2025 Houston Law Guide | Federal and Texas State Law Guidance

Author: Chase Hill

  • Tax Court Denies Summary Judgment in Brauser v. Commissioner Over Restricted Stock Donation

    Case Overview

    In Brauser v. Commissioner, No. 20434-23, 2025 U.S. Tax Ct. LEXIS 2460 (U.S. Tax Ct. Oct. 10, 2025), the United States Tax Court, Judge Emin Toro presiding, denied a motion for summary judgment filed by taxpayers Michael and Betsy Brauser.

    The case concerns whether the Brausers may claim a charitable contribution deduction carryover for tax year 2017, stemming from their 2015 donation of 1,576,680 shares of Orbital Tracking Corp. stock to Friendship Circle of North Broward and South Palm Beach, Inc., a Florida-based tax-exempt organization under section 501(c)(3).

    Factual Background

    In late December 2015, the Brausers donated 1,576,680 shares of stock in Orbital Tracking Corp. At the time, the shares were quoted on an over-the-counter market, but trading was infrequent and typically involved low volumes. Historical pricing data showed the stock price at $1.30 per share on December 28, 2015, and $1.25 per share on December 29, 2015.

    The stock was volatile. In 2014, the price ranged from $9.00 to $0.51 per share; in 2015, it ranged from $2.37 to $0.81. By March 28, 2016, it had fallen to $0.199 per share.

    The donated stock was subject to a restrictive legend under SEC Rule 144, 17 C.F.R. § 230.144, which governs the resale of securities acquired in unregistered private offerings. Restricted shares cannot be freely traded until certain holding periods and disclosure requirements are met, or until an opinion letter removes the legend.

    The Brausers did not obtain or attach a qualified appraisal to their 2015 or 2017 tax returns. They valued the donated shares at $1 per share, below the quoted market prices.

    In February 2020, they filed an amended 2017 return to include additional Schedule C and Schedule K-1 items. The IRS examined the amended return and, on October 4, 2023, issued a Notice of Deficiency disallowing the entire charitable contribution deduction carryover and determining an additional $93,382 of tax due for 2017. The Brausers petitioned the Tax Court.

    Legal Framework

    The central issue is whether the donated stock constituted “publicly traded securities” for purposes of the charitable contribution substantiation rules in section 170(f)(11) of the Internal Revenue Code.

    Under section 170(f)(11)(D), taxpayers claiming charitable deductions exceeding $500,000 must attach a qualified appraisal to their return. The rule does not apply to “readily valued” property, such as cash or publicly traded securities, under section 170(f)(11)(A)(ii)(I).

    A security qualifies as publicly traded if, as of the contribution date, market quotations are readily available on an established securities market. Treas. Reg. § 1.170A-13(c)(7)(xi)(A)(2). However, several limitations apply:

    1. If the security’s value is based only on an interdealer quotation system, the issuer must meet five additional reporting and recordkeeping requirements. Treas. Reg. § 1.170A-13(c)(7)(xi)(B)(1)–(5).
    2. A security is not publicly traded if restrictions materially affect value or prevent free trading. Treas. Reg. § 1.170A-13(c)(7)(xi)(C).
    3. A deduction cannot be based on a value differing from the published market quotations. Id.

    The Brausers’ Position

    The Brausers argued that the Orbital Tracking shares qualified as publicly traded securities and therefore required no appraisal. They maintained that the shares were regularly traded on an over-the-counter market with published quotations. They also contended that the SEC Rule 144 legend did not materially affect value or restrict free transferability.

    They further argued that their valuation of $1 per share, although below the market quotes of $1.25 to $1.30, did not violate Treasury Regulation § 1.170A-13(c)(7)(xi)(C) because they substantially complied with the rule or because the regulation was invalid.

    In the alternative, they argued that any failure to attach an appraisal was excusable under the reasonable cause exception of section 170(f)(11)(A)(ii)(II), asserting that they relied on their long-time accountant’s professional advice in preparing their returns.

    The Commissioner’s Response

    The Commissioner opposed summary judgment, asserting that several material factual disputes remained.

    First, the Commissioner argued that the Brausers had not shown that Orbital Tracking stock was “regularly traded” as required by Treasury Regulation § 1.170A-13(c)(7)(xi)(A)(2). Evidence indicated that the stock was quoted but not consistently or actively traded.

    Second, the Commissioner noted that Orbital Tracking’s own SEC filings described the quotations as interdealer prices “without retail mark-up, mark-down or commission,” which “may not represent actual transactions.” Because the quotations were interdealer-based, the Commissioner argued that the Brausers were required to satisfy the five additional regulatory requirements under § 1.170A-13(c)(7)(xi)(B), which they had not addressed.

    Third, the Commissioner maintained that the Rule 144 legend did materially affect value because a “sell-by” legal opinion would have been required before the shares could be sold. No such opinion was obtained, and the Brausers provided no evidence about who could issue one, how long it would take, or how much it would cost.

    Finally, the Commissioner argued that reasonable cause for failing to attach an appraisal was a question of fact that required cross-examination.

    The Court’s Analysis

    Judge Toro agreed with the Commissioner that genuine issues of material fact precluded summary judgment.

    The Court identified several unresolved questions, including the regularity of trading on the OTC market, whether the quotations were based solely on interdealer pricing, whether the Rule 144 restriction affected the value or transferability of the stock, and whether the taxpayers had reasonable cause for failing to attach an appraisal.

    Citing Fla. Peach Corp. v. Comm’r, 90 T.C. 678 (1988), and Sundstrand Corp. v. Comm’r, 98 T.C. 518 (1992), aff’d, 17 F.3d 965 (7th Cir. 1994), the Court reiterated that summary judgment is appropriate only when there is no genuine dispute of material fact and a decision can be rendered as a matter of law.

    Because these factual issues remained, the Court denied the Brausers’ motion for summary judgment and ordered the parties to file a status report by November 10, 2025, describing the status of the case and recommending further proceedings.

    Practical Implications

    The decision serves as a cautionary example for taxpayers donating restricted or thinly traded stock. Even when stock is quoted on an over-the-counter market, it may not qualify as “publicly traded” if trading activity is sporadic, prices are derived solely from interdealer quotations, or SEC Rule 144 restrictions limit resale.

