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New Partnership Audit Rules – “Centralized Partnership Audit Rules”

February 15, 2019By Anna Chen

The 2015 Bipartisan Budget Act brought changes to partnership audit rules beginning with taxable years 1/1/18. Under the old “TEFRA” rules, if an item on a partnership tax return was being audited, the audit would extend to the partners individually. The partner’s individual tax returns would be under audit at that point. Under the new rules called “Centralized Partnership Audit Rules” or “CPAR”, the partnership itself is subject to the audit, not the partners individually.

Simply put, the impact of the new rules means that the partnership, not the partners, pay the tax, penalties, and interest on any unreported income assessed by the IRS. These new rules are especially unfavorable for new partners of a partnership.If the IRS audits the partnership for a year in which the new partner was not yet a partner, the new partner is liable for the tax, interest, and penalties simply because the liability rests with the partnership in the current year. Another disadvantage is that the tax is assessed at the highest individual or corporate tax rate, regardless of the individual tax rate of the partners. The highest tax rate for the 2018 tax year is 37%.

Fortunately, there are 3 options in electing out of these new rules.

  1. Option 1: Small partnership “elect out” (IRC § 6221)

    a.Who qualifies:

    i.100 or fewer eligible partners

      1.Eligible partners:

      1. Individuals
      2. C corps
      3. Foreign corps that would be a C corp if operated in the US
      4. Estates of deceased partners
      5. S corps (see note below)

        2.Ineligible partners:

        1. Partnerships
        2. Trusts INCLUDING grantor trusts
        3. Single member LLCs
        4. Nominees
        5. Estates (other than estates of deceased partners)


        1. Husband and wife count as 2 partners
        2. If there is an S corp partner, each S corp shareholder is counted as a partner

b.The election is made annually on Form 1065. The tax return will disclose the name and tax id number of each partner. If there are S corporation partners, the shareholders’ name and tax id number must also be disclosed
c.The partnership must notify the partners of the election within 30 days
d.The election must be made on a timely filed tax return (including extensions)

KROST Insight: If a partnership qualifies as a small partnership, strongly consider electing out.

  • Option 2: Partners “amend out” with amended returns or follow “pull in” procedure (IRC §6225)
    1. Amend out
      1. Partners file an amended return reflecting income that the IRS found on the partnership exam
      2. Each partner pays related tax, penalty, and interest instead of having the tax bill fall on the partnership
    2. Pull In
      1. Reviewed year partners do not file amended returns
      2. Reviewed year partners pay tax that would have been due with amended returns
    3. Advantage to partner is that tax paid could be lower than the highest rate the partnership would be exposed to

      KROST Insight: If the partnership does not qualify to be a small partnership under option 1, the “amend out” or “pull in” procedure may result in a lower tax liability than paying the tax at the partnership level.

  • Option 3: Partnership elects to “push out” adjustments to partners (IRC §6226)
    1. Can use if partnership has ineligible partners or over 100 partners
    2. The partnership pushes out to the reviewed year partners
    3. Partners, not partnership, are liable for tax
    4. Election made 45 days after IRS mails FPA (notice of final adjustment)
    5. Partnership issues a statement to the partners

  • KROST Insight: While this option may seem similar to #2, the downside is that the partners have no administrative rights and have to accept the partnership’s changes as presented.


    • Strongly consider amending partnership agreements to include language about the partnership’s position in regard to the new audit rules. This is especially important if the partnership had new partners or departing partners beginning in 2018 or expects them in the future.
      • Some issues to consider:
        • is the choice to elect out mandatory or optional?
        • Should the personal representative (see below) be able to decide or should partners have approval rights?
        • Restructure partnership in order to qualify to elect out?
    • Amend the partnership agreement to name a partnership representative
      • The new rules also do away with the old “tax matters partner” and replaces this with a “partnership representative”
        • Does not have to be a partner, but can be
        • Actions are binding on behalf of the partnership and partners
        • Best for PR to not have absolute power
        • Instead, have PR report to and subject to direction of partnership of Board of Members
        • If no PR is selected, IRS can select one for the partnership (not the ideal situation)
        • It is recommended that the accountant or attorney NOT be the PR. There are several conflicts of interest
    • Agreements that may be affected by the new rules include:
      • Partnership agreements
      • LLC Operating agreements
      • Buy Sell Agreements
      • Contribution Agreements
      • Redemption and Dissolution Agreements
      • Merger Agreements
      • Disclosure Documents
      • Loan Agreements

    Let us know if you would like us to refer you to attorneys who can assist in amending partnership agreements in order to comply with the new rules.

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    New Partnership Audit Rules – “Centralized Partnership Audit Rules”

    February 12, 2019By Anna Chen

    New Partnership Audit Rules – “Centralized Partnership Audit Rules”

    Your response is important to us. Please let us know how you wish to treat the partnership 2018 tax return. We need to know if you would like to elect out (if eligible), or not.

    Let us know if you would like us to refer you to attorneys who can assist in amending partnership agreements in order to comply with the new rules.