BBA Audits

BBA Audits

The Role of the Partnership Representative in an Audit.

The partnership representative has sole authority to act on behalf of the partnership. Partners are bound by the decisions made by the partnership representative. Direct and indirect partners have no participation rights during the examination.

Mathematical Adjustments.

The BBA regime also provides that if an adjustment is identified on account of a mathematical or clerical error appearing on the partnership return, the IRS may make an adjustment to correct the error and may assess the partnership an imputed underpayment resulting from that adjustment. The notice to the partnership of the adjustment on the basis of correcting the error is not considered a notice of final partnership adjustment under section 6231(a)(3). Math error correction also applies to an adjustment to any inconsistently reported partnership-related item on a partner’s return when notice of such inconsistency is not provided.

Determinations at the Partnership Level.

Any partnership adjustment and the applicability of any penalty, addition to tax, or additional amount (plus interest as provided by law) that relates to such adjustment are generally determined and assessed at the partnership level.

Treatment of Payment of Imputed Underpayments.

The payment relating to any imputed underpayment, interest or penalties that is made by the partnership is non-deductible and must be treated as an expenditure described in section 705(a)(2)(B).

BBA Audit Phases.

After a case is disposed from the field to Technical Services and a notice of any proposed partnership adjustment (NOPPA) has been issued, the next phase of the examination is modification which will be handled by the BBA Unit in Ogden.

Delinquent Return and Substitute for Return (SFR)

Delinquent returns and substitute for returns are subject to the BBA regime. Election out of the BBA can only be made on an original timely filed return. Therefore, if a delinquent return includes such an election out, it is deemed invalid and will generally be denied under IRS protocol.

The IRS will generally issue Letter 3798, Non-Filer Appointment, in non-filer cases where return solicitation language is unwarranted. Letter 3798 is not a notice for selection for exam.

Once the IRS makes a determination has been made to conduct an examination of the non-filed/late filed return, it will issue Letter 2205-D and follow the BBA procedures.

Partnerships in Bankruptcy and Ceasing to Exist

The IRS may audit a BBA partnership return if deemed warranted or complete an examination even if the BBA partnership is in bankruptcy or ceases to exist. In general, the running of any period of limitations for making a partnership adjustment and assessment or collection of the imputed underpayment is suspended during the period the IRS is prohibited from making the adjustment, assessment or collection in a Title 11 case. However, the filing of a petition under Title 11 (in a BBA examination) does not prohibit the following actions:

  • A BBA examination,
  • The mailing of any notice with respect to a BBA examination,
  • The issuance of a NAP, NOPPA, and FPA,
  • A demand for tax returns,
  • The assessment of any tax and imputed underpayment, or
  • The issuance of notice and demand for payment.

Whether a partnership ceases to exist, partnership adjustments may be taken into account by the former partners of the partnership. A partnership ceases to exist if the IRS makes a determination that such partnership (including partnership-partner): 1) Terminates within the meaning of § 708(b)(1), or 2) Does not have the ability to pay, in full, any amount due (not collectible)

BBA Scope – Adjustments at the Partnership Level

A partnership adjustment and the applicability of any penalty, addition to tax, or additional amount that relates to such adjustment is determined at the partnership level. Any legal or factual determinations underlying any partnership adjustment or determination are also determined at the partnership level.

A partnership adjustment is any adjustment to a partnership-related item (PRI) and includes any portion of an adjustment to a PRI. The term PRI means:

  1. Any item or amount with respect to the partnership which is relevant in determining the tax liability of any person under chapter 1 of subtitle A of the Code;
  2. Any partner’s distributive share of any such item or amount; and
  3. Any imputed underpayment determined under the BBA regime.

An item or amount is treated as being “with respect to the partnership” if it is:

  1. Shown or reflected, or required to be shown or reflected, on a return of the partnership under section 6031, the regulations thereunder, or the forms and instructions prescribed by the IRS for the partnership’s taxable year or is required to be maintained in the partnership’s books or records, or
  2. Relating to any transaction with, liability of, or basis in the partnership but only if it’s described in the preceding sentence.

Note: An item or amount shown or required to be shown on a return of a person other than the partnership (or in that person’s books and records) that results after application of the Code to a PRI based upon the person’s specific facts and circumstances, including an incorrect application of the Code or taking into account erroneous facts and circumstances of the partner, is not with respect to the partnership.

Examples. Adjustments that constitute adjustments to partnership-related items include:

  1. The character, timing, source, and amount of the partnership’s income,gain, loss, deductions, and credits;
  2. The character, timing, and source of the partnership’s activities;
  3. The character, timing, source, value, and amount of any contributions to,and distributions from, the partnership;
  4. The partnership’s basis in its assets, the character and type of the assets,and the value (or revaluation) of the assets;
  5. The amount and character of partnership liabilities and any changes tothose liabilities from the preceding tax year;
  6. The category, timing, and amount of the partnership’s creditableexpenditures;
  7. Any item or amount resulting from a partnership termination;
  8. Any item or amount relating to an election under section 754; and
  9. Partnership allocations and any special allocations.

Examples of items that are NOT PRIs include:

  1. A deduction shown on the return of a partner that results after applying(correctly or incorrectly) a limitation under the Code (such as section 170(b)) at the partner level to a partnership-related item based on the partner’s facts and circumstances, and
  2. A partner’s adjusted basis in his/her partnership interest (outside basis).

Non-chapter 1 tax

The BBA regime applies to Subtitle A, Chapter 1 Income Tax only and will not apply to other taxes as shown below.

  1. Chapter 2 (Tax on Self-Employment Income – “SECA”)
  2. Chapter 2A (Unearned Income Medicare Contribution – “NIIT”)
  3. Chapter 3 (Withholding of Tax on Nonresident Aliens and ForeignCorporations)
  4. Chapter 4 (Taxes to Enforce Reporting on Certain Foreign Accounts)Note: No guidance exists for coordination of the BBA with Chapter 6 Consolidated Returns or any other Subtitle of the IRC at the time this interim guidance was released.

However, if the IRS makes adjustments to PRIs or determinations about PRIs in a BBA audit, those adjustments or determinations must be taken into account when determining a tax under chapters 2, 2A, 3 & 4.

Section 6501(c)(12) provides in the case of any partnership adjustment determined under the BBA regime, the period for assessment of any tax imposed under chapter 2 or 2A which is attributable to such adjustment shall not expire before the date that is one year after one of two events.

  1. In the case of an adjustment pursuant to the decision of a court in a proceeding brought under section 6234, the period for assessment shall not expire before the date that is one year after the decision becomes final.
  2. In any other case, the period for assessment shall not expire before the date that is one year after 90 days after the date on which the FPA is mailed under section 6231.

Foreign Partners. If a partnership adjustment subjects the partnership to withholding requirements under chapter 3 or 4, the partnership can either pay the chapter 1 tax (imputed underpayment under section 6225) allocable to the foreign partner’s distributive share of the adjustment or, if electing to push out the adjustments, remit chapter 3 or 4 withholding tax on the foreign partner’s distributive share of the adjustment.

Income Subject to SECA or NIIT. All Partnerships are required to determine whether a partner’s distributive share of income is subject to SECA or NIIT. Partnerships report information about SECA on Schedules K and K-1, line 14 and about NIIT on Schedules K and K-1, line 20. (Line references to 2018 version)

If a partnership correctly classifies income as subject to SECA or NIIT on its originally filed return, section 6501(c)(12) applies to allow assessment of SECA or NIIT at the partner level related to adjustments to PRIs made at the BBA Partnership level. Example – an increase to ordinary income on line 1 of Schedule K-1 will correspondingly increase net earnings from self-employment on line 14 of Schedule K-1 by the same amount.

If a partnership improperly classifies income, or does not classify income at all, as subject to SECA or NIIT on its originally filed return, it is possible that section 6501(c)(12) will not apply to the assessment of any tax imposed under chapter 2 or 2A which is attributable to partnership adjustments determined under the BBA regime. In this case, the IRS may seek to protect partners’ section 6501(a) statutes to assess SECA or NIIT related to both their originally reported distributive share and/or to their distributive share of adjustments to PRIs that are made at the BBA partnership level. Example – a sole adjustment to increase net earnings from self- employment on line 14 of Schedule K-1 from zero to equal to ordinary income on line 1 of Schedule K-1.

Examples.

An adjustment to SECA on line 14 of Schedule K-1 is a PRI whereas an adjustment to NIIT on line 20 of Schedule K-1 is not a PRI.

SECA reported on line 14 of Schedule K-1 is a PRI because it’s an item reported on the BBA partnership’s Schedule K/K-1 and affects the chapter 1 liability of any person because an individual is entitled to an adjustment to income for their deductible part of self-employment tax, which reduces their chapter 1 liability.

NIIT reported on line 20 of Schedule K-1 is not a PRI because there are no adjustments related to NIIT that affect a taxpayer’s chapter 1 liability.

Although whether partnership income is subject to SECA has been determined by the IRS to be a PRI, its auditors will follow dual procedures. Adjustments to whether partnership income is subject to SECA are primarily treated as a PRI but may be alternatively treated as not a PRI.

