Understanding the New Centralized Partnership Audit Regime – Part One

This is the first of a series of three posts on the new centralized partnership audit regime that came into effect in 2018 under the Bipartisan Budget Act, replacing the old TEFRA procedures with new partnership-level adjustments.  This first article provides an overview of the primary differences between the BBA regime and that of the old TEFRA procedures.  The second article takes a deep dive into the Code and Treasury Regulations, explaining each new provision under the BBA.  The third article wraps everything up in a nice bow and provides guidance for partners and practitioners alike in implementing the new centralized audit regime.

A New “Centralized” Audit Regime is Created

On November 2, 2015, the Bipartisan Budget Act (BBA) effectively repealed the longstanding TEFRA and electing large partnership (ELP) audit procedures, replacing them with a new centralized partnership audit regime. The new procedures fundamentally change how partnership adjustments are determined, assessed, and collected.

Under the default rules of new centralized partnership audit regime, the Service audits the partnership’s items of income, gain, loss, deduction, credit, and partners’ distributive shares for a particular year of the partnership (the “reviewed year”). However, any adjustments are made at the partnership level and are taken into account by the partnership in the year that the audit or any judicial review is completed (the “adjustment year”).

Avoiding the Default Rules

The default structure described above may be avoided by certain small, “eligible” partnerships who choose to “elect out,” of the default rules, thereby reverting to TEFRA-era procedures. Likewise, partnerships may “push out” the partnership adjustments to the reviewed year partners by making an affirmative election in any given year.

“Imputed Underpayment” Assessed and Collected at Partnership Level

In a significant departure from TEFRA, the general rule under new centralized partnership audit regime is that an “imputed underpayment” (defined and discussed below) will be assessed and collected at the partnership level. An adjustment that does not result in an imputed underpayment generally will be taken into account by the partnership in the adjustment year as a reduction in non-separately stated income or as an increase in non‑separately stated loss, or in the case of a credit, as a separately stated item.

The Partnership Representative

new centralized partnership audit regimeOne of the most significant changes under new centralized partnership audit regime is the designation of a partnership representative that, unlike the familiar tax matters partner, does not necessarily need to be a partner or even an individual. Any action taken by the partnership representative with respect to the centralized partnership audit regime is valid and binding on the partnership and partners, regardless of any other provision of state law, the partnership agreement, or any other document or agreement. Such binding authority includes representing the partnership in all interactions with the Service.

Under the Code and Treasury Regulations, a partnership must designate the partnership representative each tax year on the partnership’s timely filed return. If the partnership fails to make such a designation, the Service will, in its own discretion, designate a partnership representative. Such designation is critical, as only the partnership representative is permitted to raise defenses to penalties, additions to tax, or additional amounts, including the partnership’s organizational defenses—as well as individual, personal defenses that relate to any partner.

Any defense, whether it relies on facts and circumstances relating to the partnership or one or more partners or any other person, that is not raised by the partnership before a final determination, is waived and is not even considered if raised by any person other than the partnership representative.

“Push-Out” Election

As an alternative to new centralized partnership audit regime’s general rule that an imputed underpayment is assessed and collected at the partnership level in the adjustment year, a partnership may elect to “push out” any partnership adjustments to its reviewed-year partners. The partnership must make this election no later than 45 days after the date of the notice of final partnership adjustment (defined and discussed below). If the partnership makes such an election, sends the required adjustment statements to reviewed year partners and the Service, and otherwise meets the requirements of the Treasury Regulations, the imputed underpayment may be paid by the reviewed year partners.

Modification of Imputed Underpayment

Partnerships have the option and ability to seek modification of the imputed underpayment. A partnership generally will have 270 days to submit information to the Service to request a modification of the imputed underpayment amount following receipt of a notice of proposed partnership adjustment. Mechanically, under new centralized partnership audit regime, to seek a modification, a partner (or multiple partners) would file an amended return, which takes into account the adjustments allocable to the partners and includes payment of any tax due with the amended return.

If the partnership (in conjunction with its individual partners) successfully seeks modification, the imputed underpayment at the partnership level will be determined without regard to the portion of adjustments taken into account by partner or partners who filed such amended returns. In addition, the existence of tax‑exempt partners, as well as the application of lower tax rates to certain partners, may be taken into account by the Service to reduce the imputed underpayment.

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