Centralized Partnership Audit Regime Explained: Key Details for Partners

The Centralized Partnership Audit Regime (CPAR) changed how the IRS audits partnerships, shifting tax liability from individual partners to the partnership itself. This system simplifies audits but introduces new responsibilities and financial consequences. Understanding CPAR is essential for managing risks and compliance.

Eligibility Criteria

Not all partnerships fall under CPAR. Those with 100 or fewer eligible partners can opt out if they meet specific conditions. Eligible partners include individuals, C corporations, S corporations, and estates of deceased partners. Partnerships with another partnership, a trust, or a disregarded entity as a partner cannot opt out.

The 100-partner threshold is based on the number of K-1s issued. If an S corporation is a partner, each of its shareholders counts toward the total. For example, a partnership with an S corporation partner that has 50 shareholders would be considered to have 51 partners for CPAR purposes.

The opt-out election must be made annually on a timely filed tax return. If a partnership does not make the election, it remains under CPAR.

The Partnership Representative

Every partnership under CPAR must designate a Partnership Representative (PR), who serves as the sole point of contact with the IRS during an audit. The PR has exclusive authority to act on behalf of the partnership, including negotiating settlements and agreeing to adjustments. Once a decision is made, it is binding on the entire partnership and all partners.

A PR does not have to be a partner but must have a substantial presence in the U.S., including a taxpayer identification number, a U.S. address, and availability to meet with the IRS. If an entity is selected as PR, it must appoint a designated individual to act on its behalf. This allows partnerships to choose someone with tax expertise, such as an attorney or CPA.

If a partnership fails to designate a PR or the selected PR is deemed unsuitable, the IRS can appoint one. To avoid this risk, partnerships should carefully document their selection process and ensure their PR is capable and willing to fulfill the role.

Calculating Adjustments

When the IRS audits a partnership, it may propose adjustments based on discrepancies in reported income, deductions, credits, or other tax items. These adjustments are calculated at the partnership level and applied in the year the audit is completed, not the year under review. This can create financial complexities, as current partners may bear the consequences of adjustments related to prior years.

Adjustments that increase taxable income are multiplied by the highest individual or corporate tax rate in effect for the reviewed year. For 2024, this means 37% for individuals and 21% for corporations. However, partnerships can request a lower rate if they can show that certain partners, such as tax-exempt organizations or individuals in lower brackets, would have had a reduced tax liability.

Once adjustments are finalized, the partnership can elect to push the changes out to partners instead of paying the tax itself. This election, made within 45 days of receiving a final determination, shifts the responsibility to those who were partners during the reviewed year. This option can be beneficial if individual partners can offset tax consequences through deductions or credits not available at the entity level.

Payment of Imputed Underpayments

If the IRS assesses additional tax, the partnership must pay the imputed underpayment unless it shifts the burden to reviewed-year partners. The underpayment is calculated by applying the highest applicable tax rate to net positive adjustments, but this amount can sometimes be reduced through modification requests. Partnerships can seek adjustments for tax-exempt partners, lower individual tax brackets, or other mitigating factors, but supporting documentation must be provided within 270 days of receiving the initial notice.

Failure to pay on time results in penalties and interest, calculated based on the federal short-term rate plus three percentage points. If a partnership disputes the assessment, it has 90 days to file a petition in Tax Court, the Court of Federal Claims, or a district court. However, interest continues to accrue during litigation, making early resolution financially prudent. Some partnerships may opt for installment agreements, though these require demonstrating financial hardship and come with additional administrative costs.

Implications for Partners

CPAR shifts tax liabilities and compliance responsibilities, creating financial and legal consequences for partners.

One major issue is that current partners may bear tax adjustments related to years when they were not part of the partnership. Since CPAR assessments are imposed at the entity level, new partners could be responsible for liabilities tied to prior members. This makes due diligence essential when acquiring an interest in a partnership. Buyers should review historical tax positions and potential audit exposure before finalizing a transaction. Some partnerships address this by including indemnification clauses in their operating agreements, ensuring former partners remain liable for tax adjustments related to their tenure.

CPAR also limits individual partners’ ability to challenge IRS audit findings. Previously, each partner could contest adjustments on their personal return. Now, CPAR consolidates this authority under the Partnership Representative. If a partner disagrees with an IRS determination, they have no direct recourse unless the partnership elects to push adjustments out to reviewed-year partners. To mitigate this risk, partnership agreements should clearly define how the PR is selected, what decisions they can make unilaterally, and whether partners have any oversight in audit proceedings.