Dual Procedures means, with respect to a SECA issue, IRS revenue agents auditing both a BBA partnership and its partner(s) will protect both the BBA partnership’s section 6235 statute(s) and the partner(s) section 6501(a) statute(s) and make an adjustment at the BBA partnership level treating the partnership’s income as subject to SECA as a PRI and make an adjustment at the partner level treating it as not a PRI.

Adjusting ordinary income that will impact both lines 1 and 14 of Schedule K will be presented as an adjustment to a PRI at the partnership level and may result in an imputed underpayment. The IRS Revenue Agent may seek involvement from Technical Services (TS) or Campus Pass-Through Function (CPF) to prepare and issue partners’ SNDs to assess SECA at the partner level for their distributive share of line 14 (the adjustment at the BBA partnership level). The SNDs may state that they result from a SECA adjustment related to a partnership adjustment made in an audit of a BBA partnership and section 6501(c)(12) will apply.

Adjusting line 14 to correspond in full or part with line 1 of Schedule K generally involve dual procedures.

The IRS will present the adjustment as an adjustment to a PRI at the partnership level and compute an imputed underpayment. This PRI adjustment is generally the IRS’s primary argument.

The IRS will also prepare Form 4605A and workpapers for the SECA issue to assess SECA at the partner level for their distributive share of line 14 (the adjustment at the BBA partnership level). The reports will generally state that the partner is subject to SECA on their distributive share of income from the BBA partnership (e.g., Because the IRS has determined that the partner’s interest in the BBA partnership is not a limited partnership interest for purposes of Chapter 2 SECA).

The IRS will seek to protect the partners’ section 6501(a) statute. This will involve special language in the SND (Letter 531 Notice of Deficiency).

Auditing chapters 2 & 2A – Form 1040 is the key case

Assessments of chapters 2 and 2A taxes are made at the partner (direct and indirect) level in proceedings outside of the BBA regime. In other words, The BBA regime doesn’t apply to taxes under chapter 2A.

The IRS will issue a Form 4605A to a BBA partnership for adjustments to SECA and NIIT that are to be treated as non-PRIs. The IRS will issue Forms 886-A and 886-Ss for each partner receiving an allocable share of your Non-PRI adjustments.

Examples of partner-level audits

  1. An examiner is auditing the Form 1040 of an individual taxpayer. Taxpayer is a partner in a partnership that is subject to the BBA regime. The partnership issued a Schedule K-1 to the partner reporting $100,000 of ordinary income on line 1 and $100,000 of income subject to SECA on line 14 of Schedule K. The partner did not report the income as subject to SECA. The examiner determines, as part of theindividual’s audit, a chapter 2 deficiency of $3,800 ($100,000 X 3.8% maximum Medicare rate). BBA doesn’t apply to taxes under chapter 2 and the inconsistent reporting rules under section 6222 can’t be used to assess non-chapter 1 taxes. The examiner is not required to open an audit of the BBA partnership because there’s no adjustments to PRI.
  2. An examiner is auditing the Form 1040 of an individual taxpayer. That taxpayer is a partner in a partnership that is subject to the BBA. The partnership issued a Schedule K-1 to the partner reporting $100,000 of section 1231 gain on line 10 of schedule K from the sale of assets used in one of its trade or business activities. The partner did not report the income as subject to NIIT. The examiner determines, as part of the individual’s audit, that the partner was a passive investor in the BBA partnership and its activities. As such the examiner determines a chapter 2A deficiency of $3,800. This adjustment and assessment is made in a proceeding outside of the BBA regime; the examiner is not required to open an audit of the partnership under the BBA regime because the partner’s failure to include this income as NIIT is exclusively a partner level issue.
  3. An examiner is auditing the Form 1040 of an individual taxpayer. That taxpayer is a partner in a partnership that is subject to the BBA. The partnership issued a Schedule K-1 to the partner reporting $100,000 of ordinary income on line 1 and $0 of income subject to SECA on line 14 of Schedule K. The partner did not report the income as subject to SECA. Examiner reviews the partnership’s other partners and notes that all its partners took similar positions with respect to SECA that they, as partners, were not subject to SECA. The examiner may open the partnership for examination and follow dual procedures. Primarily the examiner will make a $100,000 PRI adjustment to line 14 of Schedule K-1 and compute an IU of $37,000. The examiner is required to utilize BBA PCS linking procedures to have the CPF issue substantially similar SNDs for SECA tax to all the partnerships’ partners and protect the partners’ 6501(a) statutes; these SNDs will state that the partner is subject to SECA on their distributive share of income from the BBA partnership because (state reason; i.e., The IRS has determined that your interest in the BBA partnership is not a limited partnership interest for purposes of Chapter 2 SECA) and this $3,800 ($100,000 X 3.8% maximum Medicare rate) assessment of SECA will be made at the partner level.

Examples of partnership-level audits

1. An examiner is auditing the Form 1065 of a partnership subject to the BBA. The partnership has 10 equal individual partners. The partnership reported $1,000,000 of ordinary income on schedule K, line 1 and reported that $0 of that income as subject to SECA on schedule K, line 14. The examiner determines that the partnership should have reported the entire $1,000,000 on line 14 of Schedule K as subject to SECA. There is no other adjustments to a PRI. Under dual procedures, primarily, this PRI adjustment will result in an IU. Secondarily, the $1,000,000 adjustment to line 14 must be taken into account for purposes of determining the partners’ SECA tax obligations. The IRS may adjust and assess each partners’ SECA tax liabilities on their individual returns. Since each partner is an equal partner, each partners’income subject to SECA will be increased by $100,000 or 10% of the increase to line 14 of Schedule K-1. The IRS will issue a SND stating that the partner is subject to SECA on their distributive share of income from the BBA partnership and assess $3,800 ($100,000 X 3.8% maximum Medicare rate) to each partner for their SECA tax related to an adjustment made to the BBA partnership. The examiner must follow the BBA linkage procedures and protect the partners’ section 6501(a) statutes.

Auditing chapters 3 & 4

A partnership (domestic or foreign) is subject to the U.S. withholding tax rules that apply to payments of U.S. source income to foreign partners.

Assessing chapters 3 and 4 taxes are generally in proceedings outside of the BBA regime. If foreign withholding is the only issue, the examination is not subject to the BBA regime and you do not have to follow these procedures.

  1. Rate adjustments and failure to file or withhold are determinations that must be made under a chapter 3 or 4 audit; such as:
    1. Applying an incorrect withholding rate on Form 8804 or 1042 on partner level income.
    2. A partnership’s failure to withhold any tax on FDAP income to third parties.
    3. A partnership’s failure to withhold on a disposition of U.S. real propertyinterests (FIRPTA withholding).
    4. A failure to file Forms 1042 and/or 8804 but no disagreement of amount ofFDAP or ECI.

Base adjustments may be made under either a chapter 1 BBA audit or a chapter 3 or 4 audit which include items identified by Form 1042 or Form 8804 audit; such as:

  1. Income omissions by the partnership.
  2. Determination that partnership is engaged (or treated as engaged) in aU.S. trade or business and has effectively connected income.
  3. Determination that a partnership has U.S. or foreign source income.
  4. Any other changes to the character or source of the partnership’s income.

A base adjustment to increase the partnership’s income is an adjustment to a PRI and will result in an IU. The tax imposed on the partnership for its failure to withhold on that income, however, is not a tax imposed by chapter 1; rather, it is a tax imposed by chapter 3.

  1. A partnership paying the IU will satisfy its chapters 3 and 4 withholding obligations.
  2. For partnerships that elect to push out the chapter 1 adjustments, the partnership must pay the amount of tax required to be withheld under chapters 3 and 4 on any adjustment. If the chapter 3 or 4 audit is completed first, then any partnership adjustments for which chapter 3 or 4 withholding has been paid are removed from the calculation of the IU.

Examples of chapter 3 or 4 audits.

