BBA audit regime affects buyers and sellers of partnership interests

By Dinh Tran, J.D., LL.M.; Todd McArthur, J.D.; and Bill Wilkins, J.D., Washington, D.C.

Editor: Annette B. Smith, CPA

Audit procedural issues typically do not come to mind when tax planners advise on the purchase or sale of a partnership interest. However, tax planners may want to consider the impact of the centralized partnership audit regime enacted as part of the Bipartisan Budget Act of 2015, P.L. 114-74, (BBA audit regime) for at least three reasons:

  • Under the default rule of the BBA audit regime, the IRS now has authority to determine, assess, and collect tax on partnership underpayments at the partnership level;
  • A single person — the partnership representative (or a designated individual) — has the exclusive authority to represent, negotiate, and bind the partnership at all stages of a partnership proceeding subject to the BBA audit regime; and
  • Partners do not have a statutory right to notice or to participate in the partnership proceeding.

The BBA audit regime, generally effective for partnership tax years beginning after Dec. 31, 2017, is a radical change from the so-called TEFRA (Tax Equity and Fiscal Responsibility Act) partnership audit procedures it replaced. The regime was enacted to streamline partnership examinations and to reduce the administrative burden on the IRS to assess and collect tax resulting from partnership audits. Given that context, buyers and sellers of partnership interests reasonably can expect increased partnership audit activity. This item provides a brief overview of the BBA audit regime and discusses some of the practical considerations that partners may want to keep in mind when buying or selling partnership interests.

Brief overview of the BBA audit regime

Under the default rule of the BBA audit regime, the IRS examines all "partnership-related items" for a partnership's tax year (the reviewed year). If any partnership adjustments result in an "imputed underpayment," the IRS will assess and collect the imputed underpayment from the partnership in the year in which the IRS sends the notice of final partnership adjustment (FPA) or, in the case of an adjustment under judicial review, the year in which the court's decision becomes final (the adjustment year). The IRS determines the imputed underpayment by applying detailed grouping, subgrouping, and netting rules to all adjustments and by multiplying the total netted partnership adjustment by the highest federal income tax rate in effect for individuals or corporations.

An imputed underpayment, as determined under the default rule, may be the "wrong" amount and may be borne economically by the "wrong" partners. The imputed underpayment generally does not take into account any tax attributes of the partnership's direct or indirect partners, such as the tax-exempt status of any partner, that otherwise would reduce the imputed underpayment. Partners in the adjustment year generally will bear the economic impact of the partnership's payment of an imputed underpayment even if they were not partners in the reviewed year. Partners in the reviewed year that are not partners in the adjustment year generally will bear no economic impact.

As the sole person authorized to represent the partnership in a BBA audit, the partnership representative (or the designated individual in case the partnership representative is an entity) can mitigate the wrong-amount and the wrong-partner issues by requesting permitted modifications of an imputed underpayment or by making a push-out election. An imputed underpayment can be reduced to account for permitted modifications, among others, that take into account: (1) the tax-exempt status of any partner; (2) lower rates of tax applied to C corporation partners or applied to capital gains and qualified dividend income allocable to individual partners; (3) adjustments taken into account in closing agreements; (4) any reduction or exemption from tax available to a non-U.S. partner eligible for benefits under an income tax treaty with the United States; (5) adjustments properly taken into account in amended returns filed by all relevant partners or pursuant to alternative procedures accomplishing the same effect (the pull-in procedure); and (6) other factors as determined in the IRS's discretion. The partnership must substantiate all facts supporting a request for modification to the IRS's satisfaction, and no modification is effective until the Service approves it.

Modifications of imputed underpayments can at least partially address the wrong-amount issue, but they do not address the wrong-partner issue. The partnership can further address the wrong-amount issue and can address the wrong-partner issue by filing with the IRS a push-out election, signed by the partnership representative, within 45 days from the date the IRS mails the FPA. Upon making a push-out election, the partnership is committed to providing all reviewed-year partners (i.e., the "right" partners), no later than 60 days after the date that all partnership adjustments are finally determined, with statements reflecting the partners' shares of the partnership adjustments and other required information.

The reviewed-year partners must take into account their shares of partnership adjustments that are associated with the imputed underpayment (including the effect of any modifications). Each reviewed-year partner calculates the additional tax due, if any, for the reviewed year (and years between the reviewed year and the adjustment year) by reference to its separate tax attributes. The additional tax must be reported and paid generally in the year the statement is furnished by the partnership to the partner.

Note: There are advantages and disadvantages of making a push-out election that are beyond the scope of this discussion. Depending on the context, a push-out election may not always be desirable.

Considerations common to buyers and sellers

All partners may want to negotiate some form of notification and oversight rights — such as participation, approval, consultation, or veto rights — to address the sole and exclusive authority held by the partnership representative (or designated individual). However, those contractual provisions will not bind the IRS. A partnership representative can bind a partnership in a BBA audit even if acting outside the terms of its contractual obligations. For that reason, among others, partners should carefully consider the identity of the partnership representative and terms addressing the possible termination and replacement of the partnership representative.

