What Is a TEFRA Partnership and Its Repealed Audit Rules?

The Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) introduced rules to streamline how the Internal Revenue Service (IRS) audits partnerships. Before TEFRA, the IRS had to audit each partner individually to adjust items originating from the partnership, a process that was burdensome for the agency. The TEFRA rules resolved this by creating a single, unified audit proceeding at the partnership level.

The core idea was to determine the tax treatment of all “partnership items”—any item more appropriately determined at the partnership level—in one consolidated action. This approach prevented inconsistent outcomes that could arise from separate audits of individual partners. These rules applied to partnerships with more than 10 partners, with a limited exception for smaller partnerships where all partners were individuals, C corporations, or estates of deceased partners.

The TEFRA Audit Process

When the IRS selected a TEFRA partnership for an audit, it initiated a single administrative proceeding to examine all partnership items, and the outcome was binding on all partners. A central figure in this process was the Tax Matters Partner (TMP), a designated general partner who served as the primary liaison between the partnership and the IRS. The TMP had responsibilities including receiving notices from the IRS, keeping other partners informed of the audit’s progress, and representing the partnership.

While the TMP had authority to negotiate, individual partners retained the right to participate in proceedings and negotiate their own settlements. The audit process began when the IRS issued a Notice of Beginning of Administrative Proceeding (NBAP) to the TMP, who was then responsible for forwarding this notice to the other partners. Upon completion of the audit, if the IRS proposed adjustments, it would issue a Final Partnership Administrative Adjustment (FPAA).

The FPAA is the functional equivalent of a notice of deficiency, detailing the proposed changes to partnership items and their effect on the partners’ tax liability. The TMP had the authority to challenge the FPAA in court, and if the TMP did not act, other partners could also petition for judicial review.

Repeal and Transition to the BBA Regime

The TEFRA partnership audit rules were repealed by the Bipartisan Budget Act of 2015 (BBA), effective for partnership taxable years beginning after December 31, 2017. This change marked a significant shift in how partnership audits are conducted. The repeal was driven by the recognition that the TEFRA system had become inefficient for handling audits of modern, complex partnership structures, particularly those with multiple tiers of ownership.

The primary motivation behind the BBA was to create a more effective system for the IRS to assess and collect tax. Under TEFRA, the final tax liability had to be collected from each partner individually, a slow and resource-intensive process. The BBA was designed to solve this collection problem by shifting the responsibility for payment directly to the partnership entity itself in most cases, replacing the core mechanics of the TEFRA process.

The Centralized Partnership Audit Regime under BBA

The BBA’s default rule for handling audit adjustments is that any tax deficiency, or “imputed underpayment,” is assessed and collected directly from the partnership. This payment is made in the year the audit is completed, not the audited year, and is calculated at the highest individual or corporate tax rate for the reviewed year.

This regime replaced the Tax Matters Partner with a new role known as the Partnership Representative (PR). The PR has the sole and exclusive power to act on behalf of the partnership and to bind all partners in an audit proceeding with the IRS. Unlike the TMP, the PR does not need to be a partner, and their decisions are legally binding on all partners, regardless of any contrary provisions in the partnership agreement.

As an alternative to the partnership paying the imputed underpayment, the PR can make a “push out” election. If this election is made, the partnership is no longer liable for the tax. Instead, it furnishes statements to its partners from the reviewed year, who then account for the adjustments on their individual tax returns and pay the associated tax plus interest. The choice between the partnership paying or pushing out the liability is made by the PR and can have significant economic consequences for current and former partners.

Electing Out of the BBA Regime

Certain eligible partnerships have the option to annually elect out of the centralized BBA audit regime. If a partnership successfully elects out, any audit for that year would be conducted under the pre-TEFRA rules, meaning the IRS would have to open separate proceedings to adjust tax items for each partner individually.

To qualify for this election, a partnership must have 100 or fewer partners during the taxable year. For the purpose of this count, each Schedule K-1 issued to a partner is counted. If a partner is an S corporation, the count must include not only the K-1 issued to the S corporation but also all K-1s issued by the S corporation to its shareholders.

Additionally, all partners in the partnership must be “eligible partners.” Eligible partners include:

• Individuals
• C corporations
• Foreign entities that would be treated as a C corporation if they were domestic
• S corporations
• The estates of deceased partners

Partnerships with partners that are other partnerships or trusts are ineligible to make the election. The election must be made each year on the partnership’s timely filed tax return, Form 1065, U.S. Return of Partnership Income.