United States: Congress Overhauls The Partnership Tax Audit Rules

On November 2, 2015, President Obama signed the Bipartisan Budget Act of 2015 (the "Bill"),1 which repeals the TEFRA Unified Audit Procedures2 and replaces them with a radically modified "corporate" model for partnership tax audits. The new rules are designed to help fund the Bill3 by replacing the current three-tiered regime for partnership audits with a uniform system in which audits and assessments occur at the partnership level, subject to some options to elect out of that "default" rule. The current audit regime will remain in place for returns filed for partnership taxable years up until December 31, 2017, after which the new rules will take effect. While the new rules potentially simplify the partnership audit procedures from the perspective of the Internal Revenue Service ("IRS"), they create significant concerns and uncertainty for partners, as many of the most important aspects of the new rules have been left to be determined in future Treasury Regulations.


The current partnership4 audit rules consist of three different audit regimes depending on the number of partners in a partnership. First, the Internal Revenue Service ("IRS") audits partnerships with ten or fewer partners under general audit procedures for individuals, auditing the partnership and the individuals separately. Second, partnerships with more than ten partners are audited under the TEFRA rules,5 which allow for a single administrative proceeding by the IRS at the partnership level. After the partnership level audit is completed, each partner's tax liability for the taxable year under audit is adjusted according to the results of the partnership level proceeding. Third, under the electing large partnership provisions,6 partnerships with 100 or more partners can elect to be treated under an audit regime that is similar to the TEFRA rules in that a partnership level audit is conducted. However, rather than the partners making adjustments to their tax returns in the year under audit, any adjustment is made to a partner's tax return in the year the audit is completed.


The Bipartisan Budget Act of 2015 repeals the three-tiered audit system for partnerships and replaces it with one set of rules, with some elective exceptions.7 This default rule, a radical departure from current law, provides that the IRS will conduct audits and assess tax at the partnership level. The tax is payable by the partnership 90 days after the IRS sends a notice of final partnership adjustment or, if the partnership challenges the assessment, when a court decision becomes final. The new rule therefore represents a "corporate" like audit and assessment model.

When an adjustment is made at the partnership level, the tax is assessed by netting all adjustments of income, gain, loss or deduction for the taxable year and multiplying the net amount by the highest corporate or individual tax rate on ordinary income. In the case of such an "imputed" underpayment, the Treasury Secretary is directed to establish procedures whereby a partnership can show that the adjustment would be lower if it were based on partner-level information (e.g., a partner is tax-exempt)8 from the year under audit. However, depending on what information will need to be provided to the IRS, these procedures may not be available to certain partners for which confidentiality is a significant concern. If a partnership does avail itself of these procedures and pays a reduced assessment as a result, partners may insist that the partnership agreement have special provisions to ensure that the benefit of the reduction is recognized by the partners that are not subject or subject to a reduced rate of U.S. tax.

A "partnership representative," which need not be a partner but which must have a "substantial presence in the United States," will participate in the audit on behalf of the partnership, and the partners will have no automatic rights to participate in or opt out of the proceedings.9 As a result, partners that want the right to participate in the audit process will need to build those rights into the partnership agreement.

Because adjustments take place in the year that the adjustment occurs rather than the year in which the liability arose, the partners that had the "benefit" of the challenged position in a prior taxable year may not be required to include amounts in income in the year of assessment if the partners in a partnership change from year to year. Partners should consider amending partnership agreements to contain indemnification provisions to address this potential inequity. Moreover, the audit procedures and tax liability therefore likely will be an important part of the negotiation process for sales or redemptions of partnership interests.

There are two exceptions to assessment of tax at the partnership level. First, similar to the current regime, partnerships with 100 or fewer qualifying partners can opt out of the new rules and be audited under the rules applicable to individual taxpayers. Any adjustments would be taken into account at the partner level but would be applicable to the year being audited rather than the year the audit is completed. However, this election is not available for partnerships that have a partnership as a partner, including most funds that have a general partner that is treated as a partnership for U.S. tax purposes.

Second, within 45 days after the IRS notice of a final partnership adjustment, a partnership can opt to have the partners pay the tax. In this case, the partnership furnishes the IRS and each partner who was a partner during the audited year with a statement of each partner's share of any adjustment to income, gain, loss, deduction or credit. Those partners must then take their share of the adjustment into account on their individual returns in the year that the statement was furnished by the partnership, not the year under audit.

In order to head off adjustment and assessment at the partnership level or where a partnership decides to change an item on its previously filed tax return, the new rules allow partnerships to file requests for administrative adjustments when they believe an additional payment will be due (or an overpayment was made). The partnership can elect to make any adjustment at either the partnership or the partner level. An adjustment will be determined and taken into account for the partnership taxable year in which the administrative adjustment request is made with the result that there may be more interest payable on the assessed amount.

If a partnership wants to challenge a final partnership adjustment, then it can file a "readjustment" petition with the Tax Court, the U.S. district court where the partnership's principal place of business is located or the Claims Court. To file a petition in U.S. district court or the Claims Court, the partnership must pay the imputed underpayment shown in the final partnership adjustment. The petition must be filed within 90 days after the final partnership adjustment is mailed.


As noted, the new rules will only take effect for returns filed for partnership taxable years beginning after December 31, 2017. A partnership can elect to have the new rules apply for taxable years beginning after November 3, 2015, and before 2018.

Going forward, as discussed above, partnership agreements will need to contain architecture taking into account the new rules. In particular, moving the focus of audits to the year they occur, rather than the year in which the tax items were recognized, is certain to raise issues as the partners in a partnership change over time. Therefore, even existing partnership agreements will need to be revised to account for the new rules.


1 Pub. L. 114-74, available at https://www.congress.gov/bill/114th-congress/house-bill/1314/text?overview=closed.

2 TEFRA is the Tax Equity and Fiscal Responsibility Act of 1982. Pub. L. 97-248. See IRC §§ 6221-6234.

3 The Joint Committee on Taxation estimates that these provisions will increase revenues by $9.3 billion over a 10-year period.

4 The rules apply to an entity treated as a partnership for federal income tax purposes whether the entity is, under local law, a general or limited partnership, a limited liability company or something else.

5 IRC §§ 6221-6234.

6 IRC §§ 6240-6255.

7 By repealing Subchapter C of Chapter 63 of the Internal Revenue Code, Congress also repealed IRC §6234, which allowed the IRS to adjust items in a taxpayer's "oversheltered" tax return, i.e., a return that shows no income and a loss from partnership items.

8 Other information that would reduce the partnership level "imputed" underpayment of tax would include that the partner filed an amended return and has paid the tax, the tax rates applicable to specific types of partners and the type of income subject to the adjustment.

9 The new rules thus do away with a partner's right under current law to participate in audit proceedings, to form a group of partners having at least a 5% interest in the partnership to receive notices relating to the partnership audit and to form a group of partners having at least a 5% interest in the partnership that can file a petition for readjustment of partnership items.

Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Morrison & Foerster LLP. All rights reserved

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Michelle M. Jewett
Similar Articles
Relevancy Powered by MondaqAI
Ostrow Reisin Berk & Abrams
Ropes & Gray LLP
Dickinson Wright PLLC
In association with
Related Topics
Similar Articles
Relevancy Powered by MondaqAI
Ostrow Reisin Berk & Abrams
Ropes & Gray LLP
Dickinson Wright PLLC
Related Articles
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions