The centralized partnership audit regime under Internal Revenue Code Section 6221 lets the IRS examine a partnership’s return, calculate any additional tax at the entity level, and collect that tax from the partnership itself rather than chasing individual partners. It took effect for tax years beginning after December 31, 2017, replacing the older TEFRA system.1Office of the Law Revision Counsel. 26 U.S. Code 6221 – Determination at Partnership Level Smaller partnerships can elect out each year if they meet strict eligibility rules, and partnerships that stay in have a separate option to push the tax out to the partners who were actually there during the audited year.
How Entity-Level Adjustments Are Calculated
When the IRS audits a partnership under this regime, it examines the partnership’s reported income, deductions, and credits at the entity level. Any resulting tax, along with penalties and interest, is assessed against the partnership.1Office of the Law Revision Counsel. 26 U.S. Code 6221 – Determination at Partnership Level The amount owed is called the imputed underpayment, and Section 6225 sets out how it is figured.
The IRS nets all adjustments for the reviewed year and applies the highest individual or corporate rate in effect for that year.2Office of the Law Revision Counsel. 26 USC 6225 – Partnership Adjustment by Secretary The approach is deliberately aggressive. It assumes every dollar of underreported income would have been taxed at the top rate, which usually overstates the real tax owed. The partnership can request modifications to reduce that number, but the starting point favors the IRS.
There is also a timing problem built into the default rule. The partnership pays the underpayment in the year the audit closes, so current partners bear the cost even if the audited year involved a different lineup. That mismatch between who benefited and who pays is the main reason partnerships care about electing out or, failing that, pushing the adjustment out to the reviewed-year partners.
The Partnership Representative
Every partnership under the regime must designate a partnership representative. This person has sole authority to act for the partnership during an audit, and the partnership and all partners are bound by what the representative does.3Office of the Law Revision Counsel. 26 USC 6223 – Partners Bound by Actions of Partnership That authority covers settling with the IRS, agreeing to adjustments, and choosing whether to push the tax out to partners.
The representative does not have to be a partner. Any person or entity with a substantial presence in the United States qualifies, meaning a U.S. street address, a U.S. phone number, a taxpayer identification number, and the ability to meet with the IRS in person.3Office of the Law Revision Counsel. 26 USC 6223 – Partners Bound by Actions of Partnership If the partnership fails to name someone, the IRS picks the representative, and the partnership has no say in who that is.
Electing Out
A partnership can avoid the regime entirely by making an annual election out under Section 6221(b), but it has to meet every requirement. Missing one disqualifies the partnership for that year.1Office of the Law Revision Counsel. 26 U.S. Code 6221 – Determination at Partnership Level
The 100-Statement Ceiling
The partnership must be required to furnish 100 or fewer Schedules K-1 for the tax year. The count is based on statements required under Section 6031(b), not the raw number of partners.1Office of the Law Revision Counsel. 26 U.S. Code 6221 – Determination at Partnership Level When an S corporation is a partner, the partnership must add every shareholder of that S corporation to the count.4Internal Revenue Service. Instructions for Schedule B-2 (Form 1065) – Election Out of the Centralized Partnership Audit Regime A partnership with 90 partners that includes an S corporation with 15 shareholders lands at 105 and is ineligible.
Who Can Be a Partner
Every partner must be one of the following:
- An individual filing their own return.
- A C corporation, including a foreign entity that would be a C corporation if domestic.
- An S corporation, subject to the extra look-through disclosures below.
- The estate of a deceased partner. Estates only, not trusts.
One partner outside those categories locks the partnership into the regime for the year.1Office of the Law Revision Counsel. 26 U.S. Code 6221 – Determination at Partnership Level The most common disqualifiers are partnerships owning partnership interests and trusts of any kind, including revocable living trusts and charitable remainder trusts.5Internal Revenue Service. Elect Out of the Centralized Partnership Audit Regime Disregarded entities, such as single-member LLCs that do not file their own federal returns, are also ineligible partners under the Treasury Regulations.6eCFR. 26 CFR 301.6221(b)-1 – Election Out for Certain Partnerships Review the ownership structure every year, because a single change, such as a partner moving their interest into a revocable trust, wipes out the election for the entire year.
