Filing for Electing Large Partnership Status
Understand the tax classification that allows certain large partnerships to streamline reporting by netting most financial items at the entity level.
The simplified reporting system previously available to certain large partnerships has been repealed and replaced by a centralized partnership audit regime. This new system, enacted by the Bipartisan Budget Act of 2015, is the default for how the Internal Revenue Service (IRS) audits all partnerships. However, an election is available for some partnerships to opt out.
The Centralized Partnership Audit Regime
Under the centralized system, the IRS audits the partnership’s tax return at the entity level instead of auditing each partner. If an audit results in an adjustment, any tax, penalties, and interest are assessed and collected directly from the partnership. This payment occurs in the year the audit or judicial review is completed. The financial burden of a prior-year tax adjustment is therefore borne by the partners in the current year, who may differ from the partners during the year under examination.
Eligibility to Elect Out of the Centralized Regime
Partnerships can elect out of the centralized audit regime for a tax year if they have 100 or fewer partners and all partners are considered “eligible.” The partner count includes anyone who was a partner at any point during the year. A partnership cannot elect out if any partner is another partnership or a trust.
Eligible partners include:
- Individuals
- C corporations
- S corporations
- Foreign entities that would be treated as a C corporation if they were domestic
- Estates of deceased partners
Making the Annual Election
An eligible partnership must elect to opt out each year on its timely filed Form 1065 tax return. The election cannot be made on an amended return. To make a valid election, the partnership must disclose the name, taxpayer identification number, and federal tax classification for each partner to the IRS. The partnership must also notify each partner that the election has been made. An election is binding for that tax year and cannot be revoked without IRS consent.
Implications of the Election
If a partnership successfully elects out of the centralized regime, the previous audit rules apply. Should the IRS audit the partnership and make adjustments, it will pass those adjustments through to the individuals and entities who were partners in the audited year. The IRS then assesses and collects any resulting tax from each of those partners separately.