    To preserve charitable contribution deductions, donors should obtain qualified appraisals when in doubt, maintain evidence of market activity, and document reliance on professional advice.

    The Brauser case will proceed to further factual development, and its outcome will likely depend on expert testimony and evidence regarding trading volume, market accessibility, and the actual impact of the Rule 144 legend.

    Citation

    Brauser v. Comm’r, No. 20434-23, 2025 U.S. Tax Ct. LEXIS 2460 (U.S. Tax Ct. Oct. 10, 2025) (Toro, J.).

  • The Structure of the IRS: Who Handles Your Case?

    The Internal Revenue Service is the federal government’s administrative agency charged with enforcing the Internal Revenue Code. Its structure has a direct impact on how tax controversies are handled, since different divisions of the IRS serve different categories of taxpayers. Understanding which division is responsible for a case helps predict how issues will be developed, what kinds of examiners or attorneys will be involved, and what strategies may be most effective.

    Leadership and National Headquarters

    The IRS is an agency of the Department of the Treasury and is headed by the Commissioner of Internal Revenue, who is appointed by the President and confirmed by the Senate under I.R.C. § 7802. The Commissioner’s office in Washington, D.C. sets national policy, oversees the operating divisions, and develops major enforcement and service initiatives. The Office of Chief Counsel is also housed at headquarters, with attorneys responsible for drafting regulations, issuing rulings, and advising IRS personnel nationwide. Field attorneys from the Chief Counsel’s office represent the Commissioner in the U.S. Tax Court and certain bankruptcy proceedings.

    The Four Operating Divisions

    Since the IRS Restructuring and Reform Act of 1998, the agency has been organized around four operating divisions, each with end-to-end responsibility for a distinct group of taxpayers.

    Wage and Investment Division (W&I). This division serves the majority of individual taxpayers — roughly 120 million filers whose income consists primarily of wages and investment returns. W&I oversees return processing, customer service, and correspondence audits. Its subunits handle pre-filing assistance, return integrity and compliance checks, and administration of refundable credits.

    Small Business/Self-Employed Division (SB/SE). This division manages compliance for approximately 21 million self-employed individuals and about nine million small businesses with assets under $10 million. SB/SE is also responsible for estate and gift tax matters, employment tax issues, and most collection activity. Within SB/SE, specialized units handle field audits, compliance services, and enforcement of delinquent accounts.

    Large Business and International Division (LB&I). LB&I oversees corporations, partnerships, and other entities with assets over $10 million, many of which conduct cross-border operations. Its structure emphasizes “practice areas” focused on common issues such as transfer pricing, treaty compliance, and pass-through entity taxation. LB&I examiners handle some of the most complex audits, often involving international transactions, accounting method disputes, or specialized industries.

    Tax-Exempt and Government Entities Division (TE/GE). TE/GE addresses pension and retirement plans, public charities and private foundations, political organizations, and governmental bodies such as state and local governments. This division reviews applications for exempt status, issues determination letters, and conducts examinations to ensure ongoing compliance with statutory requirements.

    Supporting Units and Specialized Offices

    In addition to the operating divisions, the IRS has nationwide functional offices that play critical roles in tax controversies. The Criminal Investigation Division investigates potential criminal violations of the tax laws and related financial crimes. The Independent Office of Appeals provides an administrative forum for dispute resolution separate from examination, with authority to settle cases based on hazards of litigation. The Taxpayer Advocate Service acts as an ombudsman, assisting taxpayers whose cases have been stalled or whose rights may be impaired. Other units manage communications with Congress, develop compliance statistics, and support technology and research.

    Oversight and Reform Efforts

    Congress established the IRS Oversight Board under I.R.C. § 7802 to provide outside expertise in governance and accountability. Although the Board has been inactive since 2015 due to lack of confirmed members, its creation reflects ongoing concerns about IRS management and taxpayer service. The agency’s current structure was itself a product of the IRS Reform Act of 1998, which shifted the organization away from a geographic model and toward divisions based on taxpayer type. This reorganization was designed to improve service, reduce duplication, and create accountability within distinct taxpayer populations.

  • Partnership Fundamentals: What You Need to Know About Formation and Taxation

    What Exactly Is a Partnership for Tax Purposes?

    For federal tax purposes, “partnership” is defined broadly in § 761(a) as any syndicate, group, pool, joint venture, or other unincorporated organization through which a business or financial venture is carried on, provided it is not classified as a corporation, trust, or estate. Not all co-ownership arrangements qualify. For example, § 761(a)(1) and Treas. Reg. § 1.761-2(a)(2) exclude groups formed solely to hold investment property without conducting a trade or business. Likewise, co-owners of property who merely lease real estate without providing services are not treated as a partnership, but adding services can convert the arrangement into a partnership. See Treas. Reg. § 301.7701-1(a)(2).

    In other words, the IRS does not require you to file partnership papers for you to be treated as a partnership. If you and someone else are carrying on a business together—even informally—the IRS may classify you as a partnership. Simply co-owning property isn’t enough, but providing services alongside that ownership can be.

    Do You Need to File Anything Under State Law to Have a Partnership?

    Surprisingly, the answer is no. Treasury Regulation § 301.7701-1(a)(1) makes clear that a partnership may exist for federal tax purposes even without a formal entity recognized under state law. Courts look primarily to intent. In Commissioner v. Culbertson, 337 U.S. 733 (1949), the Supreme Court explained that a partnership exists when parties, in good faith and with a business purpose, intend to carry on an enterprise together and share in its profits. Contributions of labor or capital are not strictly required.

    Put simply, you don’t need to go through state filings for the IRS to treat you as a partnership. If two or more people intend to run a business and divide the profits, the law may recognize a partnership—even if no one invested money or contributed labor at the start.

    How Are Startup Costs Treated for Tax Purposes?

