A glimpse into the new partnership audit rules.

• Author: Freeman, Jason B.

The Bipartisan Budget Act (BBA) of 2015, P.L. 114-74, marked a major change in how the IRS will approach partnership audits in the future. The act, which generally applies to returns filed for partnership tax years beginning in 2018, repeals the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) and electing large partnership regimes that currently govern partnership administrative procedures. In their place, it imposes a new, centralized system for the audit, adjustment, assessment, and collection of partnership-related taxes. Certain partnerships, however, will have the ability to elect out of the new regime.

Under the BBA, partnership adjustments will generally be assessed and collected at the partnership level. This represents a fundamental change from current practice that is in tension with the general flowthrough treatment that has historically been accorded to partnerships under Subchapter K principles. This shift is, in large part, a reaction to a growing awareness that the IRS struggles to audit large partnerships and (just as importantly) to make assessments against their partners under the existing TEFRA regime.

Which Partnerships Will Be Subject to the New Rules?

The new rules will generally apply to all partnerships. However, partnerships that satisfy certain requirements and that have 100 or fewer qualifying partners will have the option to elect out of the new regime. Where such an election out is made, the partnership and its partners will be governed by the present-law deficiency procedures (Joint Committee on Taxation, General Explanation of Tax Legislation Enacted in 2015, p. 58 (March 2016)) rather than the BBA's "imputed underpayment" procedures, which are discussed below.

A partnership is eligible to elect out of the new rules, however, only if each of its partners is either an individual, a C corporation, a foreign entity that would be treated as a C corporation if it were domestic, an S corporation, or an estate of a deceased partner (Sec. 6221(b)(1) (C)). (As written, the statute does not clearly address several important issues, including whether a partnership with a partner that is a single-member disregarded entity will be rendered ineligible to opt out, although the legislative history behind the BBA indicates that Treasury may provide future guidance on this issue.) If a partnership consists exclusively of partners in the above-listed categories, it may elect out of the new audit rules if all of the...