Partnership Audits Under the BBA | Kathryn Meyer Law PC

The audit, and usually the bill, happen at the partnership level. For tax years beginning in 2018 and later, the IRS examines a partnership's return, determines adjustments and penalties, and generally assesses and collects the resulting tax from the partnership itself rather than from each partner. A single partnership representative speaks for the partnership and binds every partner, and the partnership can pay the tax, reduce it through a modification request, or push the adjustments out to the people who were partners in the year audited.

This regime, created by the Bipartisan Budget Act of 2015 and often called the BBA, replaced the older TEFRA rules. It applies to partnerships, including law firms and other businesses organized as LLCs that are taxed as partnerships, unless they elect out. A law firm that has elected S corporation status is taxed as a corporation rather than a partnership; when that election makes sense for a solo or small firm is the subject of Tax-Smart Lawyering. This page is part of Kathryn Meyer's guidance on IRS audits and examinations.

Who speaks for the partnership?

Section 6223 requires each partnership to designate a partnership representative, a partner or other person with a substantial presence in the United States, who has sole authority to act for the partnership in the audit. If no designation is in effect, the IRS may select any person. The partnership and all of its partners are bound by the representative's actions and by any final decision in the proceeding. The IRS's own comparison notes that, unlike under TEFRA, partners have no right to participate in the examination or challenge the adjustments themselves.

The designation is made on the partnership's return for each tax year, not on Form 2848. The representative can, however, use Form 2848 to appoint someone to act for it; see how a tax attorney represents you before the IRS. Choosing the representative, and agreeing in the partnership agreement how that person must consult the other partners, is one of the more consequential governance decisions a firm makes. For law firms, it belongs with the entity questions covered under tax planning for law firms.

Can a partnership opt out?

Some can. Under section 6221(b), a partnership may elect out for a year if it is required to issue 100 or fewer Schedules K-1 (counting each shareholder of any S corporation partner) and every partner is an eligible type: an individual, a C corporation, a foreign entity that would be a C corporation if domestic, an S corporation, or the estate of a deceased partner. The election must be made on a timely filed return, using Schedule B-2 of Form 1065 to list each partner, and partners must be notified.

The IRS lists partners that make a partnership ineligible, including other partnerships, trusts, disregarded entities and people holding an interest for someone else. If even one partner holds its interest through a single-member LLC that is disregarded for tax purposes, the partnership cannot elect out. A partnership that elects out is examined under the general deficiency procedures that apply to individuals.

How does a partnership audit unfold?

Stage	What happens	Key deadline
Selection	Letter 2205-D tells the partnership a return was selected	Call the examiner by the date in the letter
Notice of administrative proceeding	Letters 5893 and 5893-A, usually about 30 days later	After it, no administrative adjustment request, and partners may not report inconsistently for that year
Summary report	Preliminary results and imputed underpayment, sent to the representative	Appeals is available if at least 18 months remain on the statute for adjustments
Notice of proposed partnership adjustment	Proposed adjustments and imputed underpayment	270 days to request modification on Form 8980 (can be extended by agreement)
Notice of final partnership adjustment	Final adjustments and imputed underpayment	45 days to elect push-out on Form 8988 (cannot be extended); 90 days to petition a court

If the representative disagrees with the summary report, the IRS issues a 30-day letter package explaining how to protest to Appeals, much like an individual audit; see what to do with an IRS 30-day letter. The protest can challenge the substantive issues, the imputed underpayment amount or the penalties, and what happens at an IRS Appeals conference explains the next stage. The IRS notes that Appeals considers each disputed item only once.

What is an imputed underpayment?

Section 6225 tells the IRS to net the partnership's adjustments for the reviewed year by category and apply the highest tax rate in effect for that year under section 1 or section 11. The result, the imputed underpayment, is paid by the partnership in the "adjustment year," which in an audit is generally the year the notice of final partnership adjustment is mailed or, if the case goes to court, the year the decision becomes final, along with any penalties determined at the partnership level. Because it uses the top rate, it can overstate the tax the partners would actually have owed.

That is why modification matters. Under the statute and the IRS's procedures, partners for the reviewed year can file amended returns, or use an alternative procedure, that take their share of the adjustments into account and pay the tax, and the imputed underpayment is then computed without those adjustments. Requests go on Form 8980 within 270 days after the notice of proposed partnership adjustment.

What does a push-out election do?

