Partnership Items in TEFRA Audits: Reporting, FPAA, and Settlement

Partnership items in TEFRA audits are the line items on a partnership’s return that the IRS examines and resolves once at the entity level, then flows through to every partner’s individual return. Under the Tax Equity and Fiscal Responsibility Act of 1982, these items cover almost everything a partnership reports: each partner’s share of income, gains, losses, deductions, and credits, along with liabilities, guaranteed payments, basis adjustments, and the partnership’s accounting choices. TEFRA governed most partnerships for tax years through 2017, and the IRS still uses its procedures to close out open examinations and disputes from those years, so partners with pre-2018 exposure need to understand how the rules work.

What Counts as a Partnership Item

The Treasury Regulations define partnership items as those “more appropriately determined at the partnership level than at the partner level,” and the list is broad. It includes each partner’s distributive share of ordinary income, capital gains and losses, deductions, credits, tax-exempt income, and nondeductible expenditures such as charitable contributions made by the entity.¹

Partnership liabilities are also partnership items, including whether a debt is recourse or nonrecourse and how the liability balance changed from the prior year. That classification matters because debt allocations feed each partner’s basis, and basis caps how much loss the partner can deduct. Guaranteed payments for services or the use of capital fall into the same bucket.²

The regulation reaches further than most partners expect. Section 754 optional basis adjustments, contributions to and distributions from the partnership, transactions between a partner and the partnership acting in a non-partner capacity, the accounting method the entity uses, whether an asset is capital or ordinary, and whether the partnership qualifies for a given credit are all partnership items, because answering any of those questions requires looking at the entity’s books rather than any individual partner’s records.¹

The practical consequence is centralization. If the IRS disallows a $50,000 deduction at the partnership level, the adjustment flows to every partner’s Schedule K-1 in proportion to their allocable share. There is no separate argument with each partner about whether the expense was legitimate. That single-forum resolution was the reason Congress enacted TEFRA in the first place.

Consistent Reporting and Form 8082

Partners must report partnership items on their personal returns exactly as those items appear on the partnership’s return. If your K-1 shows $80,000 of ordinary income, you cannot substitute your own figure and file on that basis.³

The penalty for inconsistency is procedural, and it stings. Any underpayment caused by inconsistent reporting is treated as a math error, which lets the IRS assess the extra tax without issuing a notice of deficiency. You lose the right to petition the Tax Court before paying.

If you genuinely believe the partnership got it wrong, file Form 8082, Notice of Inconsistent Treatment or Administrative Adjustment Request, with your return. The form asks you to identify the K-1 line item, show the amount reported to you and the amount you are reporting, and explain the discrepancy.⁴ Filing it preserves your normal deficiency rights on the disputed item.

Affected Items and Computational Adjustments

Affected items are figures on your personal return that shift because a partnership item changed, even though the affected item itself is not on the partnership’s books. Medical expenses are the classic illustration: the deduction is limited to costs exceeding 7.5% of adjusted gross income.⁵ If a TEFRA adjustment raises your share of partnership income by $30,000, your AGI rises with it, the 7.5% floor rises, and some of the medical costs you already deducted may drop below the threshold.

Charitable contribution ceilings move the same way. Cash gifts to public charities are generally capped at 60% of AGI, so higher AGI lifts the ceiling. A partner’s basis in the partnership is also an affected item: if the IRS trims a loss that flowed to you, your basis may be higher than you first calculated. Penalties assessed at the individual level qualify as affected items too, because they depend on the size of the underpayment the partnership adjustment produced.⁶

Computational Adjustments

Once the partnership items are final, applying them to a partner is often arithmetic. The IRS issues a Notice of Computational Adjustment showing the additional tax, without a separate notice of deficiency, and partners generally cannot contest the math if it follows from the partnership-level determination.⁶

Partner-Level Penalty Defenses

Not every affected item is mechanical. Accuracy-related penalties depend on facts particular to the individual partner, so you can still argue reasonable cause for your share of any penalty after the partnership items are final. For partnership tax years ending after August 5, 1997, partners keep the right to raise these defenses even after receiving a computational adjustment notice.⁶

How the Audit Reaches Each Partner

A TEFRA examination opens with the IRS mailing a Notice of Beginning of Administrative Proceedings to the Tax Matters Partner and each notice partner, identifying the entity under exam.⁷ The examination itself works from the partnership’s Form 1065, the K-1s issued to partners, and the partnership agreement that dictates how items are allocated. The Tax Matters Partner is the point of contact for the entity and can extend the statute, negotiate settlements, and receive notices on behalf of the partnership.

