The past, present, and future of the BBA partnership audit regime

Editor: Robert Venables, CPA, J.D., LL.M.

The Bipartisan Budget Act of 2015 (BBA), P.L. 114-74, significantly changed the partnership audit and adjustment processes with the goal of making partnership adjustments less administratively burdensome. The application of the BBA is an evolving process as Treasury, the IRS, and tax practitioners attempt to navigate the complexities inherent in partnership adjustments while staying within the BBA’s framework. The intended result of the BBA, however, is potentially beneficial to both the IRS and tax practitioners: an audit resulting in partnership adjustments that affect partners on a goforward basis, removing the burden of adjusting their previously filed returns, as was required under the old regime. While guidance and implementation must be improved to address inequities, paradoxes, and administrative quagmires the BBA currently creates, the adoption of and adherence to the BBA should be welcomed by tax practitioners and viewed as a flawed but useful tool that has long been desired.

Partnerships and their audit background

Subchapter K contains some of the most complex and burdensome rules in the Internal Revenue Code. These complexities, however, are necessary to provide oversight of the aggregate and entity theories that apply to partnerships. These theories result in the attribution of fractional shares of a partnership’s items of income, deduction, gains and losses, credits, and other attributes, while partnerships themselves remain separate and distinct entities with allocation and decision-making abilities on behalf of their partners.

Partnership complexities are compounded by evolving allocation and liquidation methodologies, tiered structures, and ever-increasing reporting requirements (e.g., application of Secs. 199A and 163(j); reporting on Schedule K-3, Partner’s Share of Income, Deductions, Credits, etc. — International; and tax basis capital). The technicalities of Subchapter K can make information reporting onerous, even before considering the potential for revising or correcting previously reported information. Partnership adjustments are problematic due to the cascading nature of partnerships. A change in income or loss may change how all items of a partnership are allocated to its partners, which may result in changes to upper-tier entities, and so on.

Partnership audit and adjustment procedures enacted by Congress as part of the BBA generally attempt to adopt streamlined approaches aimed at making changes to partnership items less administratively burdensome. Prior to the BBA, the unified audit rules under the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), P.L. 97-248, generally applied. While TEFRA established several mechanics of auditing or amending partnership information, the general premise was to adjust partnership-level items and assess the partners on any adjustments in the tax year to which the adjustment related. Assessing partners in this fashion was often prohibitively burdensome, as the cost and time associated with tracing adjustments and reporting amendments could be substantial, depending on the number of owners and the partnership structure. These difficulties created an environment where IRS audits of large partnerships were rare (see U.S. Government Accountability Office, Tax Enforcement: IRS Audit Processes Can Be Strengthened to Address a Growing Number of Large, Complex Partnerships, Rep’t No. GAO-23-106020 (July 27, 2023)), and partnerships were forced to make difficult decisions in complying with TEFRA’s requirements to the detriment of their partners.

Alterations to the partnership audit and adjustment process under the BBA

The BBA was intended to improve the audit and partnership adjustment regime to allow for a more efficient and streamlined process that had partnership-level assessment options. The BBA retained some of the TEFRA concepts regarding partnership adjustments, including partnership-level adjustments and a potential opt-out for smaller partnerships. However, the BBA also implemented an imputed underpayment determination, which allows the partnership itself to be assessed for any deficiencies upon adjustment. Imputed underpayment calculations are equal to the total netted partnership adjustment multiplied by the highest rate of federal income tax in effect for the reviewed year, increased or decreased by the net credit grouping adjustment (Regs. Sec. 301.6225-1(b) (1)). Partnerships, however, retain an ability to “push out” any adjustments to their reviewed-year partners. Additionally, adjustments that do not result in an imputed underpayment are required to be pushed out to the reviewedyear partners.

The BBA uses the term “reviewed year,” which is the partnership tax year to which a partnership adjustment relates, and “adjustment year,” which is the partnership year in which a partnership adjustment becomes final (Regs. Secs. 301.6241-1(a)(8) and (1)). Push-out reporting to reviewedyear partners is an item of note, since partners’ ownership in the partnership may differ between the reviewed and adjustment years.

Partnerships that push out adjustments to their partners report the effect of each partner’s share of the adjustments in the adjustment year, which affects the filing of the partner’s tax return for the same year. The imputed underpayment and push-out options can significantly reduce the burden of reporting a partnership adjustment, either by allowing the partnership to pay the imputed underpayment directly or by providing partners with an efficient route to account for adjustments on their next tax return. Furthermore, the BBA established a new role — the partnership representative. The partnership representative has similar responsibilities to those of the tax matters partner under TEFRA; however, the role also was provided more authority to bind the partnership and its partners for certain determinations.

The ability for tax practitioners to push out audit adjustments without requiring those partners to amend prior tax returns for the reviewed year should create efficiencies compared with the TEFRA regime. There are similarities between the push-out treatment allowed by the BBA and the theory behind truing-up return adjustments on a subsequent year’s return: Both approach the process of making such adjustments on a go-forward basis and attempt to reduce disruption to a partner’s tax filings.

