What Is the BBA Centralized Partnership Audit Regime?

The Bipartisan Budget Act of 2015 (BBA) established a new method for the Internal Revenue Service (IRS) to audit entities classified as partnerships. This framework, known as the centralized partnership audit regime, applies to partnership tax years beginning after December 31, 2017. It changed the audit process by allowing the IRS to assess and collect tax adjustments at the partnership level, rather than pursuing individual partners. This shift was designed to streamline what was often a complex and inefficient process, especially for large partnerships.

The core principle of the BBA regime is that any tax underpayment identified during an audit is calculated and assessed directly against the partnership. This assessment occurs in the year the audit is finalized, called the “adjustment year,” not the original year under examination, the “reviewed year.” The regime also created the role of a Partnership Representative, a single point of contact with sole authority to act for the partnership during an audit.

Partnerships Subject to the BBA Regime

By default, the centralized audit regime applies to any entity filing a Form 1065, U.S. Return of Partnership Income, for tax years 2018 and onward. The regime is the standard procedure unless a partnership is eligible and affirmatively chooses to leave the system for a given tax year.

An eligible partnership can make an annual “election out” if it has 100 or fewer partners for the taxable year. This count is determined by the number of Schedules K-1 the partnership is required to issue. If a partner is an S corporation, each of its shareholders is counted toward the 100-partner limit.

To elect out, all partners must also be considered “eligible partners.” These 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 such as other partnerships, trusts, or disregarded entities are not eligible to elect out of the BBA regime. This limitation ensures that the ownership structure is relatively straightforward, preventing layers of pass-through entities that would complicate an audit even if the election out were permitted.

The election is made on a timely-filed partnership tax return by checking a box on Form 1065 and filing Schedule B-2, Election Out of the Centralized Partnership Audit Regime. This schedule requires the partnership to disclose the name, U.S. taxpayer identification number, and federal tax classification for every partner.

The Role of the Partnership Representative

Under the BBA regime, every partnership must designate a Partnership Representative (PR) on its annual Form 1065, unless it validly elects out. This designation is specific to each tax year. The PR holds the exclusive and binding authority to act on behalf of the partnership and all its partners in any matter related to an IRS audit, a role with more concentrated authority than the former “Tax Matters Partner” (TMP).

The PR is the sole point of contact with the IRS and can make decisions without seeking partner consent. These decisions include agreeing to tax adjustments, extending statutes of limitations, entering into settlement agreements, and deciding how the financial burden of an audit adjustment will be handled. The IRS is not bound by any limitations placed on the PR in a partnership agreement.

The designated representative can be any person, including an individual or an entity, and is not required to be a partner. The PR must maintain a “substantial presence” in the United States, which involves having a U.S. taxpayer identification number, a U.S. address, and a U.S. telephone number. If an entity is chosen as the PR, the partnership must also appoint a “designated individual” to act on its behalf who also meets the substantial presence test.

The Centralized Audit Process

The audit process begins when the IRS issues a Notice of Selection for Examination, Letter 2205-D, to the partnership. The audit officially commences when the IRS mails a Notice of Administrative Proceeding (NAP). This notice, sent as Letter 5893 to the partnership and Letter 5893-A to the Partnership Representative (PR), formally begins the proceeding for a specific tax year. Once the NAP is issued, the partnership can no longer file an Administrative Adjustment Request (AAR) to amend its return for that year.

During the examination, the PR acts as the exclusive point of contact, providing information and negotiating on behalf of the partnership. If the PR disagrees with the initial findings, there may be an opportunity to appeal the decision within the IRS.

Once the examination and any appeals are complete, the IRS issues a Notice of Proposed Partnership Adjustment (NOPPA). This notice details the proposed adjustments, penalties, and the “imputed underpayment,” which is the tax the partnership would owe. The NOPPA starts a 270-day period for the PR to request modifications, after which the IRS issues a Notice of Final Partnership Adjustment (FPA) to finalize the audit results.

Resolving the Imputed Underpayment

After a Notice of Final Partnership Adjustment (FPA) is issued, the partnership must address the tax liability. The default method is for the partnership to pay the “imputed underpayment,” which is calculated by netting all audit adjustments and applying the highest statutory federal income tax rate for the reviewed year. This payment is due from the partnership in the adjustment year, meaning current partners may bear the cost of liabilities from former partners.

The primary alternative is the “push-out” election under Internal Revenue Code Section 6226. This election shifts responsibility for the tax adjustments from the partnership to the individuals and entities who were partners during the audited tax year. To use this option, the Partnership Representative must make the election within 45 days of the FPA’s mailing date.

The partnership must then furnish a statement to each reviewed-year partner detailing their share of the adjustments. Each partner then calculates and pays the additional tax based on their individual tax situation for the reviewed year. The BBA rules also permit the PR to request modifications to reduce the imputed underpayment before it is finalized, such as showing that income is allocable to a tax-exempt partner or qualifies for a lower capital gains rate.