  1. An examiner is auditing Form 1042 filed by a partnership subject to theBBA regime. The partnership has 2 equal partners, one is a US citizen and one is a non-resident alien who is a resident of another country. The partnership earned $200 of US source royalty income and reported $100 on each partner’s Schedule K-1. The partnership withheld $15 from the foreign partner. The examiner proposes a rate adjustment and determines that the partnership should have withheld $30 from the foreign partner. As such the examiner determines a chapter 3 deficiency of $15. This adjustment and assessment is made in a proceeding outside of the BBA because the tax imposed on the partnership for its failure to withhold on that income, however, is not a tax imposed by chapter 1. Rather, it is a tax imposed by chapter 3, which is not covered by the BBA. Even though the examiner is auditing the partnership’s Form 1042, the examiner is not required to open an audit of the BBA partnership’s Form 1065.
  2. An examiner is auditing Form 1065 filed by a partnership subject to the BBA. The partnership has 2 equal partners, one is a US citizen and one is a nonresident alien who is a resident of another country. The partnership earned $200,000 of US source royalty income and reported $100,000 oneach partner’s Schedule K-1. The examiner notes that the partnership properly withheld $30,000 from the foreign partner. The examiner determines, as part of the Form 1065 audit, that the partnership should have reported $400,000 of US source royalty income and proposes a base adjustment. The imputed underpayment is $74,000, calculated as the $200,000 adjustment to royalty income subject to chapter 1 income tax times the maximum individual rate of 37%. The examiner notes that the partnership should have withheld an additional $30,000 from the foreign partner. In this instance, the $37,000 imputed underpayment attributable to the foreign partner’s $100,000 allocable share of the adjustment satisfies the partnership’s requirement to withhold chapter 3 tax; if the partnership elects to push out the partnership adjustment, the partnership must remit $30,000 of chapter 3 withholding on behalf of the foreign partner’s $100,000 allocable share of the adjustment to the foreign partner’s $100,000 allocable share of the adjustment satisfies the partnership’s requirement to withhold chapter 3 tax; if the partnership elects to push out the partnership adjustment, the partnership must remit $30,000 of chapter 3 withholding on behalf of the foreign partner’s $100,000 allocable share of the adjustment.

Planning the Examination

The IRS will perform a risk assessment prior to preparing and executing an audit. This process includes determining whether the examination is subject to the BBA regime and identifying the partnership representative.

The IRS generally will not initiate an examination with less than 12 months remaining on the statute of limitations to make adjustments under 6235(a)(1) without prior managerial approval.

Determining if a partnership is subject to the BBA regime.

The centralized partnership audit regime applies to all partnerships required to file information returns under section 6031(a) whose tax years begin on or after January 1, 2018, except:

  • Partnerships electing out of the BBA; and
  • Partnerships electing out of partnership status pursuant to section 761(a).

Section 1101(g)(4) of the BBA also provides that partnerships may “elect” to have the centralized partnership audit regime apply to partnership returns filed for tax periods beginning after November 2, 2015 and before January 1, 2018. This election may only be made within 30 days of the date the IRS first notifies a partnership in writing that its return has been selected for examination (via Letter 2205-D) or by filing an Administrative Adjustment Request under section 6227.

If the partnership is not subject to the BBA regime, the examination is subject to deficiency procedures at the partner level.

Election out of the BBA – tax periods beginning on or after 1/1/2018

An election out is deemed valid until the IRS determines it is invalid.

Eligible partnerships may make the election under section 6221(b) to elect out of the centralized partnership audit regime on their timely filed Form 1065/1066, Schedule B, question 25 (including extensions).

In addition, eligible partnerships must attach Schedule B-2 to provide information concerning their partners as required by section 6221(b)(1)(D) to include each partner’s name, correct TIN, and federal tax classification.

Determining if an election was made timely

Non-filers cannot elect out because no return was filed. The election cannot be made on a substitute for return (SFR). The SFR will be subject to the centralized partnership audit regime.

Similarly, the IRS takes the position that a constructive or de facto partnership would be subject to the centralized partnership audit regime because it would not have made a timely election.


The IRS will generally utilize the TC 150 date for determining timeliness of the election out of the BBA. If the TC 150 date reflects a late filing, you may use the partnership’s proof of timely filing, such as eFile receipts or certified mailing slips.

If the election is not made on a timely filed return (including extensions), the IRS maintains that the election out is invalid.

Eligibility to elect out of the BBA

There are two criteria that a partnership must meet to be eligible to elect out of the BBA:

  • The partnership may only have partners each of whom is an individual, a C corporation, an estate of a deceased partner, or an S Corporation, and
  • The partnership is required to furnish 100 or fewer Schedule K-1s.

If either one of these requirements is not met, the partnership is not eligible to elect out and is subject to the BBA regime.

As noted, a partnership may only have direct partners each of whom is an individual, a C corporation, an estate of a deceased partner, or an S Corporation.

A partner that is a foreign entity generally will be considered an eligible partner if the foreign entity would be treated as a C corporation if it were a domestic entity.

S Corporations may have shareholders (such as QSSTs and/or ESBTs) that would otherwise be ineligible if they were direct partners. The type of shareholders doesn’t factor into the determination of eligible partners. Note: Partnerships that have Q-Sub(s) as a partner are not permitted to elect out.

An estate of a deceased partner filing Form 1041 may issue Schedule K-1s to its beneficiaries. Similar to S Corporations, an estate may have beneficiaries that would otherwise be ineligible if they were direct partners. The type of beneficiaries doesn’t factor into the determination of eligible partners.

If any of the following entities or persons are direct partners, the partnership is ineligible to elect out of the BBA and is subject to centralized partnership audit regime:

  • A partnership or limited liability company
  • Any type of trust, even a grantor trust
  • A foreign entity that is not treated as a C Corporation if it were a domestic entity
  • A disregarded entity for federal tax purposes
  • An estate of an individual other than a deceased partner
  • A nominee

The IRS will review and perform analysis with respect to the partnership’s Schedule B-2 in order to determine whether the partnership is eligible.

Partnerships required to furnish 100 or fewer schedule K-1s

If more than 100 Schedule K-1s are required to be furnished, the partnership is not eligible to elect out.

In the determination of whether the 100 or fewer Schedule K-1 threshold is met, the standard is based upon the number of Schedule K-1s required to be furnished, not the actual number of Schedule K-1s furnished. Therefore, if the taxpayer fails to furnish one or more Schedule K-1s, those not furnished but required to be furnished will be included in the total count.

Because S corporations are allowable partners and issue Schedule K-1s to their shareholders, in the determination of whether the partnership has furnished 100 or fewer Schedule K-1s, the Schedule K-1 furnished to the S corporation partner counts as one Schedule K-1 while all of the Schedule K-1s required to be furnished to the shareholders of the S corporation partner count as additional Schedule K-1s.

With regard to a partner that is an estate of a deceased partner, the estate may file Form 1041 and furnish Schedule K-1s to its beneficiaries. For purposes of determining the number of Schedule K-1s required to be furnished by the partnership, any Schedule K-1s furnish by the estate are NOT taken into account for purposes of determining whether the partnership has furnished 100 or fewer K-1 statements.

Determining the number of schedule K-1s required to be furnished

If a statement (Schedule K-1) is required to be furnished (whether issued or not) under section 6031(b) with respect to each of its partner, then each such statement is included in the calculation of the number of schedule K-1s and should be disclosed on Schedule B-2, Part III, Line 3.

Page 1 of the Form 1065 requires an entry for the number of Schedules K-1 attached to the return. This entry will provide you a preliminary assessment as to whether the partnership is close to or has exceeded the maximum 100 threshold, notwithstanding whether any partners are S corporations or whether certain Schedule K-1s were actually issued.

If an S Corporation partner is listed, you should ensure that Schedule K-1 issued to the S Corporation is counted as well as the number of Schedule K-1s the S Corporation is required to furnish to its shareholders under section 6037(b) are also accounted for.

Determination that an election out of the BBA is invalid

The IRS does not provide a procedure to appeal a determination that an election out is invalid.

If The IRS determines that an election out is invalid, it will issue Letter 6062, Notice of Invalid Election Out of the BBA, to notify a partnership of the IRS’ determination. The IRS will generally issue this letter no earlier than the issuance of Letter 2205-D.

Revocation of the election out

Once an election is made by the partnership to elect out of the BBA regime, it cannot be revoked without the consent of the IRS.

A request to revoke the election out of the BBA regime must be made within the first 30 days after the partnership has received notification from the IRS that an examination will take place (via Letter 2205-D).

An election to revoke must be done on a year by year basis.

Partnership must mail or submit the revocation statement to the person whose name appears on Letter 2205-D. The revocation statement must have the following:

  • A statement that this is an election to revoke section 6221(b) election and identify the taxable year for which the election to revoke is being made.
  • Sign and date by any person who is authorized to sign the Form 1065. Any partner or LLC member is an authorized person.
  • The partnership must also designate a partnership representative and submit Form 8979.

The revocation statement

The revocation statement must be submitted timely, signed by an authorized person and include the required information.

Upon acceptance of accept the revocation, the partnership examination will be subject to the BBA regime

Partnership Representative (PR)

The partnership must designate a PR on each return filed for taxable years beginning after December 31, 2017. The designation is effective on the date the return is filed.

Page 3 of Form 1065 should reflect the designation of the PR. Generally, this is the initial designation of record.

If there is no designation of the PR, there is no PR designation in effect.

The partnership representative has a key role in a BBA proceeding. Under section 6223, it is the PR that has the sole authority to act on behalf of the partnership. All partners and the partnership are bound by the PR’s actions and the PR’s final decision in a BBA proceeding. There may be only one PR for a partnership taxable year at any time. Therefore, it is critical that the PR is clearly identified.

A PR can be any person, including the partnership itself. The PR is not required to be a partner, an employee, or have any other relation to the partnership. This allows the partnership to select the person best situated to represent the partnership. The only requirement is that the PR must have a substantial presence in the United States.A. If a partnership designates an entity (including the partnership itself) to be the PR, it must also appoint a designated individual (DI) to act on behalf of the EPR. The DI can be anybody but must also have substantial presence in the United States.

