For partnership tax years beginning after December 31, 2017, the Bipartisan Budget Act of 2015 (BBA) replaced the prior partnership audit rules with a centralized regime. The IRS examines the partnership, determines adjustments at the partnership level, and generally collects any resulting tax from the partnership itself unless the partnership chooses an alternative. A single partnership representative acts for the partnership, and the partners are bound by its actions.
Which Partnerships Are Covered
The regime applies to partnerships, including LLCs taxed as partnerships, unless the partnership elects out. It does not apply to S corporations, although an S corporation can be a partner in a partnership that is subject to it.
A partnership can elect out for a year only if it is required to furnish 100 or fewer Schedules K-1 and every partner is an individual, a C corporation, a foreign entity that would be a C corporation if it were domestic, an S corporation, or the estate of a deceased partner. When an S corporation is a partner, its shareholders count toward the 100 limit. The election is made each year on a timely filed return, must identify each partner, and partners must be notified. A partnership with another partnership or a trust as a partner cannot elect out.
What Changed
Before 2018, many partnerships were examined under the TEFRA unified audit procedures, with adjustments ultimately assessed against the partners, and some small partnerships were examined partner by partner. Under the BBA, the default rule is different: the partnership itself pays an “imputed underpayment.”
How an Examination Proceeds
The IRS examines the partnership return for the “reviewed year.” If it proposes changes, it issues a notice of proposed partnership adjustment. After the modification period, it issues a notice of final partnership adjustment.
By default, the partnership pays the imputed underpayment in the “adjustment year,” the year the adjustment becomes final. The imputed underpayment is generally computed by netting the adjustments and applying the highest individual or corporate tax rate in effect for the reviewed year. Because the partnership pays, the economic cost can fall on those who are partners when the adjustment is made rather than those who were partners in the year under review.
Modification
Within 270 days after the notice of proposed partnership adjustment is mailed, unless the IRS agrees to extend that period, the partnership can ask the IRS to modify the imputed underpayment. One method is for reviewed-year partners to file amended returns, or use an alternative procedure, that take their share of the adjustments into account and pay the tax due. Those adjustments are then removed from the imputed underpayment.
Push-out election
Within 45 days after the notice of final partnership adjustment, the partnership can elect to “push out” the adjustments by furnishing statements to the reviewed-year partners and the IRS. The partners then take their shares into account on their own returns, and the partnership is not liable for that imputed underpayment.
Judicial review
Within 90 days after the notice of final partnership adjustment is mailed, the partnership may file a petition in the Tax Court, the federal district court for the district of its principal place of business, or the Court of Federal Claims. A petition in district court or the Court of Federal Claims requires a deposit of the imputed underpayment and related amounts.
Under the BBA, the tax from a partnership audit is generally assessed against the partnership, not the individual partners, unless the partnership uses the modification or push-out procedures. The timing of those choices is set by statute.
The Partnership Representative
Each partnership must designate a partnership representative, who may be a partner or another person with a substantial presence in the United States. The representative has sole authority to act on behalf of the partnership in the proceeding. If no designation is in effect, the IRS may select one. The partnership and all partners are bound by the partnership’s actions and by any final decision in the proceeding.
The statute does not give individual partners a right to participate in the examination. Their protections come mainly from the partnership agreement and state law.
Correcting a Prior Return
A partnership subject to the regime generally corrects a previously filed return by filing an administrative adjustment request rather than an amended return. Partners must report items consistently with the partnership’s return or disclose an inconsistent position on Form 8082.
Partnership Agreement Provisions to Consider
- How the partnership representative is selected, removed, and replaced.
- Prompt notice to partners of IRS contacts and proposed adjustments.
- Whether partner consent is needed for settlements, statute extensions, or a push-out election.
- How an imputed underpayment is allocated among current and former partners, and whether former partners must contribute or cooperate.
- Partners’ obligations to provide information needed for modification requests.
- Whether the partnership should elect out in years when it is eligible.
The Bottom Line
The BBA regime shifted partnership audits to the entity level, gave a single partnership representative authority over the proceeding, and made the partnership the default payer of any tax due. Partners protect themselves mainly through the partnership agreement and by understanding the modification and push-out options before an examination begins.
Facing a partnership audit?
Tax attorney Cassra Minai, Esq. can review your situation in a confidential consultation.