Mitigating the Potential Consequences of Partnership Audit Changes

The partnership tax rules were intended to promote flexibility. However, that flexibility often results in complexity, which can sometimes allow partners to obtain benefits that were not contemplated by the tax law. The government has historically respected most partnership transactions reflecting that flexibility because adverse partner interests limit opportunities for obtaining unintended benefits. But by the mid-2010s, the IRS had become increasingly frustrated with difficulty in auditing partnerships and their partners. Congress responded by enacting a new audit regime as part of the Bipartisan Budget Act of 2015 (the BBA), and that regime generally became effective in 2018.

The BBA regime is taxpayer unfriendly, and it can result in partnership-level liability and far greater cost than what would have applied had a partnership's tax returns been filed consistently with the IRS's audit adjustments. There are, however, elections that can mitigate the regime's harshness. One such election — an election out of the BBA regime for qualifying partnerships — must be made annually on the partnership's tax return, IRS Form 1065. Other mitigating elections involve relatively short deadlines and can require substantial analysis and compliance.