    When forming a partnership, certain expenses must be capitalized under § 709(a). Organizational expenses—those incident to creating the partnership and chargeable to the capital account—may be deducted up to $5,000 immediately, reduced once costs exceed $50,000, with a full phase-out at $55,000. See § 709(b). Any remaining expenses may be amortized over 180 months. Importantly, syndication fees (such as the cost of issuing partnership interests) do not qualify for this election and must be capitalized. If the partnership liquidates early, unamortized expenses may be deducted under § 165.

    In other words, some startup costs can be written off right away, but once your expenses get too high, the deduction shrinks and disappears. The balance must be spread out over 15 years. Certain fees—like those for raising capital—can never be deducted this way and must be added to the business’s long-term costs.

    How Does the IRS Decide Whether an Entity Is a Partnership or a Corporation?

    The “check-the-box” regulations in Treas. Reg. § 301.7701-3 give taxpayers flexibility. By default, unincorporated entities with more than one member are treated as partnerships, while single-member entities are disregarded as separate from their owners. Either type of entity may elect to be taxed as a corporation by filing the appropriate election. This system allows business owners to tailor tax treatment to their goals, though the choice carries long-term implications for taxation and liability.

    Put simply, if you form an LLC, the IRS has default settings: one owner means it’s ignored for tax purposes, two or more owners means it’s treated as a partnership. But you can “check the box” to be taxed as a corporation if that makes more sense for your goals. The choice is powerful but also sticky, so it should be made carefully.

    What Should I Think About When Choosing Between a Partnership and a Corporation?

    The decision between a flow-through entity and a corporation depends on multiple factors. Partnerships avoid entity-level tax and allow losses to flow through to partners. Corporations, by contrast, can defer shareholder-level tax but face double taxation on distributions. Other considerations include the availability of the § 199A deduction, exposure to employment taxes, local filing fees, creditor protection, and the ability to raise capital. No single factor controls; the optimal choice depends on the owners’ income profile and long-term strategy.

    In other words, partnerships usually mean simpler taxes because profits and losses go straight to the owners. Corporations can help with liability protection and raising money, but they come with extra layers of tax. The right choice depends on your income level, risk tolerance, and long-term plans.

    How Does the § 199A Deduction Work for Partnerships?

    Section 199A provides a deduction equal to the lesser of (1) 20% of qualified business income (QBI) or (2) 20% of taxable income reduced by net capital gains. See § 199A(a). QBI for each trade or business is further limited to the greater of (i) 50% of W-2 wages or (ii) 25% of W-2 wages plus 2.5% of the unadjusted basis immediately after acquisition of qualified property. § 199A(b)(2).

    The deduction is subject to income thresholds. For 2022, the phase-out begins at $170,050 for single filers and $340,100 for joint filers, fully phasing out at $220,050 and $440,100. § 199A(b)(3).

    Specified Service Trades or Businesses (SSTBs)—including law, accounting, consulting, financial services, athletics, and other fields where the principal asset is the reputation or skill of the owners—are further restricted. See § 199A(d)(2). For high-income taxpayers, SSTB income may be partially or entirely excluded from QBI.

    Finally, guaranteed payments under § 707(c) do not count as QBI. Nor do payments to partners acting in a non-partner capacity under § 707(a). In addition, Treas. Reg. § 1.199A-5(c)(2)(i) provides that if a trade or business provides property or services to an SSTB and both are commonly owned (50% or more), that portion of income is recharacterized as SSTB income.

    Put simply, § 199A is a valuable tax break that allows many business owners to deduct up to 20% of their income. But it comes with lots of caveats: income limits, restrictions for service professions like law and accounting, and rules against manipulating related businesses to qualify. Whether you get the deduction depends on your income level, industry, and how your partnership pays partners.s to partners acting in a non-partner capacity under § 707(a). In addition, Treas. Reg. § 1.199A-5(c)(2)(i) provides that if a trade or business provides property or services to an SSTB and both are commonly owned (50% or more), that portion of income is recharacterized as SSTB income.

  • How Do Partnerships Choose Their Taxable Year?

    One of the most important decisions in partnership taxation is determining the taxable year. Unlike individuals, who almost always file on a calendar year, partnerships face statutory limits designed to prevent deferral of income. The Internal Revenue Code and accompanying regulations set out a hierarchy of rules under IRC §706(b) to ensure that a partnership’s year aligns with that of its partners.

    What’s the Difference Between a Calendar Year and a Fiscal Year?

    A calendar year runs from January 1 to December 31, which is the default reporting period for most individuals. An alternative, sometimes called a fiscal year, ends on the last day of any month other than December. For example, a partnership might prefer a June 30 year-end if its operations are highly seasonal.

    Example:
    Imagine a farming partnership whose business cycle does not line up with the calendar year. The partnership incurs substantial expenses late in the year—such as soil preparation, fertilizer, irrigation maintenance, and labor costs—in November and December to prepare fields for the next planting season. However, the related crop is not harvested and sold until February and March of the following year.

    If the partnership must use a calendar year ending December 31, these end-of-year expenses are deducted in Year 1, while the corresponding harvest revenue is not reported until Year 2. The calendar year thus splits a single economic cycle into two different tax years:

    • Year 1 shows unusually low or negative income (because it contains the costs but not the revenue), while
    • Year 2 shows unusually high income (because it contains the revenue but not the associated costs).

    This misalignment does not change the total profit over time, but it does distort the reported annual income and creates a mismatch between revenue and the expenses that produced it..

    By contrast, if the partnership were permitted to use a fiscal year ending June 30, the entire farming cycle would fall within one taxable year. The fall planting expenses and the spring harvest revenue would be reported in the same 12-month period. This alignment provides a more accurate matching of revenue and related costs, reflecting the true economics of the farming business rather than the arbitrary cutoff of December 31.

    The IRS allows fiscal years only when specific statutory rules are satisfied, so most partnerships are required to use the calendar year unless an exception applies.

    Can a Partnership Pick Any Taxable Year It Wants?

    No. Partnerships cannot freely choose any year-end they like. Under §706(b)(1)(B)(i), the first test requires a partnership to adopt the “majority interest taxable year.” That means the taxable year of the partner or group of partners who together own more than 50% of profits and capital.

