On June 13, 2017, the U.S. Treasury Department and Internal Revenue Service (“IRS”) re-released proposed regulations (the “Proposed Regulations”) governing the new centralized partnership audit regime that is scheduled to become effective for partnership taxable years beginning on or after January 1, 2018. The Proposed Regulations are largely identical to proposed regulations that were released on January 19, 2017, but were subsequently withdrawn due to an executive “regulatory freeze” order.

The Proposed Regulations provide, among other things, rules and procedures for (i) electing out of the centralized partnership audit regime, (ii) designating and replacing the partnership representative, (iii) determining amounts owed by the partnership or partners attributable to adjustments that arise out of a partnership audit, and (iv) “pushing out” partnership adjustments to the persons that were partners in the partnership in the taxable year under audit (the “review year”).


The new centralized partnership regime, which was enacted into law as new Internal Revenue Code sections 6221 through 6241 in the Bipartisan Budget Act of 2015, fundamentally changes how the IRS will audit and assess tax against partnerships (and entities treated as partnerships for federal income tax purposes) and their partners. Under the existing “TEFRA” partnership audit rules, the IRS generally conducts a single audit at the partnership level but flows through any resulting partnership adjustments to the persons that were the ultimate partners in the partnership in the year to which the adjustment relates. During the audit, the IRS principally communicates with a “Tax Matters Partner” designated by the partnership, although other partners are entitled to certain notice and participation rights.

In contrast to the existing TEFRA regime, the new centralized partnership audit regime will require by default that the partnership, rather than the partners, pay any tax, penalty, and interest attributable to an IRS audit adjustment at the partnership level. Under the new rules, the amount of any tax deficiency (the “imputed underpayment”) generally is computed based on the highest federal income tax rate applicable to an individual, but a partnership may claim a reduction in the tax rate based on the status of each partner and the character of the income in question (e.g., capital gains and qualified dividend income). Partnerships with 100 or fewer partners meeting certain requirements may elect to opt out of these rules, and partnerships that are subject to these rules are permitted to elect to “push out” any tax deficiency to the persons that were partners in the taxable year that is being audited.

In addition, the new centralized partnership audit rules no longer provide for the requirement to designate a partner as the “Tax Matters Partner” to represent the partnership in audit proceedings before the IRS. Instead, the partnership must designate a “partnership representative,” which may be any person, including a non-partner, with substantial U.S. presence. The partnership representative will have exclusive authority to resolve any partnership audit, and any such resolution is binding on all partners, which will no longer have the notice and participation rights provided in the TEFRA rules.

Scope of the Proposed Regulations

The Proposed Regulations define the scope of the centralized partnership audit regime expansively to cover “any adjustments to items of income, gain, loss, deduction, or credit” of a partnership determined at the partnership level. The Proposed Regulations broadly define the term “items of income, gain, loss, deduction, or credit” to cover all items and information required to be shown on the partnership’s return and all information included in a partnership’s books and records.

Electing Out of the Centralized Partnership Audit Regime

In general, the centralized partnership audit regime applies to all partnerships (domestic or foreign) for their partnership taxable years beginning on or after January 1, 2018. However, certain “eligible partnerships” are allowed to elect out of the centralized partnership audit regime on an annual basis. An eligible partnership is a partnership with 100 or fewer “eligible partners” during such partnership’s entire taxable year. In general, eligible partners are limited to individuals, C corporations, foreign corporations, S corporations, and estates of deceased partners.1 A partnership is treated as having 100 or fewer eligible partners during a taxable year if it is required to furnish 100 or fewer Schedules K-1 for the applicable taxable year. For this purpose, the Schedules K-1 furnished by a partner that is an S corporation to its shareholders will be counted in the number of Schedules K-1 furnished by the partnership.

Note that partnerships, trusts, and disregarded entities are not considered eligible entities. Consequently, any partnership that has a partnership, trust or disregarded entity as a partner will not be eligible to elect out of the centralized partnership audit regime.

Under the Proposed Regulations, to elect out of the centralized partnership audit regime, an eligible partnership must make the election on its timely filed return for the taxable year to which the election applies, and the partnership must notify its partners of the election within 30 days after making the election. Once a valid election is made, it is binding on all partners. A valid election can only be revoked with the IRS’s consent.

Any partnership electing out of the centralized partnership audit regime will be subject to pre-TEFRA audit procedures under which the IRS will separately examine each partner and assess tax pursuant to general deficiency procedures.