The IRS is not bound by any limitations, restrictions or agreements placed upon the PR by the partnership in the partnership agreement, any side agreements or any other document to which it is not a party.

The designation of a PR remains in effect until the designation is terminated by a valid revocation, a valid resignation, or a determination by the IRS that the designation is not in effect. If there is a change to the PR or DI, any actions of the old PR or DI prior to the change will remain valid.

A partnership, through an authorized person, may designate or change the PR or DI by submitting Form 8979 to an IRS point of contact (i.e., examiner, Appeals Officer, or Counsel attorney). An authorized person is a person who was a partner at any time during the partnership tax year to which the designation or change relates.

Form 8979 may also be submitted in conjunction with the partnership’s filing of an administrative adjustment request. If so, the change in designation (or appointment) is treated as occurring prior to the filing of the administrative adjustment request.

Substantial presence in the United States

Both the PR and DI must have a substantial presence in the United States. All the following requirements must be met:

  • Make themselves available to meet in person with the IRS in the United States at a reasonable time and place as determined by the IRS in accordance with Regulations section 301.7605-1;
  • Have a United States street address and a telephone number with a United States area code; and
  • Have a United States taxpayer identification number (TIN).

If the PR is an entity (including if the PR is the partnership itself), it must be in legal existence to have substantial presence. For example, if the PR is an Entity Partnership Representative (EPR) it must be in legal existence and both the PR and DI must have a United States street address, a telephone number with a United States area code, and a taxpayer identification number.

Form 8979

Form 8979 is the sole mean to revoke a PR or DI, resign as a PR or DI, or designate a PR where no PR designation is in effect. Form F8979 is submitted for a single taxable year.

The following table presents possible actions and who can submit Form 8979.

ACTION:FORM 8979 COMPLETED BY:
Revocation of a partnership representative (entity or individual PR). Must include the designation of a successor partnership representative (entity or individual). If a successor entity partnership representative is made, the simultaneous appointment of a designated individual is also required.Partnership (through an authorized person)
Revocation of a designated individual. Must include an appointment of a successor designated individual.Partnership (through an authorized person)
Designation of an entity partnership representative and appointment of a designated individual.Partnership (through an authorized person)
Designation of an individual partnership representative.Partnership (through an authorized person)

Partnerships can submit Form 8979 with an administrative adjustment request (AAR) or any time after the issuance of a notice of selection for examination (Letter 2205-D) to the partnership.

A PR or DI may submit Form 8979 any time after the issuance of a notice of administrative proceeding (NAP) to resign. If an EPR is resigning, the DI signs the form on behalf of the EPR. However, a DI can separately resign as well. In either case, the resignation will result in no PR designation being in effect.

Multiple revocations by the partnership within the 90-day period

Current IRS procedures provide that if two revocations the the PR are received within a 90-day period, the examining agent may (but is not required to) determine that the second revocation (the “current” revocation) results in no PR designation in effect.

The IRS will not send out Letter 6053 responding to the current revocation if it determines that no PR designation in effect.

If, however, the examining agent and his/her manager determine that the facts and circumstances so warrant, the agent may accept the current revocation (if valid) and confirm the latest PR of record. In such case, The IRS will send Letters 6053, 6007 and 6008.

If the IRS determines that there is no PR designation in effect, IRS protocol requires the agent to provide notice within 90 days of receiving the current revocation to indicate that there is no designation in effect. Otherwise, the agent is instructed not to determine that no designation is in effect because of multiple revocations. In such case, the agent will send Letters 6053 and 6007 only.

If The IRS has declared that there is no designation in effect, the examining agent must select a new PR with reasonable due diligence while balancing the need to continue the examination in an efficient and effective manner.

Once the examining agent has selected a PR, the partnership cannot revoke the PR without the permission of the IRS. Permission is granted if the partnership submits a Form 8979 and the IRS accepts the submittal as valid.

Form 8979 and examiner responsibilities

When the IRS receives Form 8979, after determining that the form is valid, within 30 days of receipt, the IRS will issue the appropriate set of letters to inform the appropriate parties about your determination.

Form 8979 is deemed valid until the IRS determines it is invalid.

There may be various reasons for submitting a Form 8979, such as:

  1. The partnership is revoking the current entity or individual PR;
  2. The partnership is revoking the current DI;
  3. The PR is resigning;
  4. The DI is resigning; or
  5. The partnership is designating a PR because there’s no PR in effect.

Generally, the most recent Form 8979 supersedes all prior Form 8979 submissions. However, it is possible that the partnership did not properly revoke the PR or DI by erroneously listing the wrong person. In such a case, that revocation and designation are invalid. The PR or DI before the invalid revocation remains as the PR or DI of record.

Regulations require that the PR and DI must have substantial presence in the United States.

The IRS will prepare and issue notices upon receiving a Form 8979, such as:

  1. Letter 6053, Notice to Partnership of Partnership Representative Status,
  2. Letter 6007, Notice to [Existing or Old] Partnership Representative ofStatus, and
  3. Letter 6008, Notice to [New] Partnership Representative of Status.

Note: The above-listed letters are not required to be mailed when the Form 8979 is received with an AAR prior to issuance of a NAP.

The IRS will mail Letter 6053 to the partnership. Letters 6007 and 6008 should be mailed to the old PR and the new PR (if applicable), respectively. If the PR is an entity, The IRS will mail the letter to the PR at the attention of the DI and use the PR address.

If the IRS made a designation of a PR, the partnership can request permission from the IRS to revoke that designated PR by submitting a valid revocation Form 8979.

Some circumstances under which the IRS can determine that no PR designation exists include:

  1. No substantial presence in the United States. See section “Substantial Presence in the United States” above.
  2. The partnership failed to appoint a DI if the PR is an EPR.
  3. The partnership failed to make a valid designation of a partnershiprepresentative.
  4. There was a valid resignation of PR or DI, but no subsequent designationby the partnership.
  5. There are multiple revocations within the 90-day period and the IRSdetermines that there is no designation in effect.
  6. The PR is no longer in effect for any other reason as determined by other published guidance.

IRS’s selection of a PR

If the IRS must select a PR, there is no specific prescribed timeframe to do so. However, the IRS must select a new PR with reasonable due diligence while balancing the need to continue the examination in an efficient and effective manner.

The IRS can select any person to be the partnership representative (except for an IRS employee, agent, or contractor unless they are a partner in the partnership); however, the person designated by the IRS should have sufficient knowledge of the partnership tax return and business operations to participate in the examination.

If the IRS seeks to designate a PR, IRS rules provide that it should consider the following factors:

  1. The intention of the partnership based on a late or untimely filed Form8979,
  2. The views of majority interest partners,
  3. The partner’s or other person’s general knowledge of tax matters andadministrative matters,
  4. The partner’s or other person’s access to the books and records of thepartnership,
  5. The profits interest held by the partner,
  6. Whether there is a partner from the year under examination or a partner atthe time the partnership representative selection is made,
  7. Whether the person is a United States person, and
  8. The person’s ability to meet with the IRS to participate in the examination.

Inquiries to determine the above items, may requires seeking information and discussing the matter with partners, employees, and other prospective candidates to assess the person’s depth of knowledge. These inquiries are not considered by the IRS to be disclosures or third-party contacts under sections 6103 and 7602. However, the IRS should not address or inquire about tax issues during such preliminary discussions.

Administrative Adjustment Request (AAR)

A partnership may file an AAR under section 6227 with respect to any PRI and correct errors on a previously filed partnership return. However, a partnership may not file an AAR solely for the purpose of changing the designation of a PR.

The filing of an AAR will extend the section 6235(a)(1) statute date which is 3 years from the date the AAR was filed.

Only the PR (or DI, if applicable) may sign and file an AAR on behalf of the partnership.

A partner may not make a request for an administrative adjustment of a PRI unless the partner is a PR (or DI, if applicable) and is doing so on behalf of the partnership.

The AAR is filed with the IRS service center where the original return was filed.

A partnership may not file an AAR more than 3 years after the later of the date the partnership return for such taxable year was filed or the last day for filing such partnership return (without regard to extension); or after a notice of administrative proceeding (NAP) has been issued with respect to such taxable year.

A partnership must determine whether the adjustments requested in the AAR result in an imputed underpayment. If so, the partnership must take the adjustments into account and make payment unless the partnership makes a valid election for the adjustments to be taken into account by the reviewed year partners.

In general, the partnership must pay the imputed underpayment on the date the partnership files the AAR. A partnership may apply modifications to the amount of the imputed underpayment if a notification (Form 8980) is attached to the AAR and includes the following:

  1. Notification to the IRS of the presence of any modification,
  2. A description of the effect that each modification had on thecalculation of the imputed underpayment,
  3. An explanation of the basis for the modification made, and
  4. Documentation to support the partnership’s eligibility for the modification.

If the partnership makes a valid election to have adjustments resulting in an imputed underpayment be taken into account by reviewed year partners, the partnership is not required to pay the imputed underpayment.