    Example: A partnership has three partners with ownership percentages of 40%, 30%, and 30%. The first two use the calendar year. Together they hold 70%, so the partnership must adopt the calendar year—even if the third partner prefers a June 30 fiscal year.

    What Happens If No Majority of Partners Share the Same Year?

    If no single group of partners with more than 50% ownership shares the same taxable year, the Code turns to the “principal partner” test. Under Treas. Reg. §1.706-1(b)(2)(i)(B), a principal partner is anyone with at least a five percent interest. If all principal partners share the same taxable year, the partnership must adopt it.

    Example: Consider a partnership with four equal partners, each holding 25%. None holds a majority, but if all four use a fiscal year ending June 30, the partnership must also use June 30.

    What If the Principal Partners All Use Different Years?

    In that case, the “least aggregate deferral” test applies. This test, found in Treas. Reg. §1.706-1(b)(2)(i)(C), requires looking at the deferral period each partner would experience under each possible taxable year and then selecting the year that minimizes the total.

    Example: Suppose a partnership has three equal partners. One uses the calendar year, one uses a June 30 fiscal year, and one uses a September 30 fiscal year.

    • If the partnership chose a calendar year, the June 30 partner would defer six months of income and the September 30 partner would defer nine months—for a total of fifteen months of deferral.
    • If the partnership chose June 30, the calendar-year partner would defer six months and the September 30 partner would defer three—for a total of nine months.
    • If the partnership chose September 30, the calendar-year partner would defer nine months and the June 30 partner would defer three—for a total of twelve months.

    Because nine months is the least aggregate deferral, the partnership must adopt the June 30 fiscal year.

    Is There Any Flexibility to Use a Different Year?

    Yes, but only in limited circumstances. Under Treas. Reg. §1.706-1(b)(2)(ii), a partnership may adopt a different taxable year if it can demonstrate a substantial business purpose. For instance, a farming partnership may argue that a year ending after harvest better reflects its income cycle. However, the IRS interprets this exception narrowly and usually requires a formal request on Form 1128.

    What Does This Mean in Practice?

    For most partnerships, especially those made up of individuals, the answer will be simple: the calendar year will control. But where ownership is split among institutional or fiscal-year partners, or where seasonal business cycles provide a strong case for a business-purpose exception, the outcome can shift. The overall structure of the rules shows that Congress and the IRS are determined to prevent manipulation—partnerships cannot simply select a fiscal year that allows partners to defer reporting income.

  • I Received a 30-Day Letter from the IRS — Now What?

    Receiving a 30-day letter from the IRS can be unsettling. This notice, usually accompanied by a Revenue Agent’s Report, explains proposed changes to your tax return and calculates the additional tax the IRS believes you owe. For example, the report might show an underpayment of $20,000 based on adjustments to income or deductions. The “30-day” part refers to the short deadline you have to decide how to respond. Here are the main options.

    1. Agree and Pay

    If you review the report and conclude the IRS is correct, you can agree with the changes, sign the waiver included with the letter, and pay the amount due (plus interest). This ends the matter quickly and avoids further administrative or judicial proceedings.

    2. Pay and Preserve Your Rights

    Even if you disagree, you may choose to pay the tax first and then file a formal claim for refund. If the IRS denies the claim or fails to act within six months, you can bring a refund suit in a U.S. District Court (with the possibility of a jury trial) or in the U.S. Court of Federal Claims (bench trial only). This route requires upfront payment but preserves the ability to litigate.

    3. File a Protest and Go to Appeals

    If you do not want to pay right away, you can file a written protest within 30 days. This sends your case to the IRS Independent Office of Appeals, which is separate from the audit function. Appeals officers have authority to settle cases based on the “hazards of litigation,” meaning they evaluate the strengths and weaknesses of both sides. Many taxpayers resolve disputes here without having to go to court.

    4. Take No Action and Await a Notice of Deficiency

    If you ignore the 30-day letter, the IRS will eventually issue a Notice of Deficiency — sometimes called a “90-day letter.” That notice gives you 90 days to file a petition in the U.S. Tax Court. The Tax Court is unique because it allows you to litigate before paying the disputed tax. However, if you miss the 90-day deadline, you lose that option and must pay first before challenging the assessment.

    Making the Right Choice

    Which path is best depends on the size of the proposed adjustment, the strength of your legal position, and whether you can or want to pay the disputed tax upfront. Acting within the deadlines is critical. Ignoring the letter will not make the issue disappear — it only moves the case further down the IRS enforcement pipeline.

  • The Tax Controversy Pipeline: From Audit to Litigation

    A federal tax controversy follows a recognizable path, beginning with the selection of a tax return for examination and potentially ending with judicial review in federal court. Each stage offers opportunities to resolve disputes, but each also carries procedural requirements that affect taxpayer rights and strategy.

    Return Selection

    The IRS examines only a small percentage of filed returns, but its selection process is increasingly sophisticated. Many returns are chosen through the Discriminant Inventory Function (DIF) system, which assigns scores based on statistical likelihood of error. Others are identified through compliance campaigns, whistleblower tips, or third-party information reporting. Certain transactions, such as those involving large losses, international activity, or complex structures, are more likely to attract IRS attention.

    Examination

    Once a return is selected, the IRS initiates an examination, commonly referred to as an audit. Examinations may be conducted by correspondence, in an IRS office, or in the field. During this process, the IRS requests documents, interviews taxpayers, and evaluates whether the reported items comply with the law. If the IRS proposes changes, it issues a Revenue Agent’s Report. The taxpayer may agree and resolve the case, or disagree and move forward in the process.

    Administrative Appeals

    If the taxpayer contests the proposed adjustments, the matter may proceed to the Independent Office of Appeals. Appeals is separate from IRS Examination and is empowered to settle cases based on the “hazards of litigation.” This means Appeals weighs the strengths and weaknesses of each side’s position and may compromise accordingly. For many taxpayers, Appeals represents the best opportunity to resolve a case without the time and expense of litigation.

