Partnership Audit Rules: Should Partnerships Elect Out of the Centralized Partnership Audit Regime?

Practice Areas

By Hemant Patel

Since 2017, partnerships are by default audited by the Internal Revenue Service (IRS) using the centralized partnership audit regime (CPAR). Under this regime, partnerships are audited at the partnership level, and any adjusted tax liability found during the audit is paid by the partnership in the year the audit is concluded. Partnerships can elect out of this tax treatment each year.

Partnership Audit Treatment: A Comparison

CPAR and its predecessor, the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), both tax partnerships at the individual partner level. All income, deductions, gains, losses, and credit of the partnership “flow through” to the partners’ income tax returns. However, there are differences in the way these regulations:

  • Audit partnerships.
  • Assess taxes due.
  • Interact with partnerships.

How Liabilities are Treated

Under TEFRA, the IRS audits each partner separately. Any deficiencies found during an audit are collected from the responsible partner(s). Under CPAR however, any underpayments that are found during an IRS audit become the responsibility of the partnership as a whole and not the individual partners. This is true even if the partners liable for the underpayment have left the partnership.

When Taxes are Assessed

Tax underpayments found by IRS are assessed for the same taxable year being audited under TEFRA. Conversely, with CPAR tax underpayments are assessed and due during the year that the adjustment is finally determined.

For example, a partnership is audited for the taxable year 2018 in 2020. The IRS finds that the partnership underpaid the amount due on their 2018 income taxes. The decision is finalized in 2021 after some litigation. Under the CPAR, the tax adjustment year is 2021, whether or not the partners are the same as they were in 2018. Using TEFRA regulations, the tax adjustment year is 2018.

Partnership Representatives and Audit Communication

Under the CPAR, partnerships must designate a partnership representative for each taxable year. The partnership representative has the sole authority to act on behalf of the partnership for audit procedures. The partnership and all partners are bound by the actions of the partnership representative, and the IRS communicates only with them.

With TEFRA regulations, the IRS must give notice to each of the partners for any administrative actions. All partners are entitled to consistent treatment.

Electing Out of the Centralized Partnership Audit Regime

Some partnerships may want to opt of the centralized partnership audit regime because it:

  • Replaces the ability of individual partners to have an input on audit management with a sole partnership representative.
  • Reflects audit adjustments in the year an audit is concluded rather than in the year being audited.
  • Makes the partnership liable for underpayment instead of individual partners.

Partnerships can opt out of CPAR and instead be governed by TEFRA if they meet the following eligibility requirements:

  • The partnership has 100 or fewer partners (based on the number of K-1s that are issued in a given taxable year), and
  • Each of the partners are an individual, a deceased partner’s estate, a C corporation, a foreign entity that would be required to be treated as a C corporation if it were a domestic entity, or an S corporation.

Partnerships can make this election on a timely-filed return for the applicable partnership taxable year and must include the name and taxpayer identification number of each partner. Also, the partnership must notify each of its partners that it is making this election.

conclusion

Certain partnerships may find it advantageous to opt out of the centralized partnership audit regime on their income taxes. Contact your trusted Chugh CPAs, LLP professional for help making this election and for other tax questions.