For partnership tax years beginning after December 31, 2017, IRS audits of most partnerships are conducted under the centralized partnership audit regime enacted by the Bipartisan Budget Act of 2015 (BBA). Adjustments are generally determined at the partnership level, and the partnership itself may owe the resulting tax unless it uses one of the alternatives the statute provides.
The Centralized Audit Regime
Section 1101 of the BBA repealed the prior TEFRA partnership audit rules for tax years beginning after December 31, 2017, and replaced them with the centralized regime in §§6221 through 6241 of the Internal Revenue Code. Under §6221(a), adjustments to partnership-related items are determined, and any tax attributable to them is assessed and collected, at the partnership level. The applicability of related penalties is also determined at the partnership level.
Two terms are central. The “reviewed year” is the partnership tax year being audited. The “adjustment year” is generally the year in which the notice of final partnership adjustment is mailed, a court decision becomes final, or an administrative adjustment request is made (§6225(d)). If the adjustments produce an “imputed underpayment,” the partnership generally pays it as of the adjustment year (§6225(a)). As a result, the cost can fall economically on the people who are partners when the audit concludes rather than those who were partners in the year audited.
How the Imputed Underpayment Is Computed
The imputed underpayment is generally determined by netting the partnership adjustments for the reviewed year and multiplying the result by the highest rate of tax in effect for that year under §1 (individuals) or §11 (corporations) (§6225(b)(1)). Because the computation starts from the highest rate, it can exceed the tax the partners would have owed individually. The modification and push-out procedures discussed below exist largely to address that.
The Partnership Representative
Each partnership must designate a partnership representative, a partner or other person with a substantial presence in the United States, who has sole authority to act on behalf of the partnership in the proceeding. If no designation is in effect, the IRS may select one (§6223(a)). The partnership and all of its partners are bound by the partnership’s actions under the regime and by any final decision in a proceeding (§6223(b)).
The representative replaces the “tax matters partner” of the TEFRA rules. Because the representative’s authority is exclusive, partnership agreements commonly address how the representative is selected and removed, what notice the other partners receive, and which decisions require partner approval.
Options During and After the Examination
Responding to proposed adjustments. At the close of the examination, the IRS generally issues a 30-day letter with its proposed adjustments, and the partnership may respond, including by filing a protest.
Modification of the imputed underpayment. After the IRS mails a notice of proposed partnership adjustment (NOPPA), the partnership generally has 270 days, which can be extended with the IRS’s consent, to submit information supporting a modification (§6225(c)(7)). Modifications can include reviewed-year partners filing amended returns that take the adjustments into account, an alternative procedure in which partners pay the tax and agree to the adjustments without amending, adjustments for tax-exempt partners, and rate modifications for adjustments allocable to C corporation partners or, for capital gains and qualified dividends, individual partners. Requests are made on Form 8980, and modifications require IRS approval.
Push-out election. Within 45 days after the date of the notice of final partnership adjustment (FPA), the partnership may elect under §6226 to “push out” the adjustments to its reviewed-year partners instead of paying the imputed underpayment. The partnership furnishes statements (Form 8986) to those partners, who take the adjustments into account on their own returns for the year they receive the statements. Interest on the resulting tax is computed at the regular underpayment rate plus two percentage points (§6226(c)(2)).
Judicial review. Within 90 days after the FPA is mailed, the partnership may petition the U.S. Tax Court, a U.S. district court, or the U.S. Court of Federal Claims (§6234(a)). Filing in a district court or the Court of Federal Claims requires a deposit of the imputed underpayment, penalties, and additions to tax (§6234(b)).
The main deadlines run from different notices: 270 days after the NOPPA to request modification, 45 days after the FPA to elect a push-out, and 90 days after the FPA to file a court petition.
Electing Out in Advance
An eligible partnership can elect out of the centralized regime for a tax year under §6221(b). The partnership must be required to furnish 100 or fewer Schedules K-1, counting the statements an S corporation partner must furnish to its own shareholders, and every partner must be an individual, a C corporation, an eligible foreign entity, an S corporation, or the estate of a deceased partner. A partnership with a partner outside those categories, such as another partnership or a trust, is not eligible. The election must be made on a timely filed return for the year, must disclose each partner’s name and taxpayer identification number, and the partnership must notify each partner. If a partnership elects out, the IRS examines the partners under the generally applicable rules rather than at the partnership level.
Correcting a Prior Return: The AAR
A partnership subject to the regime generally cannot amend the Schedules K-1 it furnished after the return’s due date (§6031(b)). To correct a prior-year return, it files an administrative adjustment request (AAR) under §6227. An AAR generally must be filed within three years after the later of the date the return was filed or its original due date, and it cannot be filed after the IRS mails a notice of an administrative proceeding for that year (§6227(c)).
Practical Considerations
Partnerships often benefit from reviewing these issues before any audit begins: whether the partnership is eligible to elect out each year, whether the partnership representative designation is current, and whether the partnership agreement addresses who bears an imputed underpayment, whether a push-out election will be made, and how former partners will cooperate. Once an examination starts, tracking the 270-day, 45-day, and 90-day periods and comparing the cost of paying the imputed underpayment with the cost of modification or a push-out are central to the decisions the partnership will face.
The Bottom Line
Under the BBA regime, the partnership is the focus of the audit, the partnership representative controls the proceeding, and the partnership may owe tax computed at the highest rate. The statute offers alternatives, including modification, the push-out election, an annual election out for eligible partnerships, and judicial review, each with its own requirements and deadlines.
Facing a partnership audit?
Tax attorney Cassra Minai, Esq. can review your partnership’s situation in a confidential consultation.