This judicial mandate not only is arbitrary but is inconsistent with our authority and with judicial economy. In Greenberg’s Express, Inc. v. Commissioner, 62 T.C. 324 (1974), we determined that ordinarily we will not go behind the statutory notice of deficiency, and this principle has been consistently applied by this Court since that time. Yet we now must determine when a partnership audit commences. Quo vadis? I submit that this arbitrary rule goes beyond the function and jurisdiction of this Court. It is for Congress to mandate such rules. Such is not our province. In my opinion, the majority’s promulgation of such a rule goes beyond the scope of our authority.
I am concerned that the report-oriented rule of the majority may lead to disturbing, unpredictable results that neither the Congress, the parties, nor this Court anticipated. It seems to me that the majority’s rule might make the examination process more difficult, not less so, as stressed by the majority. While there always is a partnership agreement (whether or not in writing), there are occasions when no partnership return is filed. If the partnership tax return is to be the sole guide, then what is to be looked to, for purposes of the small partnership qualification, if there is no such document? The majority’s miniregulations do not make for simple, easily determinable answers. Consequently, the examination procedure becomes more complex and is not facilitated.
Finally, I submit that the majority’s reference to section 6233 to bolster its contention is misplaced. Section 6233, essentially, says that if an entity which is not a partnership files a partnership return, then, to the extent provided in regulations under that section, the partnership level determination requirements shall apply even though it thereafter is determined that the filing entity was not a partnership. Section 6233 simply has nothing to do with whether a partnership is or is not a small partnership under section 6231. The majority acknowledges in its “logic” that the statute on its face makes the partnership agreement determinative, and the reference to the special exception under the section 6233 regulations is inappropriate. The section 6233 regulations are legislative and they provide the exception. No such legislative regulations are authorized by section 6231, and the regulations promulgated under section 6231 do not address the issue before us. The fact that the Congress has said that the facts are to be overridden by the tax return in one situation is a strong argument that the tax return is not to override the facts in other situations. Inclusio unius est exclusio alteráis. Consequently, we should follow the directive of the statutes to address that void, and that directive is in section 704.
In sum, the “small partnership” exception is an exception which must be narrowly construed. The “same share” requirement confirms that Congress was concerned with simplicity, as well as size. Only a simple partnership structure, devoid of non-pro-rata allocations, should be excluded from the partnership audit rules. The majority’s approach abandons this emphasis on a simple partnership structure and, consequently, expands the “small partnership” concept beyond a narrow construction. Further, I believe the means adopted by the majority exceeds our authority.
Because the agreement in this case contains complex allocation provisions, I submit that this case’s partnership does not qualify as a small partnership under section 6231.
CHABOT and GERBER, JJ., agree with this dissent.See Keeling, “Tax Treatment of Partnership Tax Audits,” 15 J. Real Est. Taxation 36. 44-45 (1987); see also Lewis & Brown, “Partnership Audits and Litigation Under TEFRA,” N.Y.U. Forty-Second Annual Institute on Federal Taxation, 3-1, 3-17 — 3-18 (1984); 467 Tax Management (BNA) A-3 (1987).
The problems associated with this- fragmented auditing of partnership items are discussed more fully in Federal Income Tax Project Subchapter K - Proposals on the Taxation of Partners, American Law Institute (adopted May 20, 1982; published 1984), at 397-399.
A first version of the TEFRA partnership audit and litigation provisions appeared as H.R. 6300, a bill introduced on May 6, 1982, and designated as the “Tax Compliance Act of 1982.” A second and comparatively identical bill numbered H. Rept. 6395 and labeled the “Tax Treatment of Partnership Items Act of 1982” was introduced on May 18, 1982. Neither of these proposed bills, however, contained a small partnership exception to its provisions’ application. H.R. 6300, sec. 602 adding sec. 6231(a) (1) to the Code, 97th Cong., 2d Sess. (introduced May 6, 1982); see also Tax Compliance Act of 1982 and Related Legislation: Hearing on H.R. 6300 Before the House Committee on Ways and Means, 97th Cong., 2d Sess. 259-260 (1982) (hereafter cited as Hearings). The exception represented a modification to H.R. 6300 and was added by the TEFRA conferees at the time they decided to include the provisions of H.R. 6300 as part of the act they were then considering. Compilation of conferees’ decision on H.R. 4961 — the “Tax Equity and Fiscal Responsibility Act of 1982,” 97th Cong., 2d Sess. 33 (Comm. Print 1982).
In hearings held before the House Committee on Ways and Means for H.R. 6300, John S. Nolan, the then chairman of the Section of Taxation of the American Bar Association, suggested that H.R. 6300 should provide an exception for small partnerships of 10 or fewer partners. Hearings at 259. He then stated that it would be “preferred to limit the universe somewhat further,” but he could think of no effective way to do so. Hearings at 259. Sec. 6231(a)(l)(B)(i)(II) represents an attempt by the TEFRA conferees, and ulitmately Congress, to limit further the scope of the small partnership exception.
Sec. 761(c) defines the phrase “partnership agreement” in the following manner:
(c) Partnership Agreement. — For purposes of this subchapter, a partnership agreement includes any modifications of the partnership agreement made prior to, or at, the time prescribed by law for the filing of the partnership return for the taxable year (not including extensions) which are agreed to by all the partners, or which are adopted in such other manner as may be provided by the partnership agreement.
Sec. 1.761-l(c), Income Tax Regs., amplifies upon this given definition through its statement that:
“As to any matter on which the partnership agreement, or any modification thereof, is silent, the provisions of local law shall be considered to constitute a part of the agreement.”
Noting this amplification, we must look to both the partner's agreement and State law to determine an individual partner’s distributive share of all existing and possibly existing partnership items.
Sec, 301.6231(a)(l)-lT(a)(4), Temporary Proced. & Admin. Regs., states that a small partnership determination is to be made with respect to each partnership taxable year. This yearly determination is required, however, because partners in a “small partnership” are free to change the number of partners in their partnership and to alter the terms of the agreement which bind them as partners.
If we were to adopt the majority’s approach, I have doubts as to whether the partners would be bound by the manner in which the partnership reported the items even though the facts show the return to be in error. Would such a rationale be based on principles of equitable estoppel? I am not sure that equitable estoppel could be applied in a situation where true operative facts were discovered indicating that the partnership incorrectly reported its partner’s distributive shares. See Century Data Systems, Inc. v. Commissioner, 86 T.C. 157 (1986).
If there is any doubt as to whether or not the partnership is covered by the TEFRA procedures, we can well expect respondent to proceed on alternate grounds, thus doubling the necessary administrative burdens on the Government, taxpayers, and this Court. I believe that the need to take these burdensome and inconsistent alternative approaches will be minimized (although not entirely eliminated) by taking the position which I advocate.