How to Elect Out of the Centralized Partnership Audit Regime
Eligible partnerships can make an annual election to opt out of the BBA regime, which shifts audit procedures and tax liability from the entity to its partners.
The Bipartisan Budget Act of 2015 (BBA) established a default system for the Internal Revenue Service (IRS) to audit partnerships. This framework, known as the centralized partnership audit regime, allows the IRS to assess and collect taxes from an audit directly at the partnership level, streamlining the process. For tax years after 2017, these rules automatically apply to all entities filing as partnerships. However, the law allows certain partnerships to remove themselves from this system by making an election each year on their tax return.
Eligibility to Elect Out of the BBA Regime
A partnership must meet two tests to qualify for the election. First, a partnership must furnish 100 or fewer Schedule K-1s to its partners for the tax year. This count includes more than just the direct partners listed on the partnership’s books.
If a partner is an S corporation, the partnership must count the Schedule K-1 issued to the S corporation plus all the K-1s the S corporation issues to its shareholders. For example, a partnership with 90 partners and one S corporation partner with 11 shareholders would furnish 101 statements, making it ineligible.
The second condition is that every partner must be an “eligible partner” for the entire year. Eligible partners include individuals, C corporations, S corporations, and estates of deceased partners. A foreign entity is also eligible if it would be treated as a C corporation if it were a domestic entity.
A partnership becomes ineligible to elect out if it has even one partner that does not meet the definition of an eligible partner.
A partnership cannot elect out if one of its partners is another partnership or a trust. This prohibition applies to all trusts, including grantor trusts that are otherwise ignored for income tax purposes. Other ineligible partners include foreign entities not treated as C corporations, estates of living individuals, and nominees.
A partnership with a partner that is a disregarded entity, such as a single-member LLC, is also not eligible. The presence of a disregarded entity as a partner disqualifies the partnership, and there is no “look-through” to the ultimate owner for this purpose.
Required Information and Disclosures for the Election
To elect out, a partnership must provide the IRS with details about each partner on Schedule B-2, “Election Out of the Centralized Partnership Audit Regime.” This schedule is an attachment to the partnership tax return, Form 1065. Errors or omissions on this form can lead the IRS to invalidate the election.
Part I of Schedule B-2 requires a complete list of every eligible partner. For each partner, the partnership must provide their full name, correct U.S. Taxpayer Identification Number (TIN), and their federal tax classification. The TIN is typically a Social Security Number (SSN) for an individual or an Employer Identification Number (EIN) for a business entity.
The federal tax classification must be identified from the list of eligible partner types, such as individual, C corporation, S corporation, or an estate of a deceased partner. This information allows the IRS to verify that every partner meets the eligibility requirements.
If a partner is an S corporation, Part II of Schedule B-2 must also be completed. This section requires the name and TIN of the S corporation partner. It also requires the name, TIN, and tax classification for every shareholder of that S corporation to confirm the 100-statement limit is met.
How to Make the Election
The election is made when the partnership files its annual income tax return. A completed Schedule B-2 must be attached to a timely filed Form 1065, U.S. Return of Partnership Income. Attaching the schedule is required; simply checking a box on the main form is not enough.
This election must be made annually and does not carry over. A “timely filed” return is one filed by the original due date or the extended due date. An election on a late-filed return is invalid. For most calendar-year partnerships, the deadline is March 15, or September 15 with an extension.
The partnership must also notify each partner that the election has been made for the taxable year. This notification must be provided to each partner within 30 days of filing the tax return. The notice should clearly state that the partnership has elected out of the centralized audit regime for that year.
Audit Procedures After Electing Out
When a partnership elects out of the BBA regime, it is not exempt from being audited. Instead, any IRS examination will be conducted under the audit rules that existed before the BBA. This prevents the IRS from assessing and collecting tax, penalties, and interest at the partnership level.
Under these pre-BBA rules, audit responsibility shifts to the individual partners. The IRS must examine partnership items on each partner’s personal or corporate tax return. If adjustments are necessary, the IRS opens separate examinations for each partner and adjusts their individual returns. This involves issuing separate notices of deficiency, giving each partner independent rights to challenge the findings.
In a BBA audit, the IRS calculates a single “imputed underpayment” at the partnership level. This amount is calculated by netting all adjustments and applying the highest statutory tax rate for the audited year. The partnership itself is then responsible for paying this amount, which can create issues if the partners in the year of payment are different from the partners in the audited year.
By electing out, the partnership avoids the imputed underpayment system. Each partner becomes responsible for their own share of any tax deficiency related to partnership items. This ensures the tax burden of an adjustment falls on the partners from the year under review, not the partnership in a later year.