Imputed Underpayment: What It Is and What to Do About It

An imputed underpayment is a tax liability determined at the partnership level as a result of an IRS audit. This concept was introduced by the Bipartisan Budget Act of 2015 (BBA), which established a centralized audit system for partnerships for tax years beginning in 2018. Under these rules, the IRS can assess and collect tax directly from the partnership itself, rather than pursuing individual partners from the year under review. The imputed underpayment is the default method for handling audit adjustments.

The Default Calculation Method

The process for calculating an imputed underpayment begins when the IRS concludes an audit and proposes adjustments to a partnership’s return. These adjustments are categorized into specific groupings, primarily reallocation, credit, and creditable expenditure, with a residual group for other items. All adjustments within each category are netted to arrive at a total for that group.

The positive net amounts from the groupings are then summed to create a total net positive adjustment, which represents the aggregate increase in the partnership’s income. This total is multiplied by the highest applicable federal income tax rate for the reviewed year, such as 37% for ordinary income adjustments. This method does not account for the specific tax situations of the individual partners, like their actual tax brackets, tax-exempt status, or offsetting losses.

The result of this calculation is the imputed underpayment. Because this default method uses the highest possible tax rate and ignores individual partner attributes, it often produces a tax liability higher than what the partners would have collectively owed. This creates an incentive for the partnership to explore alternatives, such as modification or the push-out election, to reduce the final tax bill.

Procedures for Modifying the Underpayment

A partnership can request to lower the initial imputed underpayment through a formal modification process with the IRS. The request must be submitted within 270 days after the Notice of Proposed Partnership Adjustment (NOPPA) is issued, though this period can be extended with IRS consent. All modification requests are submitted using Form 8980, Request for Modification of Imputed Underpayment Under IRC Section 6225.

One common modification method involves partners filing amended returns for the reviewed year to account for their share of the audit adjustments. The partners must pay the resulting tax, and the partnership then submits proof of these payments to the IRS to reduce the imputed underpayment.

Another modification strategy is demonstrating that certain partners would have been subject to a lower tax rate. For instance, if a portion of the underpayment is attributable to a partner that is a tax-exempt organization, that portion of the income would not be subject to tax. Similarly, if an adjustment results in long-term capital gains for a C-corporation partner, the partnership can argue for applying the lower corporate capital gains rate.

Partnerships can also utilize a “pull-in” procedure as an alternative to filing amended returns. In a pull-in, the relevant partners calculate the tax impact of the adjustments and provide this information, along with a payment, to the partnership representative. The representative then presents this to the IRS to show the tax has been accounted for.

Making the Push-Out Election

As an alternative to the partnership paying the imputed underpayment, it can elect to “push out” the audit adjustments to the individuals and entities who were partners during the reviewed tax year. This election shifts the responsibility for paying the tax from the partnership to its reviewed-year partners. This option moves the financial burden to former partners who may no longer have a connection to the partnership.

The partnership must make the push-out election within 45 days of the date the IRS issues the Final Partnership Adjustment (FPA). Once a valid election is made, the partnership is required to furnish statements to each of its reviewed-year partners on Form 8986, Partner’s Share of Adjustment(s) to Partnership-Related Items. The partnership must send these forms to both the partners and the IRS within 60 days of the FPA being finalized.

The partners who receive a Form 8986 must then report their share of the adjustments on their own income tax returns. The tax impact is reported in the partner’s tax year that includes the date the Form 8986 was furnished, not the original year that was audited. The partner calculates the additional tax on Form 8978, Partner’s Additional Tax on Certain Items, and pays the amount, plus interest, with their return for that year.