    Judicial Forums

    When administrative resolution fails, taxpayers may turn to the courts. Three forums are available, each with distinct advantages:

    • U.S. Tax Court. This is the primary pre-payment forum, allowing taxpayers to challenge a deficiency before paying it. Proceedings are specialized, with judges experienced in tax law.
    • U.S. District Courts. Taxpayers may pay the disputed tax and sue for a refund in the federal district court for their jurisdiction. District court cases allow for jury trials, which may be strategically important in certain disputes.
    • U.S. Court of Federal Claims. Like the district courts, this forum hears refund suits, but it sits in Washington, D.C. and has nationwide jurisdiction.

    The choice of forum depends on multiple factors, including the taxpayer’s ability to pay, the type of issue, procedural preferences, and perceived judicial outlook.

    Collection Proceedings

    Even after liability is determined, disputes may continue at the collection stage. The IRS has broad authority to assess liens, levy assets, and garnish wages. Taxpayers can contest these actions through Collection Due Process hearings or administrative appeals. In some cases, litigation arises over the appropriateness of collection measures or the availability of installment agreements and offers in compromise.

    Strategic Considerations

    At every stage of the pipeline, taxpayers and their advisors must weigh cost, risk, and procedural posture. Early resolution may be preferable to avoid litigation, but in some cases judicial review is the only way to secure an independent evaluation. Understanding the stages of a tax controversy helps practitioners guide clients effectively through what is often a lengthy and complex process.

  • What Are Separately Stated Items in a Partnership Return?

    Why Aren’t All Partnership Items Reported Together?

    Partnerships file an annual information return, but unlike corporations, they are not subject to entity-level tax. Instead, income, deductions, credits, and other items flow through to the partners under IRC §702(a). However, not all items are treated the same for tax purposes. Some must be “separately stated” because their treatment depends on each partner’s individual tax circumstances.

    In other words, while ordinary business income can be reported as a lump sum, items like capital gains, charitable contributions, and foreign tax credits may have very different consequences depending on who the partner is. For that reason, the partnership must identify and pass these items through separately.

    What Counts as a Separately Stated Item?

    The Code and regulations identify a list of items that must be disclosed separately on a partner’s Schedule K-1, including:

    • Short-term and long-term capital gains and losses
    • Section 1231 gains and losses
    • Charitable contributions
    • Dividends (qualified or otherwise)
    • Foreign taxes paid or accrued
    • Tax-exempt interest
    • Other items identified in the regulations at Treas. Reg. §1.702-1(a)(8)(i)-(ii)

    Each of these can impact a partner’s tax liability in different ways, so they cannot simply be included in the “bottom line” partnership income.

    Example: Why Separate Reporting Matters

    Imagine a partnership with two equal partners. The partnership earns $100,000 of ordinary business income and also realizes a $20,000 long-term capital gain.

    • If everything were lumped together, each partner would be allocated $60,000 of “income.”
    • But that would obscure the fact that $10,000 of each partner’s allocation is a capital gain.

    For a partner in the 15% capital gains bracket, that $10,000 is taxed more favorably than ordinary income. For a partner with capital losses from other investments, that $10,000 might offset those losses. The Code requires that this item be separately stated so each partner can apply their own tax situation correctly.

    Example: Charitable Contributions

    Suppose the same partnership donates $10,000 to a qualified charity. The deduction must be reported separately because it is subject to each partner’s own §170 limitations (generally based on adjusted gross income). Partner A, with significant AGI, may deduct the full $5,000 share. Partner B, with limited AGI, may only deduct a portion this year and carry the rest forward. Without separate reporting, this individualized limitation would be impossible to apply.

    The Bottom Line

    Separately stated items under IRC §702(a) ensure that each partner’s distributive share reflects the real tax consequences applicable to them individually. While it adds complexity to partnership reporting, it is a necessary safeguard to make sure tax rules apply fairly and consistently.

  • What Tax Elections Can a Partnership Make?

    One of the defining features of partnerships is that the entity, not the individual partners, is responsible for making most tax elections. These elections can significantly affect how income, deductions, and credits are reported, so understanding who controls them is crucial. For example, if a partnership purchases equipment costing $100,000, it must decide whether to claim immediate expensing under §179 or depreciate the equipment over several years under MACRS. That election is made at the partnership level, and whichever method is chosen determines how each partner reports their share of income or loss. An individual partner cannot unilaterally decide to depreciate while others expense — the decision binds everyone.

    Example: Suppose the partnership has $200,000 of ordinary business income before depreciation, with two partners: A owns 50% and B owns 50%.

    • If the partnership elects §179 expensing, the entire $100,000 deduction is taken in Year 1. Taxable income is reduced to $100,000, and each partner is allocated $50,000 of income.
    • If the partnership uses MACRS 5-year straight-line depreciation, only $20,000 is deducted in Year 1. Taxable income is reduced to $180,000, and each partner is allocated $90,000 of income. The remaining $80,000 deduction is spread evenly across future years, continuing to reduce each partner’s share of income by $10,000 annually.

    This comparison shows how a single partnership-level election can dramatically affect the timing of income recognized by each partner, even though the total deduction over time is the same.

    Who Makes Tax Elections in a Partnership?

    Under IRC §703(b), the partnership as an entity makes all elections affecting the calculation of taxable income, except for a few elections reserved to the individual partners. This means decisions about depreciation methods, accounting conventions, and the treatment of organizational expenses are made collectively at the partnership level and bind all partners.

    In other words, if you are a partner, you cannot simply choose your own depreciation schedule or accounting method for partnership items. Those decisions are made once, for the entire partnership, and apply uniformly to every partner’s distributive share.

    Example: Depreciation Election in a Partnership

    The Setup

    • Partnership has $200,000 of ordinary income before depreciation in years 1 and 2.
    • It buys $100,000 of 5-year equipment.
    • Two partners: A owns 60%, B owns 40%.
    • Partner A would prefer §179 expensing (immediate deduction).
    • Partner B would prefer MACRS 5-year straight-line depreciation (~$20,000 per year).