Partnership Representative

As noted above, under the centralized partnership audit regime, all partnerships must designate a person to be the partnership representative. Unlike the Tax Matters Partner under the TEFRA regime, which represents the partnership but cannot bind the other partners, the partnership representative will have the exclusive authority to act on behalf of the partnership and take actions that bind the other partners, including: (i) agreeing to settlements, (ii) agreeing to a notice of final partnership adjustment, (iii) making an election under section 6226, and (iv) agreeing to an extension of the period for adjustments under section 6235. Because of the broad authority of the partnership representative, it will be particularly important for partners who are not the partnership representative to negotiate contractual rights and protections in the partnership agreement. However, the Proposed Regulations also provide that any action taken by the partnership representative is valid and binding on the partnership for U.S. federal income tax purposes, even if such action is contrary to a provision of state law, partnership agreement, or any other document or agreement. Accordingly, if the partnership representative violates the terms of any such document or agreement, the other partners may have recourse against the partnership representative for a breach of contract, but they will not be able to opt out of or otherwise renegotiate any agreement with the IRS.

The Proposed Regulations provide rules regarding (i) the eligibility requirements for a partnership representative, (ii) the designation of the partnership representative, and (iii) the replacement of the partnership representative. Generally, a partnership may designate any person, including an entity,2 to be the partnership representative, provided the person has a “substantial presence” in the United States. The Proposed Regulations set forth three requirements for a “substantial presence” in the United States:

  1. The partnership representative must have a U.S. address and phone number where the partnership representative can be reached during normal business hours;

  2. The partnership representative must have a U.S. taxpayer identification number; and

  3. The partnership representative must be able to meet in person with the IRS in the United States at a reasonable time and place as is determined by the IRS.

Unlike the Tax Matters Partner under the TEFRA regime, the partnership representative does not need to be a partner in the partnership. For example, a management company that does not own any partnership interests may serve as partnership representative of all of the partnerships it manages so long as it satisfies the substantial presence test.

The partnership representative is designated on the partnership’s tax return for the applicable taxable year. A separate designation must be made for each taxable year, i.e., a designation for one taxable year is not effective for any other taxable year. If there is no designation of a partnership representative, the IRS may, after a 30-day notice period, select any person to serve as the partnership representative. A partnership representative designation is effective until terminated by (i) a valid resignation by the partnership representative, (ii) a valid revocation by the partnership, or (iii) a determination by the IRS that the designation is not in effect. The Proposed Regulations provide, subject to additional guidance from the IRS, that a partnership representative may not be changed (either by resignation or revocation) until the IRS issues a notice of administrative proceeding to the partnership or the partnership files a valid administrative adjustment request for a valid purpose other than changing the partnership representative.

Imputed Underpayment

Under the centralized partnership audit regime, any imputed underpayment resulting from a partnership adjustment for any taxable year generally must be collected at the partnership level. Under the Proposed Regulations, the imputed underpayment generally is computed by multiplying (i) the total netted partnership adjustment, as determined under certain technical grouping and netting mechanisms, by (ii) the highest federal individual income rate in effect for the reviewed year. This amount is then adjusted to take into account the partnership’s credits. If this computation results in a net positive adjustment, the resulting amount is the imputed underpayment; if the computation results in a net non-positive amount, the adjustment does not result in an imputed underpayment.3 The imputed underpayment calculation will almost always result in an overestimation of tax due. To correct potential overstatements of tax due under the imputed underpayment regime, the partnership representative may request the IRS to make the following modifications:

  1. A partnership may request modification of an imputed underpayment if the partnership representative provides to the IRS affidavits from each reviewed year partner that such partner (i) filed amended returns for the reviewed year and for any other years with respect to which any tax attribute is affected by reason of the partnership adjustment(s), and (ii) made all appropriate payments.

  2. A partnership may request modification based on the status of its reviewed year tax-exempt partners. If the IRS approves that modification, the imputed underpayment is calculated without regard to the portion of the partnership adjustment that is allocable to the tax-exempt partner and with respect to which the partner would not be subject to tax for the reviewed year by reason of its status as a tax-exempt entity.

  3. A partnership may request modification of an imputed underpayment by changing the tax rate applied to the portion of the total netted partnership adjustment allocable to a reviewed year partner that is a C corporation or an individual with respect to capital gains and qualified dividends.

  4. Publicly traded partnerships may request modification of an imputed underpayment in the case of a net decrease in a specified passive activity loss for specified partners.

The IRS also proposed three specific additional methods of modification. First, it allows a partnership to request modification of the number and composition of imputed underpayments. Second, a special modification is allowed for reviewed year partners that are RICs and REITs where they can show that they have been in compliance with section 860 and the regulations thereunder. Third, the IRS will allow an appropriate modification based on any closing agreement entered into by any partner pursuant to section 7121.

