The TEFRA rules do not apply to certain entities called small partnerships. These small partnerships have two requirements that must be met for the exception to disallow TEFRA rules. These requirements include:
1. The partnership must have 10 or less partners.
2. All partners are natural persons who are U.S. citizens or resident aliens, C corporations, or estates of deceased partners.
These two requirements are generally viewed as mandatory and must be present to waiver the TEFRA rules. Thus, a small partnership can specially allocate items without jeopardizing its exception from the TEFRA rules. However, flow-through entities cannot be a partner for the exception to apply.
TEFRA Partnership Exception Examination
If the IRS examines the partnership for TEFRA qualification, each tax year is examined separately to determine whether the small partnership exception applies. For this reason, a partnership may be subject to the TEFRA procedures in one year but not the next year and vise versa.
Non-TEFRA Audit Procedures
Under non-TEFRA audit procedures, the IRS will notify each partner in the partnership separately of the pending audit. Each partner will separately control the audit and any extension of the statute of limitations. The normal statute of limitations runs for three years from the date the partner’s return is filed.