This post, entitled “How to Implement the New Centralized Partnership Audit Regime of the BBA,” is the third and final of a series on the new centralized audit regime that came into effect in 2018 under the Bipartisan Budget Act, replacing the old TEFRA procedures with new partnership-level adjustments. The first article provided 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. This third article wraps everything up in a nice bow and provides guidance for partners and practitioners alike in implementing the centralized audit regime of the BBA.
A Fundamental Change
The BBA fundamentally changes the way that the IRS conducts partnership audits, assessment, and collection of any resulting income tax deficiencies. Congress enacted these sweeping changes in response to the increasing difficulties that the Service experienced under TEFRA, which required the Service to pass audit adjustments to partnership items through to the ultimate partners, thereby forcing the Service to identify potentially large numbers of partners, often through tiers of partnerships, in order to determine the proper share of the adjustment for each ultimate partner. So, let’s now discus implementing the new centralized partnership audit regime of the BBA.
The Centralization Experiment
The involvement of partners who had the right to be notified of, and intervene in, the partnership proceedings further complicated TEFRA audits. The BBA replaced such disparate procedures with “centralized” new rules under which audits of partnerships and partners are, by default, conducted at the partnership level with limited involvement of the partners, with any resulting income taxes generally assessed to and collected from the partnership itself.
Time of the Essence
Existing partnerships must adapt to the BBA regime with a certain sense of immediacy. Qualifying small partnerships must decide whether or not to elect out of the new regime under IRC § 6221(b). A partnership that does not qualify to elect out by reason of size or disqualifying partners should review its governing documents as soon as possible to determine what changes are necessitated by the new centralized partnership audit regime of the BBA.
Decisions, Decisions (in Implementing the New Centralized Partnership Audit Regime of the BBA)
The partnership must determine how it will appoint (and remove) the partnership representative, as this should not be left to the Service’s discretion. The partnership should likewise specify the authority and notice obligations of the partnership representative. The partnership may wish to indemnify the partnership representative, and the partnership should also identify its recourse if the partnership representative acts beyond its authority.
Partnerships subject to the new audit regime must also determine whether the partnership itself or the partners thereof will bear the tax consequences of an adjustment, including whether the partnership will be responsible for such costs (with current year partners bearing such costs indirectly), or whether the partnership will “push out” any partnership adjustments to the constituent partners.
Further, it will require partners to file amended returns in response to adjustments, or require partners to contribute to the partnership a pro rata share of an adjustment taken at the partnership level. Finally, in a purchase or sale of partnership interests, the transacting parties should include provisions addressing the new audit regime, as an acquiring partner could become directly or indirectly liable for an underpayment that occurred during a year prior to becoming a partner.
An Ounce of Prevention
The new centralized partnership audit regime of the BBA is complex, and the regulations interpreting the Code sections are nuanced. Existing partnerships must understand that compliance with the BBA rules will require changes, often significant, to their entity’s operating agreement. Failing to make such changes, will cause unintended—albeit foreseeable—consequences. As illustrated by the foregoing, being caught unprepared is inexcusable and potentially costly for the partnership. By affirmatively planning for the (relatively) unlikely event of an audit, the partnership will ensure that, to the greatest extent possible, the audit is performed on the partnership’s terms.
A Pound of Cure
If the partnership instead chooses to bury its proverbial head in the sand, the Service will control every element of the audit, including selecting the individual or entity that has the power and authority under the BBA to bind the partnership in nearly all audit decisions (that is, the partnership representative). As the old adage goes, an ounce of prevention is worth a pound of cure, and this is certainly true when it comes to partnership audit planning under the new centralized partnership audit regime.