If the adjustments requested in the AAR do not result in an imputed underpayment, such adjustments must be taken into account by the reviewed year partners.

If a reviewed year partner is required to take into account the adjustments requested in the AAR, the partnership must furnish a statement to the reviewed year partner and file such statement with the IRS on the date the AAR is filed. Each statement must include correct information as follows:

  1. The name and TIN of the reviewed year partner;
  2. The current or last address of the partner that is known to the partnership;
  3. The reviewed year partner’s share of items as originally reported orpreviously reported;
  4. The reviewed year partner’s share of the adjustments in the underlyingAAR;
  5. The date the statement is furnished to the partner; and
  6. The partnership taxable year to which the adjustments relate.

If a partner of the partnership that filed an AAR is a pass-through entity, the pass-through partners must issue statements to its partner and include the following (in addition to the above).

  • The name and TIN of the partnership that filed the AAR;
  • The adjustment year of the partnership that filed the AAR; and
  • The extended due date for the adjustment year return of the partnership that filed the AAR.

Note: The above list doesn’t have all the items required for pass-through partners.

Each reviewed year partner must take into account their share of all the adjustments requested in the AAR as shown on such statements.

Each reviewed year partner’s share of the adjustment requested in the AAR is determined in the same manner as each adjusted PRI was originally allocated on the partnership return for the reviewed year.

If the partnership pays an imputed underpayment with respect to the adjustments requested in the AAR, the reviewed year partner’s share of the adjustments requested in the AAR only includes adjustments that did not result in the imputed underpayment.

If the adjusted PRI was not reported on the partnership’s return for the reviewed year, each reviewed year partner’s share of the adjustments will be based on how such items would have been allocated per the partnership agreement.

If an adjustment involves a reallocation of an item, the reviewed year partner’s share of the adjustment requested in the AAR is determined in accordance with the AAR.

AAR exam scope

The IRS may determine that an AAR is not valid or readjust any items that were adjusted on the AAR. Also, the amount of an imputed underpayment determined by the partnership, including any modifications, may be re-determined by the IRS.

The partnership audit plan should include any PRI that you do not agree with, including the following:

  1. Any substantial issue relating to the adjustments requested in the AAR,
  2. Discrepancies in the imputed underpayment as determined in the AAR,including modifications, and
  3. The allocation of the adjustments to the reviewed year partners as reported in the filed statements.

Initiating taxpayer contact (Letter 2205-D)

All initial taxpayer contacts are required to be made by mail. The IRS will mail Letter 2205-D to all partnerships regardless of the tax year.

Letter 2205-D is used to:

  1. Provide notice of selection for examination to any partnership, whethersubject to the unified rules under TEFRA (Tax Equity and Fiscal Responsibility Act of 1982), the centralized partnership audit regime (Bipartisan Budget Act of 2015), or separate deficiency proceedings;
  2. Confirm certain information of record; and
  3. Request that the taxpayer call-back to schedule an initial appointment forthe examination of partnership income tax returns.

BBA partnership Form 2848, Power of Attorney (POA)

Form 2848, Power of Attorney and Declaration of Representative, is used to authorize an individual to represent a PR who is acting on behalf of the partnership under the centralized partnership audit regime.

A power of attorney (including a Form 2848, Power of Attorney) may not be used to designate a partnership representative.

The PR or DI (for an EPR) of record must sign the Form 2848 and the authorized individual must be eligible to practice before the IRS.

For matters unrelated to the centralized partnership audit regime, a separate Form 2848 must be signed by a partner that has authority to do so under state law. For dissolved partnerships, see 26 CFR 601.503(c)(6).

Note: Any statute extension (Form 872-M) should be signed by the PR or DI (for an EPR).

Notice of Administrative Proceeding (NAP)

The IRS must mail to the partnership and PR a NAP when initiating an examination of the partnership for a taxable year, including an examination following an AAR filed by the partnership. The IRS should issue the NAP no earlier than 30 days but no later than 60 days from the issuance of Letter 2205-D.

The NAP will generally be mailed by certified mail. Letter 5893 will be mailed to the partnership’s last known address. Letter 5893-A will be mailed to the PR’s last known address that is reflected in the IRS records as of the date the letter is mailed.

If there is no PR in effect, the IRS will generally mail the NAP to “PARTNERSHIP REPRESENTATIVE” at the last known address of the partnership

If the PR NAP is mailed to an address other than the address shown on the Form 1065 and it is returned as undeliverable, the IRS must mail the PR NAP by certified mail to the address reflected on the partnership return.

A partnership cannot file an AAR and its partners cannot amend their returns to file inconsistently from the partnership after the NAP has been mailed with respect to the taxable year.

A separate NAP will be sent for each year under examination since each year stands on its own. Not that different audit regimes could apply to the different years.

Withdrawal of the NAP

The IRS may, without consent of the partnership, withdraw a NAP within 60 days from the issuance of the NAP if it is determined an AAR had been filed before the issuance of the NAP and no exam is warranted, or for other reasons.

Consistency principle

In general, a partner’s return must be consistent with the partnership return in all respects, including:

  • Items reported on the partnership return filed with the IRS (including amendments or supplements thereto),
  • Any AAR filed by the partnership under section 6227 and the regulations thereunder, and
  • Any statement, schedule or list (including amendments or supplements thereto) filed by the partnership with the IRS pursuant to section 6226 and the regulations thereunder.

A partner is also bound by any action taken by the partnership and any final decision in a proceeding with respect to the partnership under the BBA regime.

For example, a partnership subject to the BBA regime elects to push out the adjustments to its reviewed year partners. Each partner must take into account the adjustments consistently with how the adjustments are reflected on the statement issued by the partnership. Otherwise, it is considered a failure to treat a PRI in a manner which is consistent with the partnership return.

If the treatment of an item on the partner’s return is consistent with how the item was treated on a schedule (e.g., Schedule K-1) or other information furnished to the partner by the partnership but inconsistent with the treatment of the item on the partnership return that is filed with the IRS, the partner’s reporting is considered inconsistent with the partnership return. Upon notice of such inconsistency, a partner may file an election under section 6222(c)(2)(B) to be treated as providing notice to the IRS of the inconsistent treatment.

A partner’s treatment of a PRI attributable to a partnership that did not file a return is per se inconsistent.

For example, a foreign partnership is required to file a return under section 6031 but failed to file one for calendar year 2018. A domestic partner claimed losses arising from the foreign partnership in calendar year 2018. The domestic partner’s reporting of the loss is inconsistent with the partnership return.

For a partner that is a partnership (partnership-partner), the consistency principle applies regardless if the partnership-partner is subject to the centralized partnership audit regime or has made an election out pursuant to section 6221(b).

Partner fails to report a PRI consistently

When a partner fails to report an item on its return consistent with the partnership, whether intentional or not, there are two treatment streams depending on whether the partner has provided notice of the inconsistently reported PRI to the IRS.

  1. Generally, if the partner files inconsistently and does not provide notice, math error will apply, and the IRS may assess any resulting tax to make the partner consistent. Deficiency procedures will not apply to such assessment.
  2. If the partner files inconsistently but provides notice of the inconsistency (via Form 8082, Notice of Inconsistent Treatment or Administrative Adjustment Request), math error correction will not apply.

The notice provision only applies to items reported on the partnership return filed with the IRS (including amendments or supplements thereto) and PRI reported on an AAR filed by the partnership under section 6227 and the regulations thereunder.

Math error correction

The IRS may adjust the inconsistently reported item on the partner’s return to makeit consistent and assess the underpayment of tax that results from that adjustment to correct the mathematical or clerical error when:

  • A partner filed inconsistently with the partnership return and did not provide notice to the IRS of such inconsistent treatment.
  • A partner filed inconsistently with items reported from an AAR under section 6227 and the regulations thereunder and did not provide notice to the IRS of such inconsistent treatment.
  • A partner filed inconsistently with any statement, schedule or list (including amendments or supplements thereto) filed by the partnership with the IRS pursuant to section 6226 and the regulations thereunder regardless if notice was provided.
  • A partner filed inconsistently with any final decision in a proceeding with respect to the partnership under the BBA regime regardless if notice was provided.

The procedures under section 6213(b)(2) for requesting abatement of an assessment made on the basis of math error do not apply.

The underpayment of tax is the amount by which the correct tax, as determined by making the partner’s return consistent with the partnership return, exceeds the tax shown on the partner’s return.

For any partnership-partner that is subject to the BBA regime, the underpayment of tax is determined in accordance with §301.6225-1 (an imputed underpayment) and may be assessed at the partnership-partner level.

The math error correction is not considered an FPA under section 6231(a)(3) and a petition for readjustment under section 6234 is not applicable.

For any partners that are nonBBA partnerships or S-Corporations, the math error correction must be assessed to the reviewed year partners (or indirect partners) and shareholders, respectively.

