Should I Opt Out of the Centralized Partnership Audit Regime?

The Centralized Partnership Audit Regime, or CPAR, is the framework the Internal Revenue Service (IRS) uses to audit partnership tax returns. Enacted as part of the Bipartisan Budget Act of 2015, CPAR was designed to streamline the process of examining partnership returns and collecting any resulting tax underpayments. It applies to all partnership tax years beginning after December 31, 2017.

Certain eligible partnerships can make an annual election to opt out of the CPAR framework. This decision reverts the audit process to an older system where the IRS deals with partners individually.

The Centralized Partnership Audit Regime Explained

Under CPAR, the IRS assesses and collects taxes, penalties, and interest directly from the partnership entity itself. This is a departure from the prior system, which required the IRS to pursue each partner individually. The liability is imposed on the partnership in the year the audit or any related judicial review is completed, which is called the “adjustment year,” not the original year that was audited, known as the “reviewed year.”

A core component of CPAR is the “imputed underpayment.” This is the amount of underpaid tax calculated at the partnership level as a result of an audit adjustment. The calculation is not based on the individual tax situations of the partners. Instead, the net positive adjustment to the partnership’s income is multiplied by the highest statutory federal income tax rate for the reviewed year. This method simplifies the calculation for the IRS but can result in a higher tax liability than if each partner’s specific tax rate was used.

Every partnership must designate a Partnership Representative (PR) on its annual tax return. This representative, who does not have to be a partner, has the sole authority to act on behalf of the partnership and all its partners during an IRS audit. The PR’s decisions—including agreeing to adjustments, settling with the IRS, or initiating litigation—are legally binding on every partner, who have no statutory right to participate in the proceedings.

Determining Your Eligibility to Opt Out

A partnership must meet two criteria to be eligible to opt out of the Centralized Partnership Audit Regime (CPAR). The first condition is a limit on the number of partners. The partnership must issue 100 or fewer Schedules K-1 to its partners for the tax year in question. This count is based on the total number of K-1s the partnership is required to furnish.

If one of the partners is an S corporation, the number of Schedules K-1 issued by the S corporation to its own shareholders must be added to the partnership’s K-1 count. For example, a partnership with 90 partners, one of which is an S corporation with 15 shareholders, would be considered to have 105 partners and would therefore be ineligible to opt out.

The second criterion relates to the type of partners. Every partner must be an “eligible partner” as defined by the IRS. Eligible partners include:

• Individuals
• C corporations
• S corporations
• Estates of deceased partners

A foreign entity can also be an eligible partner, but only if it would be treated as a C corporation if it were a domestic entity.

The presence of even one “ineligible partner” disqualifies the entire partnership from opting out for that tax year. Ineligible partners include:

• Other partnerships
• Trusts
• Disregarded entities, such as single-member LLCs
• Nominees, which are persons holding an interest on behalf of another person
• Estates of individuals other than a deceased partner

This means partnerships with complex, tiered ownership structures are often unable to meet the requirements to make the opt-out election.

Consequences of the Opt-Out Decision

If a partnership remains within CPAR, the default outcome is that the partnership itself is liable for any “imputed underpayment,” which is the tax deficiency calculated at the highest applicable tax rate. This payment is made by the partnership in the current “adjustment year,” meaning the partners who are in the partnership when the audit concludes bear the economic burden, even if they were not partners during the “reviewed year” that was audited. The entire process is controlled exclusively by the Partnership Representative, whose decisions bind all partners.

Opting out of CPAR shifts the audit process back to the partner-level audit rules. Under this system, the IRS cannot assess a tax liability against the partnership entity. Instead, the IRS must open separate audit proceedings for each individual partner from the reviewed year to assess and collect their proportionate share of any tax adjustments.

The financial liability for an audit adjustment moves from the current-year partnership to the specific individuals who were partners in the year under audit. The administrative burden, however, is transferred from a single partnership-level proceeding to multiple, individual partner-level audits. Each partner regains control over their portion of the audit and can negotiate their own settlement with the IRS.

How to Make the Opt-Out Election

The decision to opt out must be made on an annual basis. A partnership must make the election each tax year for which it wants the opt-out to apply; the election does not carry over to future years. The election must be made on the partnership’s timely filed tax return, including any valid extensions, for the specific year it covers.

The election itself is made on the partnership’s annual tax return, Form 1065. On Schedule B of Form 1065, there is a question asking if the partnership is electing out of the CPAR, and answering “Yes” signifies the intent to opt out.

A partnership making the election must also complete and attach Schedule B-2, “Election Out of the Centralized Partnership Audit Regime,” to its Form 1065. This schedule requires the partnership to disclose detailed information for every partner, including their legal name, U.S. taxpayer identification number (TIN), and their partner type. If any partner is an S corporation, the partnership must also list the name and TIN for each of the S corporation’s shareholders.

Finally, the partnership must notify each of its partners that the opt-out election has been made within 30 days of making the election. This ensures all partners are aware that any potential audit for that year will be handled at the individual partner level.