    Scenario 1: Partnership Elects §179 Expensing

    • Year 1 Deduction: $100,000
    • Taxable income: $200,000 – $100,000 = $100,000

    Allocations:

    • Partner A (60%): $60,000 income
    • Partner B (40%): $40,000 income
    • Year 2 Deduction: $0 (no depreciation left)
    • Taxable income: $200,000 – $0 = $200,000

    Allocations:

    • Partner A (60%): $120,000 income
    • Partner B (40%): $80,000 income

    Scenario 2: Partnership Uses MACRS Depreciation

    • Year 1 Deduction: $20,000
    • Taxable income: $200,000 – $20,000 = $180,000

    Allocations:

    • Partner A (60%): $108,000 income
    • Partner B (40%): $72,000 income
    • Year 2 Deduction: $20,000
    • Taxable income: $200,000 – $20,000 = $180,000

    Allocations:

    • Partner A (60%): $108,000 income
    • Partner B (40%): $72,000 income

    Why Partners Cannot “Split” Elections
    If Partner A expensed and Partner B depreciated, Year 1 would look like this:

    • A’s share of income: $60,000 – (A’s “share” of $60,000 deduction) = $0
    • B’s share of income: $80,000 – (B’s “share” of $20,000 deduction) = $60,000

    By Year 2, A would have no deduction while B would still get $8,000 of depreciation. That kind of mismatch is exactly why IRC §703(b) requires the partnership to make one election for all partners.

    Are There Exceptions Where Partners Make Their Own Elections?

    Yes. While the partnership controls most elections, certain ones are made at the partner level. These include elections under:

    • §108(b)(5): Reduction of basis of depreciable property when income from cancellation of debt is excluded.
    • §108(c)(3): Elections relating to qualified real property business indebtedness.
    • §617: Deduction and recapture rules for mining exploration expenditures.
    • §901: The foreign tax credit.

    Each of these elections reflects an area where Congress determined that the consequences are highly personal to the individual taxpayer’s circumstances.

    Example: Suppose a partnership incurs foreign income taxes. The election to claim a foreign tax credit under §901 is made individually by each partner. One partner might claim the credit, while another might deduct the taxes instead, depending on which treatment yields the greater benefit given their overall tax situation.

    What Happens With Contributed Property?

    Special rules apply when a partner contributes property with built-in accounting attributes. Under IRC §168(i)(7), if a partner contributes depreciable property to the partnership, the partnership must continue to use the contributor’s method and recovery period for that property. This prevents a “reset” of depreciation schedules simply by shifting the asset into partnership form.

    Example: If a partner has a machine that has been depreciated for three years under MACRS and contributes it to the partnership, the partnership cannot restart depreciation as if it were newly acquired. Instead, it must continue using the same depreciation method and remaining recovery period the partner was already using.

    Why Does This Matter for Partners?

    Because elections can shape the timing and character of income, they influence not only when tax is paid but also how it interacts with other parts of the Code. Uniformity at the partnership level promotes consistency and prevents manipulation, but it also means individual partners must live with decisions they did not personally make.

    For new partners, this highlights the importance of due diligence before buying into a partnership. The entity may already have made elections that bind every partner going forward. For existing partnerships, these rules underscore the need for careful planning, because the wrong election could have ripple effects for years.

  • Who Handles Tax Disputes in the Federal System?

    When a tax dispute arises, it can feel overwhelming to figure out who exactly is involved. Federal tax controversies are not handled by a single office or court — several government entities share responsibility. Each plays a distinct role in making, interpreting, enforcing, and litigating tax law.

    Congress

    Congress writes the Internal Revenue Code. It enacts the statutes that set out what income is taxable, which deductions and credits are available, and the rates at which tax is imposed. Every tax rule starts with legislation.

    Treasury Department

    The Treasury Department issues regulations that interpret and implement the Code. These regulations provide detailed guidance on how statutory provisions apply in practice. Regulations carry significant legal weight and are often central in disputes.

    Internal Revenue Service (IRS)

    The IRS is the administrative agency charged with enforcing the Code. It issues tax forms, processes returns, conducts audits, collects taxes, and attempts to resolve disputes at the administrative level. The IRS is the primary point of contact for taxpayers and the central player in most controversies.

    Joint Committee on Taxation

    This congressional committee has a specific oversight role: it must approve refunds exceeding $2 million before they can be issued. While not directly involved in day-to-day disputes, the committee provides an additional layer of accountability for very large refund claims.

    Department of Justice (DOJ)

    When tax cases move to federal court (other than the U.S. Tax Court), the DOJ represents the government. DOJ attorneys handle both civil and criminal tax litigation in U.S. District Courts and the U.S. Court of Federal Claims.

    The Courts

    Several courts provide judicial resolution of tax controversies, each with distinct rules:

    • U.S. Tax Court. A specialized national court where taxpayers may challenge a deficiency without first paying the tax. IRS Chief Counsel attorneys represent the Commissioner here.
    • U.S. District Courts. General federal trial courts. Taxpayers must pay first and sue for a refund. These courts allow jury trials.
    • U.S. Court of Federal Claims. Located in Washington, D.C. Like district courts, refund suits require payment first, but no jury trials are available.
    • U.S. Courts of Appeals. Review decisions of the Tax Court, district courts, and the Court of Federal Claims.
    • U.S. Supreme Court. The final arbiter of tax law, though it hears relatively few tax cases.

    Why This Matters

    Understanding which entity is responsible at each stage of a tax controversy helps taxpayers and their advisors make informed decisions. A dispute may begin with an IRS audit, move to Appeals, and then proceed into litigation in Tax Court or a refund forum. At higher levels, appellate courts and even the Supreme Court may weigh in. Knowing the role of each player ensures taxpayers preserve their rights and navigate the process strategically.

  • Cash vs. Accrual for Partnerships: IRS Rules, Exceptions, and Tax Planning

    Choosing an accounting method determines when your partnership recognizes income and deductions. For many partnerships the cash method defers tax until money actually changes hands; the accrual method accelerates recognition when the right to receive or the obligation to pay arises. Federal law restricts who may use cash accounting. Under I.R.C. § 448(a)(2), a partnership cannot use the cash method if any partner is a C corporation, unless an exception applies. Two principal exceptions are (i) when the C-corporation partner is a personal service corporation (PSC) (§ 448(b)(2)), and (ii) when the partnership’s average annual gross receipts for the preceding three taxable years do not exceed $25 million (§ 448(b)(3)). In addition, a partnership may not use the cash method if it is a “tax shelter” as defined for these purposes in § 461 (§ 448(a)(3)).