The partnership representative may request modification of the imputed underpayment generally within 270 days following the date the notice of proposed partnership adjustment is mailed by the IRS. Any partner who believes that it may benefit from any such modification (e.g., a tax-exempt entity) may want to have the partnership representative agree in a partnership agreement or other agreement or document to timely request such modification.

Push-Out Election

Section 6226 provides an alternative to the partnership’s payment of the imputed underpayment. Under this alternative, a partnership may elect to “push out” an imputed underpayment to the persons who held an interest in the partnership at any time during the reviewed year, rather than pay the imputed underpayment at the partnership level and having the current partners bear the economic burden of the tax liabilities of any former partners from the reviewed year.4 If a partnership makes a valid push-out election, the partnership is no longer liable for the imputed underpayment. If this election is made, the interest rate imposed on the imputed underpayment at the partner level is two percentage points higher than if the imputed underpayment is paid by the partnership.

The Proposed Regulations contain detailed procedures for making a valid section 6226 push-out election. Generally, a partnership has 45 days from the date the IRS mails the notice of final partnership adjustment (“FPA”) to make the push-out election with respect to any imputed underpayment contained in the FPA. A valid election must be signed by the partnership representative, filed with the IRS, and satisfy a number of other requirements, including, among other things, that it provide to the IRS and each reviewed year partner with statements identifying each such reviewed year partner’s share of the partnership adjustments related to the imputed underpayment (“section 6226 statements”).

Each reviewed year partner that is furnished a section 6226 statement is required to take into account the items that were adjusted at the partnership level, and pay its share of any tax, penalties, additions to tax, or additional amounts reflected on the section 6226 statement, as well as any interest on such amounts. The Proposed Regulations include a voluntary safe harbor provision, which allows a reviewed year partner to elect to pay an amount of additional tax and interest stated on the section 6226 statement in lieu of recomputing its tax liability for the reviewed year and other affected years.

The Proposed Regulations, like the previously-released proposed regulations that were withdrawn, continue to reserve on whether tiered partnerships will be permitted to push out adjustments to their ultimate indirect partners, which is a significant issue for many partnerships, including investment funds. However, the preamble states that the IRS and Treasury are considering an approach for tiered partnerships to push out adjustments beyond first-tier partners that will be the subject of proposed regulations in the near future.

Terminated Partnerships

The Proposed Regulations provide special rules for partnerships that “cease to exist.” Under the Proposed Regulations, a partnership “ceases to exist” if the partnership terminates within the meaning of section 708(b)(1)(A) or does not have the ability to pay, in full, any amount the partnership owes under the new audit regime. Generally, if the IRS determines that a partnership ceases to exist, the partnership adjustments are taken into account by the persons who are partners at the time the partnership ceases to exist (which may not be the same persons as the reviewed year partners).


Partnerships generally will not be subject to the rules contained in the Proposed Regulations until tax years beginning after December 31, 2017, but should be considering appropriate amendments to their partnership agreements to address a number of the issues discussed above, including (i) the designation and removal of the partnership representative, (ii) partners’ notice and participation rights in connection with audits, (iii) appropriate indemnification protection for the partnership representative, and (iv) how to ensure that imputed underpayments are economically borne by the appropriate partners (or former partners). The Proposed Regulations also have broad implications for common transactions involving transfers of partnership interests, as the parties to such transactions will have to navigate how to allocate exposure to federal income taxes that may be payable at the partnership level.

In addition to tax practitioners, partnerships, and their partners, the Proposed Regulations also were awaited by state taxing authorities. It is still uncertain how states will respond to the Proposed Regulations and whether they will likewise move to a default of collecting partnership audit adjustments at the partnership level.

The Proposed Regulations are complex. This summary above does not address all issues in the Proposed Regulations. If you have any questions regarding the Proposed Regulations, please contact us.


  1. An S corporation is an eligible partner regardless of whether one or more shareholders of the S corporation is not an eligible partner.

  2. If a partnership appoints an entity as the partnership representative, such partnership must also designate, at the same time, a designated individual who meets the substantial presence test described above to act on behalf of the entity.

  3. In general, partnership adjustments that do not result in an imputed underpayment must be taken into account by the partnership in the “adjustment year,” that is, the taxable year in which the adjustment decision becomes final.  The Proposed Regulations are silent with respect to the allocation of adjustments that do not result in an imputed underpayment, leaving their allocation to the partnership agreement.

  4. In order to mitigate the burden on current partners of having the partnership pay any imputed underpayment, the partnership also can require that reviewed year partners indemnify the partnership for their share of any adjustment determined under the new centralized partnership audit regime.  However, a push-out election still may be preferable because it eliminates the burden on the partnership to collect any indemnifiable amounts from the reviewed year partners.