Notifying the partner of an assessment on account of mathematical error

The IRS will provide a Letter 6202, Notice of Partner’s Inconsistency, which identifies the adjustment(s) with respect to inconsistent treatment and the underpayment of tax on account of math or clerical error, including any penalty and interest as provided by law. The letter is mailed to the partner’s last known address. If the partner corrects the inconsistency or qualifies and makes a validelection to be treated as having provided notice, then a math error correction will not apply.

Only a partnership-partner may correct the inconsistency by filing an AAR (for partnership-partner subject to the BBA) under section 6227 or an amended partnership return (for partnership-partner not subject to the BBA) prior to assessment.

  • If correction (via filing of AAR or amended return) for the inconsistency is made within 60 days from the issuance of Letter 6062, the partnership- partner has complied with the requirements.
  • If no correction is made or can be made within the 60-day period, an assessment due to math error will be made. Contact the BBA POC.

If the inconsistency is due to the partner filing consistently with a statement, schedule or other form prescribed by the IRS and furnished to the partner by the partnership (e.g., Schedule K-1) but differs from what the partnership actually filed with the IRS, then the partner has 60 days from the issuance of Letter 6062 to file a written election under section 6222(c)(2)(B).

The written election must demonstrate that the treatment of such item on the partner’s return is consistent with the treatment of that item on the statement, schedule, or other form prescribed by the IRS as furnished by the partnership.

The written election must have the following contents:

  • Clearly identify as an election under section 6222(c)(2)(B),
  • Signed by the partner making the election,
  • Accompanied by a copy of the statement, schedule, or other form furnished to the partner by the partnership and a copy of the IRS notice that notified the partner of the inconsistency, and
  • Include any other information required in forms, instructions, or other guidance prescribed by the IRS.

If a valid election is filed timely, the election will be treated as having provided notification of the inconsistent treatment and the assessment based on math error will not apply (instead deficiency proceedings will apply)

A partner files inconsistently with the partnership return and provides notice of the inconsistent treatment

When a partner reports a PRI inconsistent with the treatment of such item on thepartnership return and provides notice to the IRS (via Form 8082), assessment based on math error does not apply.A. Form 8082 must be attached to the partner’s return on which the PRI is treated inconsistently. Otherwise, the adjustment and corresponding assessment are considered as based on math error.

The partner is protected only to the extent of the items identified as inconsistent treatment. Assessments to the unidentified, inconsistent PRI on the partner’s return are treated as being based on math error.

If the IRS disagrees with the identified inconsistent treatment, the IRS may adjust the identified, inconsistently reported item in a deficiency proceeding with respect to the partner as follows:

  • To make the item consistent with the treatment of that item on the partnership return, or
  • To determine the correct treatment of such item, notwithstanding the treatment of that item on the partnership return.

Any final decision with respect to an inconsistent position in a proceeding to which a partnership is not a party is not binding on the partnership.

Informal claims (LB&I Taxpayers)

As discussed above, after a NAP is issued, an AAR cannot be filed. However, for LB&I taxpayers, the partnership may submit informal claims within 30 days from the opening conference which is consistent with the LB&I Examination Process (LEP). An informal claim is a request to change any PRI that may result in a negative adjustment.

Note: LB&I examiners are required to address the informal claim procedures with the partnership at the opening conference.

Informal claims timely submitted by a BBA partnership must meet the standards of Treasury Regulation Section 301.6402-2, which provides that a valid claim must:

  • Set forth in detail each ground upon which credit or refund is claimed;
  • Present facts sufficient to apprise the IRS of the exact basis for the claim;and
  • Contain a written declaration that it is made under penalties of perjury.

A BBA partnership must submit or mail the informal claim to the person whose name appears on Letter 2205-D within 30 days from the initial conference.

The adjustment will reflect on the applicable grouping and subgrouping per purposes of Forms 14791 and 14792.

The adjustment will reflect in the “Other Information” section of Forms 14791 and 14792.

The IRS will not accept any informal claim after the 30-day window has lapsed unless certain exceptions are met as provided under the LEP.

Statute of limitations (SOL) on making adjustments

The statute of limitations under section 6235 is applicable to the time allowed to make partnership adjustments instead of time to assess. The general rule is that no partnership adjustment for any partnership taxable year may be made after the later of three specified dates:

  • 6235(a)(1) date,
  • 6235(a)(2) date, or
  • 6235(a)(3) date.

The notice of proposed partnership adjustment must be issued prior to the expiration of the 6235(a)(1) date.

The 6235(a)(1) date is the later of:

  • 3 years after the date the return was due;
  • 3 years after the date the return was filed; or
  • 3 years after an Administrative Adjustment Request (AAR) is filed.

The following chart sets out several relevant statutes of limitations provisions:

IRC 6235(c)(2): Substantial omission of income in excess of 25 percent of the amount of gross income per 6501(e)(1)(A) [or omission from gross income of amounts properly includible under IRC 951(a) per 6501(e)(1)(C).]6 years
IRC 6235(c)(3): Failure to file a partnership return.Note: Under IRC 6235(c)(4), a return executed by the Secretary under IRC 6020(b) on behalf of the partnership shall not be treated as a return of the partnership.Adjustments can be made at any time
IRC 6235(c)(5): Reportable foreign transactions – failed to report information described in section 6501(c)(8).Date that is determined under IRC 6501(c)(8)
IRC 6235(c)(6): Listed Transactions – failed to include any information with respect to a listed transaction as described in IRC 6501(c)(10).Date that is determined under IRC 6501(c)(10)

The IRS will generally request an extension if the 6235(a)(1) date will expire within 14 months if the case is not a no-change. If the partnership refuses to extend the 6235(a)(1) date, The IRS will generally begin the process of closing the examination.

A partnership may request to go to Appeals and protest an adjustment on a substantive issue, any penalty associated with such adjustment, and the imputed underpayment amount.

No change exam

If the examination results in a no-change he partnership agrees with the no-change, Technical Services will prepare and CCP will issue the no-change letters to the partnership (Letter 6099) and PR (Letter 6099-A).

Partnership adjustments and imputed underpayment (IU)

A partnership does not compute and pay an income tax upon filing Form 1065 but instead passes through any profits and losses to its partners. However, when a partnership is examined under the BBA regime, any partnership adjustment resulting in an imputed underpayment and the applicability of any penalty, addition to tax, or additional amount (plus interest as provided by law) that relates to such adjustment are determined, assessed and collected at the partnership level.

In general, Form 886-A, Explanation of Items, is used to convey each adjustment. In addition to preparing a Form 886-A for each substantive issue, you will prepare a Form 886-A for the imputed underpayment.

An imputed underpayment may reflect an amount that is larger than the cumulative amount of tax the partners would have paid as a result of the partnership adjustments. Disregarding adjustments that would otherwise reduce the imputed underpayment and using the highest tax rate permit a streamlined audit process in which the IRS and the partnership generally do not account for particular partners’ facts and circumstances. The imputed underpayment determination allows the partnership to pay an amount of tax that generally eliminates the need for the IRS to proceed against and collect from the partnership’s partners.

There are two types of imputed underpayments: a general imputed underpayment and a specific imputed underpayment. Each type of imputed underpayment is based solely on partnership adjustments with respect to a single taxable year.

Imputed underpayment (IU)

  1. The formula for computing the imputed underpayment (IU) is as follows:

Highest rate in effect for the reviewed year under section 1 or 11

X

Sum of Net positive adjustments to creditable expenditure and credit groupings (and net negative adjustment to credit grouping if appropriate)

+/-

Total netted partnership adjustments (TNPA)

=

Imputed Underpayment (IU)

The process of taking the proposed audit adjustments and inputting those adjustments into the above formula requires an understanding of the unique BBA concepts of grouping, subgrouping and netting.

Grouping involves placing each proposed audit adjustment into one of four groupings: reallocation, credit, creditable expenditure and residual. Each of these groupings will be explained in more detail below.

After an adjustment is placed into a grouping, subgrouping is the process of further defining that adjustment into a subgrouping, generally in accordance with how that adjustment would be required to be taken into account separately under section 702(a) or any other provision of the Code. This is necessary to keep adjustments that are similar in nature together while keeping adjustment that are different apart. These subgroups generally follow the line items on Schedule K/K-1 or other separate and distinct line items on Form 1065 and schedules. However, subgrouping is only necessary when any proposed adjustment within a grouping is a negative adjustment.

A negative adjustment is any adjustment that is a decrease in an item of gain or income, an increase in item of loss or deduction, or an increase in an item of credit or creditable expenditure.

A positive adjustment is any adjustment that is not a negative adjustment.

Generally, netting is the process of summing all adjustments together within each grouping or subgrouping, as appropriate. The specific rules and limitations of netting will be discussed later.

Once all adjustments have been grouped, subgrouped (if applicable) and netted, the total netted partnership adjustment (TNPA) can be determined and entered into the above formula. The TNPA is the sum of all net positive adjustments in the reallocation grouping and the residual grouping. If, after netting, either the reallocation or residual grouping summed total is less than or equal to zero, it is not taken into account in calculating the TNPA.

