Electing Out of the New Partnership Audit Rules

| 11/1/2018
Partnerships will face two new choices on their 2018 Form 1065, “U.S. Return of Partnership Income”: whether to elect out of the new centralized partnership audit regime enacted by the Bipartisan Budget Act of 2015 (BBA) and who to designate as partnership representative.

Determining whether to elect out
IRC Section 6221(b) allows certain small partnerships to elect out of having the BBA apply on a timely filed partnership return for the taxable year to which the election applies, including extensions. A partnership electing out of the BBA must disclose to the IRS the name and tax identification number of each partner (including shareholders of an S corporation that is a partner), and it must notify its partners that it made the election out of the BBA within 30 days of making the election. A partnership that fails to file a timely partnership return cannot make an election out for that taxable year. The IRS did not prescribe the form or manner for this notification.
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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.

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Rochelle Hodes
Rochelle Hodes
Principal, Washington National Tax