How to File
The election is made by attaching a completed Schedule B-2 to a timely filed Form 1065, including any valid extension.4Internal Revenue Service. Instructions for Schedule B-2 (Form 1065) – Election Out of the Centralized Partnership Audit Regime The statute requires the election to be made with a timely filed return, so an amended return after the deadline will not save it.1Office of the Law Revision Counsel. 26 U.S. Code 6221 – Determination at Partnership Level Schedule B-2 discloses the name, taxpayer identification number, and federal tax classification of every partner. When an S corporation is a partner, the partnership must also collect the name, TIN, and entity type of each shareholder. Bad or missing TINs can cause the IRS to reject the election, so this information is worth gathering early.
After filing, the partnership must notify each partner that the election has been made within 30 days.7Federal Register. Centralized Partnership Audit Regime The election is not permanent; it has to be made fresh every year.
The Push-Out Election
Partnerships that stay in the regime, whether by choice or because they don’t qualify to elect out, can still avoid paying the imputed underpayment at the entity level. Section 6226 lets the partnership representative make a push-out election, shifting the tax to the people who were partners during the reviewed year.8Office of the Law Revision Counsel. 26 USC 6226 – Alternative to Payment of Imputed Underpayment by Partnership
The window is tight. The representative must elect in within 45 days of receiving the IRS’s notice of final partnership adjustment, and revocation requires IRS consent.8Office of the Law Revision Counsel. 26 USC 6226 – Alternative to Payment of Imputed Underpayment by Partnership The partnership then issues each reviewed-year partner a statement showing their share of the adjustments. Each partner reports the adjustments on their own return for the year they receive the statement, recalculating what they would have owed in the reviewed year and every affected year since.
The push-out solves the fairness problem in the default rule. Without it, today’s partners pay for mistakes made in years they may not have been part of the partnership. With it, the tax lands on the partners who reported, or should have reported, the income. The cost is more paperwork for everyone and a hard deadline for the representative.
Reducing the Imputed Underpayment
If the partnership ends up owing an imputed underpayment and doesn’t push it out, the starting calculation almost always overstates the actual tax. Section 6225(c) allows modifications that bring the number closer to what the partners would really have owed.2Office of the Law Revision Counsel. 26 USC 6225 – Partnership Adjustment by Secretary The common categories are:
- Amended returns filed by individual partners for the reviewed year. When a partner pays the tax they personally owe on the adjustment, the partnership’s imputed underpayment is reduced by that amount.
- Tax-exempt partner status. The portion of the adjustment allocable to a tax-exempt partner can be removed from the calculation.
- Lower applicable rates. When some of the adjustment would have been taxed at a rate below the top statutory rate, such as capital gains rates, the partnership can demonstrate this to reduce the underpayment.
The partnership requests these modifications on Form 8980, supported by documents like partner amended returns on Form 8982 and tax-exempt certifications on Form 8983.9Internal Revenue Service. About Form 8980, Partnership Request for Modification of Imputed Underpayments Under IRC Section 6225(c) Modifications happen in a defined window before the underpayment is finalized, so gather partner information as soon as an adjustment is proposed rather than waiting for the final notice.
Check the Partnership Agreement
Operating agreements drafted before 2018 usually say nothing about who serves as partnership representative, what authority that person has, or how the economic burden of an imputed underpayment gets shared. That silence is expensive. The representative can legally settle an audit and bind every partner regardless of what the agreement says about decision-making. Updating the agreement to address representative selection, indemnification for audit liabilities, and whether to push out adjustments is one of the most overlooked pieces of partnership tax compliance.