United States: The IRS Re-Publishes Proposed Regulations On The New Partnership Audit Regime


The Department of the Treasury and the Internal Revenue Service (IRS) have published proposed regulations (the Proposed Regulations) under the centralized partnership audit regime (New Audit Regime) that was enacted into law under the Bipartisan Budget Act of 2015 (BBA). The Proposed Regulations are substantially the same as regulations proposed in January of 2017 and withdrawn shortly thereafter in response to the regulatory freeze implemented by the Trump administration.

The New Audit Regime will replace the rules that currently govern partnership audits (i.e., the rules enacted under the "Tax Equity and Fiscal Responsibility Act of 1982" (TEFRA) and the "electing large partnership" (ELP) rules) and are intended to increase the IRS's ability to examine partnerships, particularly large and tiered partnerships. In general, under the New Audit Regime, a tax adjustment resulting from a partnership audit will be determined, assessed and collected at the partnership level, unless the partnership elects to have each person who was a partner in the tax year under review assume the audit tax liability. The New Audit Regime generally will be effective for partnership tax years beginning after December 31, 2017.

This alert summarizes the main provisions of the Proposed Regulations, which provide long-anticipated guidance on how the New Audit Regime will be applied. For further discussion of the New Audit Regime as enacted under the BBA, please see our prior client alert.

Partnership Representative

Under the existing TEFRA partnership procedures, a partnership is required to designate a "tax matters partner" as a liaison between the partnership and the IRS. Although the tax matters partner has the authority to bind the partnership in connection with an audit, it cannot bind the partners in the partnership. Moreover, a partner who is not a tax matters partner has certain rights during an audit, including certain notification rights and the right to participate in the proceedings. The New Audit Regime introduces the concept of the "partnership representative", who serves as the sole point of contact between the partnership and the IRS. In contrast to the restricted scope of authority of the tax matters partner under the TEFRA rules, the New Audit Regime provides that all partners and the partnership are bound by the actions of the partnership representative and no person other than the partnership representative has a statutory right to participate in a partnership-level audit proceeding. The authority of the partnership representative with respect to an audit may not be limited by state law or the partnership agreement (although the partners may contractually limit such authority as among themselves and negotiate for indemnification as a remedy for any breach).

The Proposed Regulations provide rules for the designation of a partnership representative. In general, a partnership may designate any person, including an entity, to be the partnership representative, provided that such person has a substantial presence in the United States. Unlike a tax matters partner, the partnership representative need not be a partner of the partnership; the partnership may designate a non-partner, including the partnership's management company, as the partnership representative. The Proposed Regulations establish a three-prong test to determine whether the contemplated partnership representative has a substantial presence in the United States:

  • First, the person must be able to meet in person with the IRS in the United States at a reasonable time and place, as determined by the IRS;
  • second, the partnership representative must have a US address and telephone number where the partnership representative can be contacted during normal business hours; and
  • third, the partnership representative must have a TIN.

If the partnership designates an entity as the partnership representative, the partnership also must appoint an individual with a substantial presence in the United States to act on behalf of the entity.

A partnership must designate its partnership representative on the partnership's tax return. A separate designation must be made for each tax year and is effective only for such year. If the partnership fails to designate a partnership representative for any given tax year, the Proposed Regulations provide that the IRS may select any person to serve as partnership representative. In selecting such person, the IRS will consider a number of factors, including: Whether the person is a partner in the partnership; the views of the partners having a majority interest in the partnership; the person's access to the books and records of the partnership; and whether the person is a US person.

Imputed Underpayment

At the conclusion of its audit of a particular partnership, the IRS must send a Notice of Proposed Partnership Adjustment (the NOPPA) to the partnership representative providing the partnership with its "imputed underpayment" determined pursuant to the audit. The partnership either must (1) pay the imputed underpayment itself after the partnership's tax liability is finally determined, or (2) elect to "push out" such amount to its partners after any modifications to the NOPPA are resolved (as discussed below).

The imputed underpayment is equal to the sum of total net positive partnership adjustments, multiplied by the highest federal income tax rate applicable to either individuals or corporations that is in effect for the tax year under audit (the Reviewed Year). In order to give effect to limitations set forth in the Code, the total net positive partnership adjustments are grouped into separate categories—reallocation, credits and residual—which are then netted pursuant to detailed procedures set forth in the Proposed Regulations. The IRS may calculate multiple "specific imputed underpayments," rather than only a "general imputed underpayment," if doing so would be appropriate under the factual circumstances, such as adjustments attributable to a transaction that involved certain partners.

The partnership —through its partnership representative —is permitted to request that the IRS modify the imputed underpayment to account for numerous factors, including Reviewed Year partners' amended tax returns, amounts allocable to tax-exempt partners, lower tax rates attributable to income allocated to Reviewed Year partners, or adjustments allocable to passive activity losses of Reviewed Year partners in a publicly traded partnership.

