How Revenue Code 624 Affects Partnership Audits

The Internal Revenue Service uses a centralized partnership audit regime for tax years 2018 and later. This system establishes a standard set of procedures for how the IRS examines partnership returns and handles any resulting tax adjustments. The framework is designed to assess tax at the partnership level, creating a single, unified process rather than dealing with each partner individually. This approach centralizes the entire audit, from initial contact to final resolution, within one proceeding.

Applicability of Centralized Partnership Audit Rules

The centralized audit rules automatically apply to any entity that files a partnership return, making it the default system for examinations. This means most partnerships are subject to these procedures unless they take specific action to be excluded.

A partnership can avoid these rules by making an annual election to opt out, provided it has 100 or fewer partners for the tax year. This count is based on the number of Schedules K-1 issued. If a partner is an S corporation, the partnership must also count each shareholder of that S corporation. For example, a partnership with 90 individual partners and one S corporation partner with 11 shareholders is treated as having 101 partners, making it ineligible to opt out.

In addition to the partner count, all partners must be “eligible partners.” If a partnership has even one partner that falls outside this list, such as another partnership or a trust, it cannot make the election. Eligible partners include:

• Individuals
• C corporations
• S corporations
• The estates of deceased partners

The election to opt-out is made on a timely filed Form 1065 for the specific tax year and requires disclosing each partner’s taxpayer identification number.

The Partnership Representative Role

Every partnership subject to the centralized audit rules must designate a Partnership Representative (PR) on its annual tax return. The PR serves as the exclusive point of contact with the IRS for all audit-related matters. This individual or entity holds the sole authority to act on behalf of the partnership during an examination.

The authority granted to the PR is legally binding on the partnership and all of its partners. The PR is empowered to make all decisions during an audit, such as negotiating settlements and extending deadlines. Individual partners have no legal standing to participate in the proceedings and are bound by the PR’s decisions.

Any person or entity can serve as the PR, but they must maintain a substantial presence in the United States. This means the PR must have a U.S. taxpayer identification number, a U.S. address, and a telephone number with a U.S. area code. If an entity is chosen as the PR, the partnership must also appoint a specific individual through whom the entity PR will act.

The Audit and Adjustment Process

An audit under the centralized regime formally begins when the IRS issues a Notice of Administrative Proceeding (NAP) to the partnership and its Partnership Representative (PR). This notice confirms the start of an examination for a specific tax year. Following the initial examination, the IRS may provide a preliminary calculation of any potential tax due for the PR to review.

If adjustments are proposed, the IRS issues a Notice of Proposed Partnership Adjustment (NOPA). This notice details the proposed changes to the partnership’s return and calculates the “imputed underpayment.” The imputed underpayment is the total tax adjustment calculated at the partnership level, computed by multiplying the net income adjustments by the highest federal income tax rate for the audited year.

Upon receiving the NOPA, the PR has 270 days to request a modification of the imputed underpayment. This allows the partnership to present partner-specific information, like tax-exempt status or lower tax rates, to potentially reduce the assessment. If no modification is requested or the process is completed, the IRS issues a Final Partnership Adjustment (FPA) that solidifies the tax liability.

Options for Paying an Assessed Tax

Once a final imputed underpayment is determined, there are options for how the liability is paid. The default method requires the partnership to pay the entire imputed underpayment, including penalties and interest. This payment is made by the partnership in the “adjustment year,” which is the year the audit becomes final, not the audited year.

Alternatively, the PR can elect to “push out” the adjustments to the partners. This election must be made within 45 days of the Final Partnership Adjustment notice. A push-out election shifts the financial responsibility for the adjustment from the partnership to the partners from the “reviewed year,” which is the year that was under examination.

If a push-out election is made, the partnership must furnish a statement to each reviewed-year partner detailing their share of the adjustments. Those partners must then account for these adjustments on their own income tax returns for the current year. They will then calculate and pay the resulting additional tax.