Under section 6226, the partnership can elect, within 45 days after the notice of final partnership adjustment, to push the adjustments out instead of paying. Each person who was a partner in the reviewed year then receives a statement of their share (Form 8986) and takes it into account on their own return for the year the statement is furnished, with correction amounts for the intervening years. Interest on the pushed-out amounts is figured at a higher rate: the statute raises the add-on in the usual underpayment interest formula from 3 to 5 percentage points.

The partnership must furnish those statements, and file them with Form 8985, within 60 days after the audit adjustments become final. The IRS says that if the statements are not furnished in time, it will invalidate the election and the partnership will owe the imputed underpayment. Partners who left the firm before the audit can still receive these statements, which is one reason departing-partner provisions in a partnership agreement deserve attention.

For California firms, whether to operate as a partnership at all is weighed in which entity a California law firm can use, and how it is taxed.

What changes the answer

Whether the partnership elected out. A valid election on the timely filed Form 1065 sends the audit to the general deficiency procedures; the IRS says the election can be revoked only with its consent.
Who the representative is. If the representative is an entity, it acts through a designated individual. After Letter 2205-D, a partnership with no designation in place may designate one (with or without revocation of an earlier one).
Timing of corrections. The partnership can file an administrative adjustment request (AAR) to correct its own return only before the notice of administrative proceeding; after it, neither an AAR nor inconsistent partner reporting is allowed for that year.
Time left for Appeals. The representative can request Appeals only if at least 18 months remain on the section 6235 period, or after agreeing to extend it.
The partners' own tax profiles. Modification under section 6225 can lower the imputed underpayment, for example where partners file amended returns and pay their share.
Interest strategy. A partner disputing the adjustments can make a section 6603 deposit to stop interest from running on a potential underpayment, under the IRS's BBA procedures.

For example: a three-partner firm chooses between paying and pushing out

For example, imagine a three-partner law firm organized as an LLC taxed as a partnership. One partner holds her interest through a single-member LLC, so the firm could not elect out, and its 2023 return is examined under the BBA rules. The notice of proposed partnership adjustment shows a $90,000 increase in income and an imputed underpayment figured at the top individual rate. Within 270 days, two partners who were in lower brackets file amended 2023 returns taking their shares into account and pay the tax, and the firm requests modification on Form 8980 so the imputed underpayment is recomputed without those shares. After the notice of final partnership adjustment, the firm has 45 days to decide whether to pay the remaining imputed underpayment or push it out to the reviewed-year partners on Forms 8986, at the higher interest rate. This is a hypothetical, not a real case.

Common mistakes in partnership audits

Leaving the representative designation to chance. If none is in effect, the IRS may select any person.
Assuming the firm can elect out. A single disregarded LLC or trust among the partners prevents it.
Filing amended partner returns after the notice of administrative proceeding. Inconsistent reporting for that year is not allowed once the notice is issued, except through the modification process.
Missing the 45-day push-out window. It cannot be extended.
Forgetting former partners. Reviewed-year partners who have left can still receive push-out statements.

What to do this week

Confirm who the partnership representative and any designated individual are for each year under review.
Check whether the partnership elected out on its timely filed return for those years.
List the reviewed-year partners, their contact details and how each holds its interest.
Calendar the dates in Letter 2205-D and any notice of administrative proceeding.
Review what the partnership agreement says about the representative's duties to consult partners.
Have the representative sign a Form 2848 for counsel.

Frequently asked questions

Can individual partners join the audit?

No. The IRS notes that, unlike under the older TEFRA rules, partners have no right to participate in the examination or challenge the adjustments themselves; the representative acts for everyone.

How soon after selection does the formal proceeding start?

The IRS says it generally issues the notice of administrative proceeding about 30 days after Letter 2205-D, and a separate notice for each year under examination. It can withdraw a notice without consent within 60 days in some circumstances.

What does the summary report include?

Letter 5895, Form 14791 with the preliminary imputed underpayment, estimated interest and penalties, and Form 886-A or a lead sheet explaining each issue.

Do partners pay tax in the year audited or a later year?

Generally later. The partnership pays in the adjustment year, and pushed-out partners report their shares in the year the statement is furnished.

Does the partnership audit affect partners' own audits?

It can raise related questions, and a partner's own return has its own assessment deadline; see how far back the IRS can audit.

Are penalties included in the imputed underpayment?

Penalties are determined at the partnership level and paid with the imputed underpayment. The defenses are covered in what penalties the IRS can add after an audit.

Advice for partnerships under audit

Partnership audits move on fixed, short windows that cannot be extended, and one person makes decisions that bind everyone. Kathryn Meyer can advise the partnership representative on each notice, the modification and push-out choices, and how the audit affects current and former partners. Contact the firm or call (571) 560-8674.

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