    What the cash–accrual choice actually changes

    Under cash accounting, your partnership recognizes $1 of income only when it receives $1 of payment, and a deduction only when it pays the expense. Under accrual accounting, your partnership recognizes income when all events fix the right to receive it and the amount is determinable with reasonable accuracy, and it deducts expenses when all events have occurred that establish the liability and the amount can be determined with reasonable accuracy (subject to the economic performance rules). The difference is purely timing, but timing drives tax.

    Illustrative timing example

    • Facts. On December 28, Year 1, the partnership provides services and invoices $900,000 payable on January 15, Year 2. It also receives an invoice for $300,000 of deductible services performed in late December, which it pays on January 10, Year 2. Assume a 30% combined marginal rate for the partners.
    • Cash method (permitted only if eligible under § 448).
      Year 1 income recognized: $0 (no cash received)
      Year 1 deductions: $0 (no cash paid)
      Year 1 tax on these items: $0
      Year 2 recognizes $900,000 income and $300,000 deductions, for $600,000 net; tax at 30% = $180,000 in Year 2.
    • Accrual method.
      Year 1 income recognized: $900,000 (fixed right to payment)
      Year 1 deductions: $300,000 (fixed liability; economic performance satisfied)
      Year 1 net income: $600,000; tax at 30% = $180,000 in Year 1.

    Same amount of tax, different year. Cash accounting can be attractive when receivables are large at year-end; accrual can be preferable when you routinely incur significant unpaid expenses at year-end.

    The C-corporation partner limitation and the PSC exception

    If a partnership has any C-corp partner, § 448(a)(2) says the partnership cannot use the cash method—unless the C-corp is a PSC (§ 448(b)(2)). A PSC generally is a C corporation whose principal activity is the performance of personal services (for example, law, accounting, health) substantially performed by employee-owners. If your only corporate partner is a PSC, the bar in § 448(a)(2) does not apply, and you may still use cash accounting provided no other restriction applies (e.g., being a tax shelter).

    PSC exception example

    • Facts. P is a three-member partnership providing consulting services. Partners A and B are individuals. Partner C is a PSC. P’s three-year average gross receipts are $38 million.
    • Result. Despite exceeding $25 million, P may still use the cash method because its C-corp partner is a PSC under § 448(b)(2) (and assuming P is not a tax shelter under § 461). If Partner C were a regular C-corp, P would be pushed to accrual under § 448(a)(2).

    The small-partnership gross receipts exception

    Even with a non-PSC C-corp partner, a partnership can use cash accounting if it qualifies as a small partnership under § 448(b)(3)—i.e., its average annual gross receipts for the prior three taxable years do not exceed $25,000,000.

    Computing the three-year average: step-by-step

    • Facts. Gross receipts were: Year −3: $22,000,000; Year −2: $24,000,000; Year −1: $26,000,000.
    • Average. ($22m + $24m + $26m) / 3 = $24,000,000.
      Because $24m ≤ $25m, the partnership may use the cash method (§ 448(b)(3)), even if one partner is a non-PSC C-corp and the partnership is not a tax shelter.
    • If Year −1 had been $30,000,000:
      Average = ($22m + $24m + $30m)/3 = $25,333,333 → exceeds $25m → must use accrual (unless the PSC exception applies).

    “Cliff” year illustration with tax impact

    • Facts. In Year 1 your three-year average first exceeds $25m, forcing a switch to accrual for Year 1. On January 1 you have $8,000,000 of accounts receivable and $3,000,000 of accounts payable carried over from Year 0 under cash accounting.
    • Method change mechanics. A change in accounting method generally requires IRS consent and a § 481(a) adjustment to bring previously unrecognized items into income (or expense). Here, the positive § 481(a) adjustment is typically the net of receivables minus payables not previously recognized under cash: $8m − $3m = $5,000,000 added to income. If taken into account over four years (common for positive adjustments), the partnership picks up $1,250,000 per year, increasing partner-level tax accordingly.
    • Tax effect (30% combined rate): Additional $375,000 tax per year for four years. Planning ahead to manage receivables and payables before the switch can materially soften the blow.

    The “tax shelter” prohibition

    Even if the PSC and gross receipts exceptions would otherwise allow cash accounting, a partnership cannot use the cash method if it is a tax shelter (§ 448(a)(3)). For these purposes “tax shelter” is determined under § 461. While most operating partnerships will not be tax shelters, arrangements promoted to generate tax benefits without corresponding economic substance can fall within the definition. If a partnership is a tax shelter, it must use accrual—no small-partnership or PSC relief.

    Tax shelter screen example

    • Facts. Partnership Q has average receipts of $9 million and no corporate partner. It markets interests to outside investors primarily for projected tax losses.
    • Result. If Q is a tax shelter within the meaning of § 461, § 448(a)(3) disqualifies it from the cash method despite being under $25m and lacking a C-corp partner. Q must adopt accrual.

    Strategic considerations when you can choose

    Where cash accounting is permitted, partnerships with long receivable cycles often benefit from deferral. Conversely, capital-intensive businesses with significant year-end payables (or cost accruals) may find accrual advantageous. Your choice can also interact with other provisions (for example, inventories and cost capitalization rules) and with how income is allocated among partners.

    Side-by-side tax deferral math

    • Facts. Year 1 billings of $5,000,000 are invoiced in late December and collected in January; deductible Year 1 services of $1,500,000 are invoiced in December and paid in January. Assume no other differences and a 30% combined marginal rate.
    • Cash method (eligible partnership):
      Year 1 recognizes $0 of the late-December billings and $0 of the unpaid expenses → $0 current-year tax on those items.
      Year 2 recognizes $5,000,000 − 1,500,000 = $3,500,000 net → $1,050,000 tax.
    • Accrual method:
      Year 1 recognizes $5,000,000 − 1,500,000 = $3,500,000 net → $1,050,000 tax.
      Deferral from cash method: $1,050,000 moved from Year 1 to Year 2. The total tax is the same; the time value of deferral is the advantage.

