What Is the Partnership Audit Simplification Act?

The Bipartisan Budget Act of 2015 (BBA) established a centralized audit regime, replacing the previous Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) rules. Effective for tax years after December 31, 2017, the BBA was designed to streamline the audit process. The new system allows the IRS to assess and collect tax adjustments at the partnership level, a departure from the previous requirement of pursuing collections from each partner individually. This change affects nearly all entities filing a partnership return, altering responsibilities for partnerships and their partners during an IRS examination.

The Centralized Partnership Audit Regime

Under the BBA’s centralized system, audit adjustments are determined at the partnership level. Any tax, penalties, and interest from these adjustments are calculated and collected directly from the partnership. The tax is paid by the partnership in the year the audit or judicial review is completed, known as the “adjustment year,” not the year under audit, which is called the “reviewed year.”

A core component of this system is the “imputed underpayment,” which is the default amount of tax the partnership must pay. It is calculated by netting all audit adjustments and applying the highest statutory federal income tax rate for the reviewed year. This calculation method means the initial assessment is often higher than the aggregate tax the partners would have paid, as it does not account for individual partners’ specific tax situations, such as lower tax brackets or tax-exempt status.

This default rule can create a financial burden for partners in the adjustment year, who may be different from the partners present during the reviewed year. For instance, a new partner in 2024 could bear the cost of a tax liability from the partnership’s 2021 activities. The regime provides mechanisms for the partnership to modify this imputed underpayment or shift the liability to the reviewed-year partners.

The Role of the Partnership Representative

The BBA introduced the role of the Partnership Representative (PR), replacing the “Tax Matters Partner” from the former TEFRA rules. The PR has the sole authority to act on behalf of the partnership and bind all partners in an IRS audit and any subsequent judicial proceedings. This authority is binding regardless of any conflicting provisions in the partnership agreement or other state-law documents.

Unlike the previous Tax Matters Partner, who had to be a partner, the PR can be any person or entity with a substantial presence in the United States. If an entity is the PR, it must appoint a “Designated Individual” to act on its behalf. The PR’s powers include agreeing to audit adjustments, extending statutes of limitations, and deciding how to handle an imputed underpayment.

Partnerships must designate their PR annually on their Form 1065 tax return. If a partnership fails to do so, the IRS has the authority to appoint one. To protect their interests, it is common for partners to include provisions in the partnership agreement that guide or constrain the PR’s actions.

Modifying an Imputed Underpayment

The BBA provides procedures for the Partnership Representative (PR) to request a modification of an imputed underpayment. These procedures aim to align the tax liability with what the partners would have owed if they had reported correctly. Modification requests must be initiated within 270 days of the IRS issuing a Notice of Proposed Partnership Adjustment (NOPPA).

One method is the “pull-in” procedure, where reviewed-year partners compute and pay the tax on their share of adjustments. The partners provide the PR with documentation, such as Form 8982, to submit to the IRS. This reduces the imputed underpayment by the amounts paid without requiring partners to file amended returns.

Modification can also be requested for partners with a specific tax status. For example, the portion of an adjustment allocable to a tax-exempt partner can be removed from the calculation. Similarly, if an adjustment should be a capital gain instead of ordinary income, the PR can request that the lower tax rate be applied.

The main alternative to the partnership paying the tax is the “push-out” election under Internal Revenue Code Section 6226. The PR can elect to pass the audit adjustments to the individuals and entities who were partners during the reviewed year. This election must be made within 45 days of the Final Partnership Adjustment (FPA).

The partnership then furnishes a Form 8986 to each reviewed-year partner, detailing their share of the adjustments. Each partner must then account for these adjustments on their own tax return for the current year. A consequence of the push-out election is that the interest rate on the underpayment is two percentage points higher than the standard rate.

Opting Out of the BBA Regime

Certain partnerships can avoid the centralized audit regime by making an annual “opt-out” election. This removes the partnership from the BBA rules for that tax year, and any audit would be conducted under pre-BBA rules where the IRS assesses each partner separately. To be eligible, a partnership must meet strict criteria.

The first requirement is that the partnership must have 100 or fewer partners. For this count, if an S corporation is a partner, each of its shareholders is counted. For example, a partnership with 98 individual partners and one S corporation partner with three shareholders is considered to have 101 partners and is ineligible to opt out.

The second requirement is that all partners must be “eligible partners.” Eligible partners include:

• Individuals
• C corporations
• Certain foreign entities treated as C corporations
• S corporations
• Estates of deceased partners

A partnership is ineligible to opt out if any of its partners is another partnership, a trust, or a disregarded entity. The presence of even one ineligible partner disqualifies the partnership from making the election.

The opt-out election must be made annually on a timely-filed Form 1065. The partnership makes the election on Schedule B and must complete Schedule B-2, disclosing the name and taxpayer ID for every partner. The partnership must also notify each partner of the election within 30 days.

Filing an Administrative Adjustment Request

When a partnership under the BBA needs to correct a previously filed return, it cannot file an amended Form 1065. Instead, it must file an Administrative Adjustment Request (AAR) using Form 1065-X. The AAR is the exclusive mechanism for a partnership to proactively correct its own return.

The AAR must be filed by the Partnership Representative within three years from the date the original return was filed or its due date, whichever is later. An AAR cannot be filed after the IRS has issued a notice of an administrative proceeding for that tax year.

If the adjustments on the AAR result in an imputed underpayment, the partnership has two choices. The default option is for the partnership to pay the imputed underpayment when it files the AAR. Alternatively, the partnership can elect to “push out” the adjustments to the reviewed-year partners.

If the partnership pushes out the adjustments, or if the AAR does not result in an imputed underpayment, it must furnish Form 8986 statements to its reviewed-year partners. These partners then take their share of the adjustments into account on their own tax returns for the year the AAR is filed.