Considerations for buyers

The tax risks associated with uncertain partnership tax positions are elevated by the BBA audit regime because the IRS now can determine, assess, and collect any imputed underpayment tax at the partnership level. Buyers face the "wrong" taxpayer risk to the extent of their allocable share of an imputed underpayment related to a review year under the default rule. Buyers therefore may want to examine uncertain partnership tax positions in a manner similar to which buyers of stock in a corporation examine uncertain corporate tax positions.

The wrong-taxpayer risk can be mitigated if the partnership makes a push-out election for any year in which the partnership has an imputed underpayment. Buyers also may want to examine whether or when the partnership representative is obligated to make a push-out election and consider requesting that a push-out election be made absent an express obligation to do so in the operative documents. Buyers still may face risks relating to pre-acquisition imputed underpayments, for example, to the extent that any tax liability pushed out to reviewed-year partners can give rise to tax distributions under the partnership agreement.

Note: For this reason, buyers may want to consider requesting from the seller a tax indemnity addressing pre-acquisition BBA audit issues.

Buyers also should consider their exposure to pre-acquisition partnership taxes that are not pushed out and to post-acquisition BBA audits. They may want to review the partnership agreement for terms addressing the conduct of BBA audits and the manner in which imputed underpayments are economically apportioned among the partners and financed, including:

  • The identity, qualification, and any terms for removal and replacement of the partnership representative;
  • Any obligations of the partnership representative to seek permitted modifications of an imputed underpayment and of direct and indirect partners to provide necessary information and otherwise cooperate;
  • The manner in which any imputed underpayment will be economically apportioned among the partners and will be financed, including obligations of partners and former partners to contribute funds or to indemnify the partnership for their shares of an imputed underpayment; and
  • Any rights of partners to approve or otherwise limit key decisions of a partnership representative, such as making or not making a push-out election.

Note: Regulations may limit the ability of the partners and the partnership to determine the allocation of tax liabilities.

Considerations for sellers

Sellers of partnership interests (assuming the entire partnership interest is sold) will not be adjustment-year partners for partnership years that are subject to BBA audits after the date of sale. They therefore generally will not bear liability for any resulting imputed underpayment that is paid by the partnership under the statute.

At the same time, sellers should keep in mind contractual provisions that could subject them to continuing contractual liability, such as obligations to finance their shares of an imputed underpayment or otherwise indemnify the partnership even after the date of sale. They should expect to have discussions with buyers regarding the possibility of a seller tax indemnity for pre-acquisition tax periods. Sellers also may have continuing obligations to cooperate in BBA audits, such as providing information necessary to support any permitted modifications to an imputed underpayment in a presale reviewed year.

If the partnership is not obligated to make a push-out election, sellers may want to consider negotiating assurances that a push-out election will not be made without their consent. At a minimum, they may want to negotiate rights to ensure that they maintain sufficient interests, rights, and access to necessary partnership information in reviewed years for which they are exposed. Sellers also may want to retain assurances that the partnership representative will manage diligently any relevant post-sale BBA audit, such as seeking to reduce any imputed underpayment with all available permitted modifications (even if a push-out election will be made).

Sellers face an additional risk if the IRS determines that the partnership has ceased to exist, the sellers were partners in the partnership during the last tax year for which a partnership return was filed, and there are no remaining partners in the adjustment year that corresponds to the reviewed year for which an imputed underpayment is owed. A partnership ceases to exist if (1) the partnership terminates within the meaning of Sec. 708(b)(1); or (2) the partnership does not have the ability to pay in full any amount due under the provision of Subchapter C of Chapter 63 for which the partnership is or becomes liable, but only if the IRS makes a determination that the partnership has ceased to exist under one of those two situations.

A partnership terminates within the meaning of Sec. 708(b)(1) only if no part of a business, financial operation, or venture of the partnership continues to be carried on by any of its partners in a partnership. In this event, the sellers will have to take into account any partnership adjustments as if a push-out election had been made.

Note: Sellers may want to analyze whether their sale of partnership interests will result in a partnership termination or other circumstances that suggest the partnership may cease to exist in a year and to ask the buyer whether it intends to liquidate the partnership within the year in which they were partners.

Assessing potential BBA audit risk

Buyers and sellers of partnership interests should consider adding to their due-diligence lists the impacts that the BBA audit regime will have on their respective interests for partnership tax years generally beginning after Dec. 31, 2017. Buyers face the wrong-taxpayer risk for their adjustment-year share of any imputed underpayment relating to pre-acquisition reviewed years unless a push-out election is made. Sellers remain potentially liable for pre-acquisition imputed underpayments. The interests of buyers and sellers remain subject to the exclusive authority to represent and bind the partnership held by the partnership representative. In this context, buyers and sellers should consider the merits of contractually addressing BBA audit proceedings and results to reduce the risk of unexpected tax liabilities.


Annette B. Smith, CPA, is a partner with PricewaterhouseCoopers LLP, Washington National Tax Services, in Washington, D.C.

For additional information about these items, contact Ms. Smith at 202-414-1048 or

Contributors are members of or associated with PricewaterhouseCoopers LLP.

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