However, the rigidity of certain aspects and burdensome administrative requirements of the BBA have made compliance with it complex, puzzling, and detrimental to partners in certain circumstances. These aspects, which have been raised with the IRS and Treasury through multiple rounds of comment letters and discussion, need to be addressed to allow the IRS and tax practitioners to fully realize the benefits from the streamlined nature afforded by the BBA in a fair and consistent manner (see, e.g., American Bar Association (ABA) comment letter, “Comments on the BBA Stranded Overpayment Problem” (March 24, 2021); AICPA comment letter, “Changes to Simplify and Improve the AAR Process Under the Centralized Partnership Audit Regime and Proposed ‘AAR-EZ’ Process Framework” (May 25, 2021); and AICPA comment letter, “Centralized Partnership Audit Regime, Including Related Forms and Schedules” (April 28, 2023)).

Requested improvements to the BBA

Comments to the IRS and Treasury on the BBA encompass various aspects of the regime, including making the forms clearer and more user-friendly, clarification of filing responsibilities, unifying the treatments of audit adjustments and partnership-initiated adjustments in situations where they differ, addressing tiered partnership scenarios, adjusting requirements of imputed underpayment computations, and applying various other fixes for oversights and uncertainties. Areas that have garnered the most attention include a fix for what is considered the “stranded-overpayment” issue and the desire for a simplified method for making partnership changes not impactful to partners’ items of income, deduction, gain, loss, or credit.

The stranded-overpayment issue is a concern that, under certain scenarios of the BBA, tax savings from reductions in a partner’s share of income could be permanently lost. This is due to the classification of tax credits created from BBA push-out adjustments as nonrefundable and only eligible to offset taxes paid by the partner in the adjustment year. This issue alone has been widely publicized and is detrimental to the adoption of the BBA requirements by tax professionals, who use alternatives to avoid this potential consequence.

This issue has been clearly identified within Congress, Treasury, and the IRS, as potential fixes for it have been included in legislative proposals, and requirements to comply with the BBA have been temporarily lifted in instances where substantial adjustments were the product of retroactive tax law changes, such as those of the Coronavirus Aid, Relief, and Economic Security (CARES) Act, P.L. 116-136. To date, however, no permanent solution to this issue exists. The simple fix would be to allow partners with excess BBA credits in the adjustment year to carry forward those excess credits and offset subsequent-year taxes.

Requests for simplified reporting of administrative changes are born from the fact that the forms and deliverables under the BBA prioritize partner-level reporting, while some changes to partnership returns do not actually change a partner’s share of partnership items (e.g., checkboxes and answers on Form 1065, Schedule B, Other Information; misclassified expenses or balance sheet items; and certain adjustments to arrive at book income).

Although stranded overpayments and simplified reporting are high-impact issues, all concerns with the BBA should be closely considered to promote compliance, ease of use, and consideration of uncommon situations.

Tax professionals push for more flexible reporting options

While adjustments to the BBA regime that could be accomplished through Treasury or IRS intervention would improve the current processes, working groups within the AICPA, the ABA, and other professional associations have also suggested more significant alterations to the audit and adjustment processes that would require congressional action. These suggestions are aimed at transforming the forward-looking nature of the BBA by eliminating the determination of tax assessment in a reviewed year and instead treating any adjustments to income as additional income or deduction items in the adjustment year only. This would potentially eliminate penalties and interest related to underpayments of tax on adjustment items and remove a barrier that tax practitioners currently must navigate when approaching the impact of adjustments with partnerships and partners. While this type of requested approach may seem radical, professional associations continue to press Congress, Treasury, and the IRS to eliminate punitive charges and simplify tax reporting for the benefit of the tax practitioner community, which is faced with issues of both time compression and talent shortages (see AICPA comment letter, “H.R. 3708, the Tax Deadline Simplification Act” (June 20, 2023)).

Making the best of an imperfect regime

The BBA has not perfected the audit and partnership adjustment regime; however, certain aspects are a stark improvement from previous reporting options available to partnerships and their partners. As Treasury and the IRS continue to fine-tune certain processes and administrative aspects, tax practitioners need to carefully review the regime’s requirements, opportunities, and pitfalls to assure partnerships and their partners are utilizing the regime appropriately. Additionally, wellinformed practitioners can promote application of the BBA audit regime as a less disruptive approach to partnership adjustments over prior regimes in many situations. The efforts of working groups to adjust both the BBA regime and general reporting requirements to reflect the issues impacting tax professionals ideally will result in substantial positive changes to these processes in the future.

Editor Notes

Robert Venables, CPA, J.D., LL.M., is a tax partner with Cohen & Co. Ltd. in Fairlawn, Ohio.

For additional information about these items, contact Venables at rvenables@cohencpa.com.

Contributors are members of or associated with Cohen & Co. Ltd.