The partnership representative must submit a request for modification within 270 days after the date the NOPPA is mailed by the IRS. When doing so, the partnership representative must provide the partnership's structure, operation, and ownership details to the IRS, including any other information requested by the IRS to substantiate the partnership representative's modification request.

Push-Out Election

The partnership representative may decide, on behalf of the partnership, to pass the imputed underpayment liability through to its Reviewed Year partners (a Push-Out Election), rather than paying the imputed underpayment at the partnership level and placing the burden of such liability on its current partners (or seeking an indemnity from former partners). Significantly, the Proposed Regulations continue to reserve on guidance about whether the Push-Out Election can be made in a tiered partnership. The Preamble to the Proposed Regulations states that this issue will be the subject of guidance "to be published in the near future" as the IRS gathers comments about how it can ensure that the partnership's adjustments are properly pushed out through tiers.

In order to make a valid Push-Out Election, the partnership representative must file the election no later than 45 days after the date the Final Partnership Adjustment (FPA) is mailed by the IRS. (The FPA is sent to the partnership after modifications, if any, to the NOPPA are resolved.) Additionally, the Push-Out Election must be signed by the partnership representative and be accompanied by: (1) The name, address, and TIN of the partnership; (2) the taxable year to which the Push-Out Election relates; (3) a copy of the FPA; (4) in the case of an FPA that includes specific imputed underpayments, identification of the imputed underpayment(s) to which the Push-Out Election applies; and (5) the name, address and TIN of each Reviewed Year partner.

Within 60 days of the final determination of the partnership's tax liability (i.e., the later of the expiration of the time to a file a petition for judicial review of the FPA or, if such a petition is timely filed, when the court's decision becomes final), the partnership that makes a Push-Out Election must furnish to each Reviewed Year partner, and file with the IRS, a statement containing information about each Reviewed Year partner and its share of the partnership's adjustments attributable to the audit. A Reviewed Year partner may elect to pay a "safe harbor" amount —equal to such partner's share of the partnership's imputed underpayment—to avoid the complexities of filing amended returns and accounting for its share of the partnership's adjustments in the Reviewed Year and intervening tax years. To calculate interest on each Reviewed Year partner's share of the imputed underpayment, the Proposed Regulations impose an underpayment rate equal to five percentage points (rather than three percentage points) plus the federal short-term rate. As such, a Push-Out Election results in additional costs to the partners.

Election Out

A partnership may elect out of the New Audit Regime (the Election Out) only if it has 100 or fewer partners, all of whom are "eligible partners". "Eligible partners" are defined as individuals, US and non-US C corporations, S corporations and estates of deceased partners. The Proposed Regulations do not expand upon the categories of eligible partners enumerated in the BBA. For purposes of this rule, "C corporations" include regulated investment companies (RICs) and real estate investment trusts (REITs), as well as certain tax-exempt entities classified as corporations under the Internal Revenue Code (the Code). Disregarded entities, trusts, and partnerships are not considered eligible partners and, therefore, the Election Out will not be available to partnerships with any such persons as partners. Whether a partnership has 100 or fewer eligible partners is determined by counting (1) the number of Schedules K-1 that the partnership is required to issue to its partners during the applicable tax year and (2) with respect to any S-corporation partner, each shareholder of such S-corporation partner that existed during such year.

For partnerships that successfully elect out of the New Audit Regime, the IRS will be required to initiate deficiency proceedings at the partner level to adjust items associated with the partnership and thereby assess and collect any tax that may result from the adjustments. The Preamble to the Proposed Regulations states that the IRS intends to scrutinize a partnership's decision to make an Election Out, which will include analyzing whether the partnership correctly has identified all of its partners for US federal income tax purposes, notwithstanding whom the partnership reports as its partners. For example, the IRS intends to review the partnership's partners to confirm that none are acting as nominees or agents for a beneficial owner.

In order to make an Election Out, the partnership must provide the IRS with the names, tax ID numbers (TINs) and US federal tax classifications of all partners of the partnership (including all shareholders of any S corporation partner) and must notify its partners within 30 days after making the election. A partnership may make the Election Out only on a timely-filed partnership return (including extensions) for the partnership tax year to which the election relates. This means that, for a given tax year, the partnership must decide whether or not to make the Election-Out before the commencement of any audit with respect to such year. Once made, an Election Out may be revoked only with the consent of the IRS.


As the New Audit Regime is roughly six months from taking effect, the approach to satisfying an imputed underpayment is a heavily negotiated aspect of partnership agreements, especially for those partnerships that cannot meet the requirements of the Election Out. Incoming partners will be well advised to protect themselves from the tax liabilities of the Reviewed Year partners by seeking the adoption by the partnership of the Push-Out Election, or by negotiating with the partnership for protections against such liabilities in the partnership agreement or a side letter.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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