Electing Out of the New Partnership Audit Rules

A partnership is eligible to elect out of the BBA if both of the following apply:

1. All of the partners are individuals, C corporations (including a foreign entity that would be treated as a C corporation if domestic), S corporations, or the estate of a deceased partner. Partnerships with partners that are disregarded entities are not eligible to elect out of the BBA.
2. The partnership is required to file 100 or fewer Schedule K-1s.

In the case of S-corporation partners, the number of Schedule K-1s required to be filed includes those required to be filed by the partnership for the S-corporation partner and each Schedule K-1 the S-corporation partner is required to file. Assume a partnership has 99 partners: 98 individuals and one S corporation. The S corporation has three shareholders. The partnership is ineligible to elect out because 102 Schedule K-1s are required to be filed – 99 for its partners plus the three the S corporation files for its shareholders. 

If a partnership that elects out of the BBA (non-BBA partnership) is audited, each partner of the non-BBA partnership potentially is subject to a separate audit with respect to partnership-related items. The consequences of separate partner audits could include the following:

• Each partner could receive its own deficiency notice and have to go to court to challenge the adjustments.
• The non-BBA partnership could be required to respond to multiple information requests for each partner under audit from different agents in different locations at different times.
• Each partner under audit could face different tax outcomes.
• Partner audits could impair the partnership’s ability to manage its affairs, but the partnership would not have control over when the audits were resolved.

The election is made by checking the designated box on Form 1065, Schedule B, and by completing Form 1065, Schedule B-2, “Election Out of the Centralized Partnership Audit Regime.”

Whether to elect out of the BBA is something an eligible partnership should determine based on all of the facts and circumstances. Partnerships should not assume that this election is the best choice. In fact, after considering the benefits of having a centralized audit of partnership-related items and the consequences of having separate audits of each partner, a partnership might determine that it is not in its best interest to elect out of the BBA.