    Common transition pitfalls and how to avoid them

    1. Crossing the $25m threshold unknowingly. The three-year average can creep up quickly. Model your receipts quarterly so you are not surprised by a forced switch under § 448(b)(3).
    2. Ignoring aggregation/affiliation effects. Related-party gross receipts may be aggregated for the test under the statute and regulations; organizational changes can move you over the threshold.
    3. Missing the consent process. Changing methods generally requires a Form 3115 filing and a properly computed § 481(a) adjustment. Skipping this can lead to audit exposure and duplicate income.
    4. Assuming the PSC exception applies. Verify that a corporate partner meets the PSC definition; otherwise, the presence of a regular C-corp forces accrual (§ 448(a)(2)).
    5. Overlooking the tax-shelter rule. If the structure could be characterized as a tax shelter under § 461, cash accounting is off the table (§ 448(a)(3)) regardless of receipts.

    Quick reference to governing provisions

    • Cash method limitations for partnerships with C-corp partner: I.R.C. § 448(a)(2)
    • PSC exception: § 448(b)(2)
    • Small-partnership gross receipts exception (three-year average ≤ $25m): § 448(b)(3)
    • Tax shelter prohibition (by reference to § 461): § 448(a)(3)
    • Tax shelter definition context: § 461
    • Method change conformity (general adjustment rule): § 481(a) (for transitions)

  • I Received a Notice of Deficiency — What Are My Options?

    A Notice of Deficiency, often called a “90-day letter,” is one of the most important documents the IRS can issue. It signals that the IRS has formally determined you owe additional tax and intends to assess it. The notice triggers strict deadlines and limited choices for how to respond.

    Petition the U.S. Tax Court

    The primary option is to file a petition with the U.S. Tax Court within 90 days of the notice’s date. The Tax Court is unique because it allows taxpayers to challenge the IRS’s determination before paying the disputed tax. This provides a valuable opportunity to have an independent judge review the IRS’s position. If the deadline is missed, the right to Tax Court review is lost.

    Pay First and Seek a Refund

    Taxpayers may also choose to pay the disputed amount in full and then file a formal claim for refund with the IRS. If the claim is denied or not acted upon within six months, the taxpayer can pursue a refund suit in federal court. Two forums are available: a U.S. District Court, where jury trials are possible, or the U.S. Court of Federal Claims, which hears refund suits without juries. This path requires upfront payment but preserves judicial review.

    Take No Action

    If no action is taken, the IRS will assess the deficiency after the 90-day period expires and begin collection through liens, levies, or wage garnishment. Inaction effectively concedes the IRS’s determination and removes the opportunity for independent review.

    Why Timely Action Matters

    The Notice of Deficiency is more than just another IRS letter — it is a formal legal notice that starts the countdown to significant rights and consequences. Taxpayers must decide promptly whether to contest the IRS in Tax Court, pay and seek a refund, or allow the assessment to proceed. Understanding these options ensures that important rights are not lost by default.

  • What Is a Federal Tax Controversy?

    Federal tax controversies arise when a dispute develops between a taxpayer and the federal government over the proper application or enforcement of the Internal Revenue Code. These disputes may involve individuals, small businesses, large corporations, or tax-exempt organizations. They can be resolved administratively within the Internal Revenue Service (IRS) or judicially in one of several federal courts. Unlike routine tax compliance, which focuses on timely and accurate filing of returns, controversies begin when the IRS challenges a taxpayer’s position or the taxpayer challenges an IRS determination.

    Key Government Participants

    Although the IRS is the most visible participant, several government entities play important roles in the process. Congress enacts the statutes that govern federal tax obligations. The Treasury Department issues regulations and sub-regulatory guidance interpreting those statutes. The IRS enforces the law by issuing forms, examining returns, assessing liabilities, and collecting taxes. The Department of Justice Tax Division litigates federal civil tax cases in the district courts and the Court of Federal Claims, as well as all federal criminal tax cases. The Joint Committee on Taxation must approve any refund exceeding $2,000,000. Despite this broad institutional framework, the IRS serves as the primary front-line agency in tax controversies, handling the bulk of examinations, administrative appeals, and collections.

    The Stages of a Tax Controversy

    A tax controversy typically follows a predictable sequence. It begins with return selection, where the IRS identifies a return for review, often through automated scoring systems, referrals, or compliance campaigns. The next stage is examination, where the IRS reviews the return and may propose adjustments. If the taxpayer disagrees, the matter can proceed to the IRS Independent Office of Appeals, which is designed to provide a forum for resolution short of litigation. If no agreement is reached, the taxpayer can seek judicial review. The U.S. Tax Court provides a pre-payment forum, allowing the taxpayer to challenge the deficiency without first paying it. Alternatively, taxpayers may pay the disputed tax and pursue a refund suit in either a U.S. District Court or the U.S. Court of Federal Claims. Even after liability is resolved, disputes may continue over collection actions such as liens, levies, or installment agreements.

    Administrative vs. Judicial Resolution

    The distinction between administrative and judicial resolution is critical. Administrative proceedings are generally more efficient and less costly, but they take place within the IRS, which acts as both examiner and adjudicator. Judicial proceedings provide independence and formal procedural protections, but often require greater expense and, in refund cases, pre-payment of the tax in dispute. This dual system is designed to balance administrative efficiency with the taxpayer’s right to due process.

    Why Tax Controversies Matter

    The stakes in tax controversies can be substantial. Financial exposure often includes not only the underlying tax but also penalties and interest. In some cases, precedent set in a single case affects the treatment of many similarly situated taxpayers. Equally important are the rights at issue: the right to be informed, the right to quality service, the right to pay no more than the correct amount of tax, and the right to appeal an IRS determination in an independent forum. Tax controversies also shed light on broader systemic issues, including the “tax gap” — the difference between taxes legally owed and taxes actually collected. By some estimates, this gap reaches hundreds of billions of dollars annually. Effective resolution of controversies therefore serves not only the interests of individual taxpayers but also the integrity of the federal tax system as a whole.