A net positive adjustment means an amount that is greater than zero which results from netting adjustments within a grouping or subgrouping. A net positive adjustment includes a positive adjustment that was not netted with any other adjustment.

A net negative adjustment means any amount which results from netting adjustments within a grouping or subgrouping that is not a net positive adjustment. A net negative adjustment includes a negative adjustment that was not netted with any other adjustment.

Multiply the TNPA by the highest rate of Federal income tax in effect for the reviewed year under section 1 or 11 and increase or decrease the product by: The net positive adjustments from the creditable expenditure grouping.

Note: A net decrease to creditable expenditures is treated as a net positive adjustment to credits and increases the product of the TNPA times the highest tax rate in effect.

Note: A net increase to creditable expenditures is treated as a net negative adjustment that is excluded from the calculation of the TNPA and is an adjustment that does not result in an IU.

The net positive adjustments from the credit grouping.

The net negative adjustment from the credit grouping if the examination team determines that it is appropriate to allow the net negative adjustments to be taken into account in calculating the IU.

Only the net positive adjustment in each grouping will be used to computethe IU, except for credit grouping.

A net negative adjustment does not result in an IU; thus, such adjustmentmust be taken into account by the partnership in the adjustment year. That is, the adjustment is included on the partnership’s tax return for the year in which such adjustment becomes final.

The adjustment year is the taxable year in which:

  • The notice of final partnership adjustment (FPA) is mailed or when a waiver of the FPA is executed by the IRS, or
  • If a petition under section 6234 is filed, the date when the court’s decision becomes final.

Steps in computing the imputed underpayment (IU)

Computing the IU requires approximately 7 steps:

Step 1

The first step in computing an IU involves the placing of each proposed adjustment into one of four groupings: reallocation, credit, creditable expenditure and residual groupings. Each of the four groupings is explained below:

  • Reallocation grouping – In general, any adjustment that allocates or reallocates a PRI to and from a particular partner or partners is a reallocation adjustment, except for an adjustment to a credit or to a creditable expenditure. Each reallocation adjustment generally results in at least two separate adjustments, each of which become a separate subgrouping. See step 2 which discusses the concept of “subgrouping.”
  • One leg of the reallocation adjustment reverses the effect of the improper allocation of a PRI that will result in a negative adjustment. This adjustment must be taken into account by the partnership in the adjustment year and cannot generally be netted against other adjustments. See step 3 which discusses the concept of “netting.”
  • The other leg of the adjustment makes the proper allocation of the PRI and will result in a positive adjustment.
  • These reallocations are theoretical to the actual partners impacted, that is, they will not impact the partner themselves.

Credit grouping – Any adjustment to a PRI that is reported or could be reported by a partnership as a credit on the partnership’s return, including a reallocation adjustment to such PRI, is placed in the credit grouping.

  1. Generally, a decrease in credits is treated as a positive adjustment, and an increase in credits is treated as a negative adjustment.
  2. A reallocation adjustment relating to the credit grouping is placed into two separate subgroupings and will not be netted together nor will they be netted with other credit adjustments (except for other credit reallocation adjustments allocable to that partner or group of partners).
    1. A decrease in credits allocable to one partner or group of partners is treated as a positive adjustment generally in its own subgrouping.
    2. An increase in credits allocable to another partner or group of partners is treated as a negative adjustment generally in its own subgrouping and does not result in an IU and must be taken into account by the partnership in the adjustment year.

asdfditable expenditure grouping – Any adjustment to a PRI where any person could take the item that is adjusted (or item as adjusted if the item was not originally reported by the partnership) as a credit (i.e., creditable foreign tax expenditure or qualified research expense), including a reallocation adjustment to a creditable expenditure, is placed in the creditable expenditure grouping.

Generally, a decrease in creditable expenditures is treated as a positive adjustment to credits, and an increase in creditable expenditures is treated as a negative adjustment.

A reallocation adjustment relating to creditable expenditure grouping is placed into two separate subgroupings and will not be netted together.

Adecreaseincreditableexpendituresallocabletoone partner or group of partners is treated as a positive adjustment to credits.

Anincreaseincreditableexpendituresallocabletoanother partner or group of partners is treated as a negative adjustment and does not result in an IU and must be taken into account by the partnership in the adjustment year.

Example: if the adjustment is a reduction of qualified research expenses, the adjustment is to a creditable expenditure grouping because any person allocated the qualified research expenses by the partnership could claim a credit with respect to their allocable portion of such expenses under section 41, rather than a deduction under section 174.

Residual grouping – Any adjustment to a PRI that doesn’t belong in the reallocation, credit, or creditable expenditure grouping is placed in the residual grouping. Also includes any adjustment to a PRI that derives from an item that would not have been required to be allocated by the partnership to a reviewed year partner under section 704(b), such as an adjustment to a liability amount on the balance sheet.

Creditable expenditure grouping – Any adjustment to a PRI where any person could take the item that is adjusted (or item as adjusted if the item was not originally reported by the partnership) as a credit (i.e., creditable foreign tax expenditure or qualified research expense), including a reallocation adjustment to a creditable expenditure, is placed in the creditable expenditure grouping.

  1. Generally, a decrease in creditable expenditures is treated as a positive adjustment to credits, and an increase in creditable expenditures is treated as a negative adjustment.
  2. A reallocation adjustment relating to creditable expenditure grouping is placed into two separate subgroupings and will not be netted together.
    1. Adecreaseincreditableexpendituresallocabletoone partner or group of partners is treated as a positive adjustment to credits.
    2. Anincreaseincreditableexpendituresallocabletoanother partner or group of partners is treated as a negative adjustment and does not result in an IU and must be taken into account by the partnership in the adjustment year.
    3. Example: if the adjustment is a reduction of qualified research expenses, the adjustment is to a creditable expenditure grouping because any person allocated the qualified research expenses by the partnership could claim a credit with respect to their allocable portion of such expenses under section 41, rather than a deduction under section 174.

Residual grouping – Any adjustment to a PRI that doesn’t belong in the reallocation, credit, or creditable expenditure grouping is placed in the residual grouping. Also includes any adjustment to a PRI that derives from an item that would not have been required to be allocated by the partnership to a reviewed year partner under section 704(b), such as an adjustment to a liability amount on the balance sheet.

Any adjustment that changes the character of a PRI is a recharacterization adjustment. A recharacterization adjustment will generally result in at least two separate adjustments in the appropriate grouping (reallocation, credit, creditable expenditure, or residual).

  1. One adjustment reverses the improper characterization of the PRI that will result in a negative adjustment.
  2. The other adjustment makes the proper characterization of the PRI and will result in a positive adjustment.
  3. The adjustments that result from a recharacterization are generally placed into separate subgroupings.

If the effect of a partnership adjustment is reflected and taken into account in one or more other partnership adjustments, you may treat the adjustment amount as zero solely for purposes of computing the IU.

Step 2.

The second step in computing an IU is to determine if any proposed adjustment, within one of the four groupings, needs to be subgrouped. If all the proposed adjustments within any grouping are positive adjustments only, then subgrouping is not required for such grouping, and you can determine the IU at this point by plugging in the positive numbers to the above formula. If any of the proposed adjustments within a grouping is a negative adjustment, then subgrouping for that grouping is required. Each of the proposed adjustments will need to be subgrouped according to the following rules.

  • Each adjustment is subgrouped according to how the adjustment would be required to be taken into account separately under section 702(a) or any other provision of the Code, regulations, forms, instructions, or other guidance prescribed by the IRS applicable to the adjusted PRI. For purposes of creating subgroupings, if any adjustment could be subject to any preference, limitation, or restriction under the Code (or not allowed, in whole or in part, against ordinary income) if taken into account by any person, the adjustment is placed in a separate subgrouping from all other adjustments within the grouping.
  • Generally, each separate line item of Schedule K/K-1 or return schedule (i.e., Schedule L, etc.), represents a separate and distinct subgrouping. The format for Schedule K/K-1 generally follows the requirement of section 702(a) that each partner is required to take into account separately their distributive share of each class or item of partnership income, gain, loss, deduction or credit. Thus, adjustments to ordinary income must be placed in a different subgroup as capital gain income or interest income since each of those items is required to be separately stated under section 702(a).
  • Separate line items on Schedule K/K-1 (or other schedules onForm 1065) may include multiple components making up the total shown. If any line item on Schedule K/K-1 or other schedules consists of multiple items and the components are required to be taken into account separately under the Code, regulations, forms, instructions, or other guidance prescribed by the IRS, then such line item must be further subgrouped. For example, if there is more than one type of income to be included on Schedule K/K-1, line 11, Other Income/(loss), the partnership is required to attach a statement to Form 1065 that separately identifies each type and amount of income for each distinct category and each of those would constitute a separate subgroup. As another example, if the Schedule K/K-1, line 1 ordinary income/(loss) entry includes income/loss from more than one trade or business activity, the partnership must identify on an attached statement to Schedule K/ K-1 the amount from each separate activity. Accordingly, the income/(loss) from each separate activity from Schedule K/K-1, line 1 would constitute a separate subgroup.
  • The ordinary income/(loss) amount reflected on line 1 of Schedule K/K-1, is sourced from Form 1065, page 1 and is a net amount consisting of various page 1 line items of income and expenses. Although those separate page 1 line items are distinct items of income and expense, if they are appropriately netted and included on line 1, Schedule K/K-1, the net amount will be considered a single subgroup, unless such amount is required to be separately delineated, such as when the partnership has more than one trade or business as previously noted.
  • If you have a negative adjustment along with a positive adjustment in the same line item of Schedule K/K-1, you must consider whether they may be properly netted at the partnership level and whether they are required to be taken into account separately by any partner because it may be subject to a limitation or preference under the Code before you can place them in the same subgroup.
  • A negative adjustment that is not otherwise required to be placed in its own subgrouping must be placed in the same subgrouping as another adjustment if the negative adjustment and the other adjustment would have been properly netted at the partnership level and such netted amount would have been required to be allocated to the partners of the partnership as a single item for purposes of section 702(a) or other provision of the Code and regulations.

