What Is a BBA Partnership and How Does It Affect Audits?

The Bipartisan Budget Act of 2015 (BBA) changed how partnerships are audited and taxed at the federal level. Instead of audits being conducted at the partner level, the IRS now assesses and collects taxes directly from the partnership. This shift simplifies enforcement but has significant implications for partners regarding liability and tax payments.

Eligibility Criteria

By default, partnerships are subject to the BBA audit rules unless they qualify to opt out. To be eligible, a partnership must have 100 or fewer partners, all of whom must be individuals, C corporations, foreign entities treated as C corporations, S corporations, or estates of deceased partners. Partnerships with other partnerships, trusts, or disregarded entities as partners cannot opt out.

The 100-partner limit is based on the number of K-1s issued for the tax year. If an S corporation is a partner, each of its shareholders counts toward this total. For example, a partnership with 90 individual partners and one S corporation with 15 shareholders would have a total of 105 partners, making it ineligible to opt out. This rule prevents complex ownership structures from avoiding the centralized audit process.

The opt-out election must be made annually on a timely filed tax return, including extensions. If successful, the IRS audits individual partners instead of the partnership. However, this does not eliminate audit risk—it simply shifts responsibility to the partners, who may face separate examinations.

The Centralized Audit Regime

Under the BBA, the IRS audits partnerships as a single entity rather than auditing each partner separately. This approach allows the IRS to assess adjustments at the partnership level instead of tracking down individual partners. Previously, adjustments flowed through to each partner’s return, but now the partnership itself is responsible for any tax liabilities unless it takes steps to shift the burden.

A designated partnership representative (PR) serves as the sole point of contact with the IRS and has broad authority to make binding decisions, including settling disputes and agreeing to adjustments. This individual or entity does not need to be a partner, and their decisions are final—partners cannot challenge the outcome. Selecting a knowledgeable PR is critical, as their choices can significantly impact the partnership’s financial obligations.

After an audit, the IRS issues a Notice of Proposed Partnership Adjustment (NOPPA), outlining any changes to income, deductions, or credits. The partnership has 270 days to provide documentation to reduce the assessed liability before the IRS finalizes the adjustment. If no modifications are made, the partnership must either pay the additional tax or elect to shift the adjustments to its partners. If the partnership does not respond, the IRS assesses the tax at the highest applicable rate, which can be financially disadvantageous.

Imputed Underpayment Calculations

If an audit results in additional tax owed, the IRS calculates the liability using the imputed underpayment method. This aggregates all adjustments and applies the highest federal income tax rate in effect for the reviewed year—37% for individuals and 21% for corporations in 2024. This simplifies collection but can inflate the tax burden since it does not consider individual partners’ tax circumstances, such as lower rates, deductions, or credits.

Partnerships can request a modification of the imputed underpayment by demonstrating that certain partners would have been taxed at a lower rate. For example, tax-exempt partners, such as charitable organizations, may not owe tax on partnership income, and individual partners might qualify for preferential capital gains rates. Supporting documentation must be submitted within 270 days of receiving the NOPPA, and the IRS has discretion in accepting or rejecting these requests.

If adjustments involve reallocating income among partners rather than increasing total taxable income, the partnership may argue that no imputed underpayment exists. This distinction is important because it could eliminate or significantly reduce the amount owed.

Push-Out Election

Instead of having the partnership pay the tax, it can elect to shift the liability to reviewed-year partners through a push-out election under Internal Revenue Code 6226. This requires notifying each partner who held an interest during the reviewed year of their share of the adjustments, and those partners must amend their prior-year returns to reflect the changes. This prevents the partnership from paying tax at the highest statutory rate, which can be beneficial if partners are subject to lower rates or have deductions.

The election must be made within 45 days of receiving the final partnership adjustment (FPA). Once elected, the partnership furnishes statements to reviewed-year partners detailing their respective adjustments. Instead of amending past returns, partners report the changes on their current-year returns, effectively deferring payment. However, interest and penalties still apply, calculated from the original due date of the reviewed-year return.

Electing Out

Some partnerships may prefer to avoid the centralized audit regime by electing out, shifting audit responsibility back to individual partners. This option is available only to partnerships with 100 or fewer eligible partners, all of whom must be individuals, C corporations, S corporations, or estates of deceased partners. If a partnership includes another partnership, trust, or disregarded entity as a partner, it cannot elect out.

To opt out, the partnership must file an annual statement with its timely filed tax return, including extensions. The statement must list each partner’s name and taxpayer identification number and confirm that the partnership meets the eligibility requirements. If the election is successful, the IRS audits each partner separately rather than the partnership as a whole. While this can provide flexibility, it also increases administrative complexity, as each partner must handle their own audit defense and potential tax liability.