How to Report Partnership Audit Adjustments on Form 8978

Form 8978, Partner’s Additional Reporting Year Tax, is a document used by partners to calculate and report their share of tax adjustments resulting from a partnership-level audit. These audits fall under the centralized partnership audit regime established by the Bipartisan Budget Act of 2015 (BBA). This system changed how the IRS audits partnerships, generally assessing and collecting tax at the partnership level.

When adjustments to a partnership’s previously filed return are finalized, Form 8978 is the mechanism through which a partner reconciles their personal tax liability. It is not an amendment of a prior year’s return but rather a calculation of additional tax to be paid in the current year.

Who Files Form 8978

A partner’s obligation to file Form 8978 is triggered when their partnership undergoes an audit under the BBA rules and makes a specific election. Under the BBA, the default rule is that the partnership itself pays any tax underpayment resulting from an audit. However, the partnership can make a “push-out” election under Internal Revenue Code Section 6226.

This election shifts the responsibility for the tax adjustments from the partnership to the individuals who were partners during the audited tax year, known as the “reviewed year.” The official notification that compels a partner to act is the receipt of Form 8986, Statement of Partner’s Share of Adjustments. The partnership issues this form to each reviewed-year partner, detailing their specific share of the audit adjustments. The filing requirement applies to non-pass-through partners, such as individuals and C corporations, who receive a Form 8986 and must account for the adjustments.

Information Required to Complete Form 8978

Before beginning the calculations on Form 8978, a partner must gather several key documents. The primary document is the completed Form 8986, Statement of Partner’s Share of Adjustments, received from the partnership. This form is foundational, as it contains the partner’s specific share of adjustments, the partnership’s Employer Identification Number (EIN), the audit tracking number, and identifies the partnership’s “reviewed year.”

Next, the partner will need their own original, as-filed federal income tax return for their “first affected year.” The first affected year is the partner’s tax year that corresponds with the partnership’s reviewed year shown on Form 8986. This original return serves as the baseline against which the audit adjustments will be applied to determine the initial tax impact.

The partner must also locate their original federal income tax returns for all “intervening years.” Intervening years are the tax years after the first affected year up to, but not including, the year the partner files Form 8978. These returns are important because an adjustment in the first affected year can have a cascading effect on tax attributes, such as a net operating loss (NOL) or tax credit carryforwards, that are used in subsequent years. Finally, a blank Form 8978 and its accompanying Schedule A can be downloaded directly from the IRS website.

Calculating the Additional Tax

This process does not involve amending prior tax returns; instead, it determines a total amount that will be added to the tax liability of the partner’s current-year return, known as the “reporting year.” The reporting year is the tax year in which the partner received the Form 8986 from the partnership.

The calculation begins with the first affected year. The partner must re-calculate their total tax liability for this year by hypothetically including their share of the partnership adjustments from Form 8986. This means preparing a pro-forma version of their original tax return for that year, incorporating the changes to income, deductions, and credits. The difference between this new, re-calculated tax liability and the tax shown on the original, as-filed return is the increase in tax for the first affected year.

Next, the partner must analyze the impact on any intervening years. An adjustment in the first affected year might change a tax attribute that was carried forward, such as a net operating loss. For example, if an audit adjustment increased the partner’s income in the first affected year, it may have reduced the amount of an NOL available to be carried forward. The partner must re-calculate the tax for each intervening year where a tax attribute was affected, determining the increase in tax for each of those years.

After computing the tax increase for the first affected year and all affected intervening years, these amounts are summed. Interest is calculated on the tax increase for each year, running from the original due date of that year’s return until the date the additional tax is paid. Penalties that were determined at the partnership level and passed through on Form 8986 are also added to the total amount due.

Filing Form 8978 and Paying the Tax

Once Form 8978 is fully completed, it and its required attachments, including a copy of the Form 8986, must be attached to the partner’s income tax return for the reporting year. For example, a partner who receives a Form 8986 in June 2024 would file Form 8978 with their 2024 income tax return in 2025.

The total amount due, as calculated on Form 8978, is reported on the partner’s main tax form for the reporting year, such as Form 1040, on the line for additional taxes. Payment for this amount should be made along with any other tax due for the reporting year’s return.

Payment can be submitted through various methods accepted by the IRS, including electronic payment systems like IRS Direct Pay, a check, or a money order. If paying by check or money order, it should be made payable to the “U.S. Treasury” and include the taxpayer’s name, address, phone number, Social Security Number, the tax year, and a notation for “Form 8978.” The partner should retain a complete copy of the filed Form 8978, the attached Form 8986, and all supporting calculations and workpapers for their records.