A partnership may request to subgroup adjustments in a manner other than the manner described above, such request is generally done in modification under §301.6225-2 after the issuance of the NOPPA. With that being said, you have discretion to review and grant such request based on the facts and circumstances and you must contact the BBA POC before agreeing to the request.

iAny request must be supported by the facts and circumstances, such as partner-level information that a negative adjustment is not subject to a presumed preference, limitation, or restriction under the Code, or in fact allowed in full against ordinary income.

Step 3.

The third step in computing the imputed underpayment is to appropriately net all the proposed adjustments within each of the groupings and subgroupings.

  • Netting means summing all adjustments together within each grouping or subgrouping, as appropriate.
  • Positive adjustments and negative adjustments may only be netted against each other if they are in the same grouping or subgrouping. An adjustment in one grouping or subgrouping may not be netted against an adjustment in any other grouping or subgrouping. Adjustments from one taxable year may not be netted against adjustments from another taxable year.
  • If any grouping only includes positive adjustments (i.e., there are no subgroupings for that grouping), all adjustments in that grouping are added together to come up with a sum of all net positive adjustments.
  • All adjustments within a subgrouping are netted to determine whether there is a net positive adjustment or net negative adjustment for that subgrouping.
    1. A net positive adjustment means an amount that is greater than zero which results from netting adjustments within a grouping or subgrouping. A net positive adjustment includes a positive adjustment that was not netted with any other adjustment. A net positive adjustment includes a net decrease in an item of credit.
    2. A net negative adjustment means any amount which results from netting adjustments within a grouping or subgrouping that is not a net positive adjustment. A net negative adjustment includes a negative adjustment that was not netted with any other adjustment.

Step 4.

The fourth step is to compute the TNPA. The TNPA is the sum of all net positive adjustments in the reallocation grouping and the residual groupings.Each net positive adjustment with respect to a particular grouping or subgrouping in the residual or reallocation grouping that results after netting the adjustments is included in the calculation of the TNPA.

  • Each net negative adjustment with respect to a residual or reallocation grouping or subgrouping that results after netting the adjustments is excluded from the calculation of the TNPA because those adjustments do not result in an imputed underpayment.

Step 5.

  • The fifth step is to determine the highest rate in effect for the reviewed year under section 1 or 11.

Step 6.

  • The sixth step is to determine the sum of net positive adjustments to creditable expenditure and credit groupings that will increase or decrease the product of the TNPA times the highest rate in effect.
  • A net decrease to creditable expenditures is treated as a net positive adjustment to credits and increases the product of the TNPA times the highest tax rate in effect. A net increase to creditable expenditures is treated as a net negative adjustment that is excluded from the calculation of the TNPA and is an adjustment that does not result in an imputed underpayment.
  • For the credit grouping, a net positive adjustment will increase the product of the TNPA times the highest tax rate in effect. A net negative adjustment, including net negative adjustments resulting from a credit reallocation adjustment, will be treated as an adjustment that does not result in an imputed underpayment, unless the examination team determines that it is appropriate to allow the net negative adjustment to credit to reduce the product of the TNPA times the highest tax rate in effect.

Step 7.

The seventh and final step is to compute the IU based on the results of steps 4 through 6 and insert those results into the IU formula identified above.

Examples

1. The AB Partnership’s 2019 return is under examination. Form 1065, page 1 consists of gross receipts of $1,000 and COGS of $250 for a net ordinary business income of $750 from a single activity. The $750 of net ordinary business income was included on Schedule K, line 1. The revenue agent proposes to increase gross receipts by $100 and increase COGS by $30. The $100 increase in gross receipts represents a positive adjustment while the increase in COGS represents a negative adjustment. Both of these adjustments are placed in the residual grouping since neither is properly classified as a reallocation, credit or creditable expenditure grouping. Since one of the adjustments is negative, subgrouping is required. The agent verified that AB Partnership netted the gross receipts and COGS as a single partnership-related item on Schedule K, line 1, and therefore, the negative adjustment for COGS will be subgrouped with the positive gross receipts adjustment. After netting these adjustments, the result is a net positive adjustment of $70 in the Schedule K, line 1 subgroup as well as a net positive adjustment in the residual grouping. The $70 will be included in the total netted partnership adjustment for purposes of computing the imputed underpayment.

2. The facts are the same as example 1 above, except the partnership’s operations included two distinct activities (“Activity A” and “Activity B”). The net income from each activity were separately stated on a statement attached to Form 1065. The audit adjustment to gross receipts of $100 (increase) was identified as being related to Activity “A” while the adjustment to COGS of $30 (increase) was identified as being related to Activity “B.” Again, both the positive adjustment to gross receipts of $100 and the negative adjustment of $30 to COGS are placed in the residual grouping. Since the separate net income from each activity are required to be separately stated on line 1 of Schedules K/K-1 (via an attached schedule), those amounts were not treated as a single partnership-related item for purposes of section 702(a) and were not allocated as a single item on the filed tax return as was proper. Therefore, each adjustment must be placed into a separate subgroup within the residual grouping. The two subgroups (within the residual grouping) could be identified as “Schedule K, line 1, Activity A” and “Schedule K, line 1, Activity B” or similar. Under the netting rules, netting adjustments across subgroups is not permitted and the positive $100 adjustment and the negative $30 adjustment may not be netted. Thus, the residual grouping contains a net positive adjustment of $100 (netting rules only allow positive adjustments to be added together in each grouping to arrive at a net positive adjustment). This amount will be included in the total net partnership adjustment for purposes of computing the imputed underpayment. The net negative adjustment of $30 is an adjustment that does not result in an imputed underpayment and must be included on the partnership’s tax return for the year in which such adjustment becomes final.

For any reallocation adjustment, the IRS will include the name and TIN of the impacted partner and whether the allocation is “to” or “from” such partner.

Interest and Penalties

Under the centralized partnership audit regime, the partnership is liable for any interest and penalties associated with any imputed underpayment (unless they elect the alternative to payment of imputed underpayment under section 6226).

IRS protocol requires the examining agreement to compute the applicable penalties and consider reasonable cause and good faith defenses.

  • For purposes of computing the penalty, the partnership is treated as an individual subject to tax under chapter 1 of subtitle A of the Code.
  • A partner-level defense may not be raised at the partnership level.

Managers must review and approve whether any penalties should be imposed as part of the examination.

30-day letter package

A partnership may protest and seek to go to Appeals for any unagreed partnership adjustment, including the substantive issues, imputed underpayment amount and penalty.

If the partnership requests to go to Appeals, the IRS generally requires at least 18 months remaining on the 6235(a)(1) date when the case is transferred to Technical Services.

The 30-day letter package includes the following:

  • Letter 5891, 30-Day Letter,
  • Form 14791, Preliminary Partnership Examination Changes, Imputed Underpayment Computation and Partnership Level Determinations as to Penalties, Additions to Tax and Additional Amounts, and
  • Form 886-A, Explanation of Adjustments for both substantive issues and imputed underpayment of tax.

Notice of proposed partnership adjustment (NOPPA) package

The NOPPA package is required in any administrative proceeding (examination) under the BBA regime, including an administrative proceeding with respect to an administrative adjustment request (AAR) filed by a partnership under section 6227. A NOPPA package is prepared for each partnership taxable year unless it is a no-change.

The NOPPA package is required in any administrative proceeding (examination) under the BBA regime, including an administrative proceeding with respect to an administrative adjustment request (AAR) filed by a partnership under section 6227.

  • A NOPPA package is prepared for each partnership taxable year unless it is a no-change.

The NOPPA package includes the following:

  • Form 14792, Partnership Examination Changes, Imputed UnderpaymentComputation and Partnership Level Determinations as to Penalties,Additions to Tax and Additional Amounts,
  • Letter 5892, Notice of Proposed Partnership Adjustments- Partnership,
  • Letter 5892-A, Notice of Partnership Adjustments-PartnershipRepresentative, and
  • Forms 886-A, Explanation of Adjustments for both substantive issues andimputed underpayment amount.