When the exam concludes with proposed changes, the IRS issues a Final Partnership Administrative Adjustment. The FPAA is the formal notice that specific partnership items will be adjusted, with consequences flowing to every partner.

Petition Deadlines After an FPAA

The Tax Matters Partner has the exclusive right to file a petition for judicial review within 90 days of the date the IRS mails the FPAA. During that window, no other partner can file. The petition can be brought in the U.S. Tax Court, the U.S. District Court for the district where the partnership’s principal place of business is located, or the U.S. Court of Federal Claims.⁸

If the Tax Matters Partner does not file, any notice partner or a five-percent group of partners gets an additional 60 days, for a total window of 150 days from the FPAA mailing date. If nobody petitions, the proposed adjustments become final, and the IRS assesses each partner through computational adjustments without individual deficiency notices.⁸

Statute of Limitations

Under TEFRA, the IRS treats the partnership-level assessment period as the controlling deadline for tax attributable to partnership items.⁹ Several situations extend or eliminate it:

Substantial omission. If the partnership left out more than 25% of the gross income it should have reported, the period stretches from three years to six.⁹
No return filed. If no return was filed, the IRS can assess at any time. An IRS-prepared substitute return does not start the clock.
Fraud. A partner who participated in preparing a fraudulent return faces an unlimited assessment period; other partners in the same entity get six years rather than three.

The Tax Matters Partner can extend the period for the entire partnership by signing Form 872-P, Consent to Extend the Time to Assess Tax Attributable to Partnership Items. One signature binds every partner.¹⁰ Mailing the FPAA also suspends the clock: it stays frozen through the 150-day petition window, and if a petition is filed, the suspension continues until the court’s decision becomes final plus one additional year.⁹

Settlement and Conversion to Non-Partnership Items

Settlements are documented on Form 870-P (AD), Settlement Agreement for Partnership Adjustments, which identifies the taxpayer, the tax years, and the specific agreed changes to partnership items.¹¹

A settlement carries a critical legal consequence: the affected partnership items convert to non-partnership items for the settling partner. Once converted, they leave the TEFRA partnership-level procedures and fall under the individual partner’s assessment rules, with a minimum one-year window for the IRS to assess.¹²

Settlement is not the only trigger. A partner’s bankruptcy filing permanently converts their partnership items to non-partnership items, even if the bankruptcy is later dismissed. The IRS Commissioner can also convert items for a specific partner in certain circumstances. Conversion does not reverse.¹²

The Small Partnership Exception

Not every partnership was subject to TEFRA’s unified audit procedures. The old rules exempted partnerships with 10 or fewer partners, provided that none of the partners was itself a partnership. For those entities, the IRS audited each partner individually rather than opening a single entity-level proceeding. Courts read the exception strictly: even a partner holding a fractional interest could disqualify the partnership from the exemption if that partner was another partnership.

What Changed for Tax Years After 2017

The Bipartisan Budget Act of 2015 repealed TEFRA’s partnership audit procedures for tax years beginning after December 31, 2017.¹³ Returns for tax years starting January 1, 2018, or later fall under the BBA centralized audit regime, and the concept of “partnership items” versus “non-partnership items” gives way to the broader “partnership-related items” with different procedural consequences.¹⁴

The default payer also flipped. Under TEFRA, adjustments flowed to partners, who each owed their share of the additional tax. Under BBA, the partnership itself pays an imputed underpayment calculated at the highest individual or corporate rate applied to the net adjustment, unless the partnership elects to push the adjustments out to its partners within strict deadlines.¹⁵ The Tax Matters Partner role, which had to be filled by a general partner, was replaced by a Partnership Representative who need not be a partner at all and has sole authority to bind the entity and its partners.¹⁶

Partnerships with 100 or fewer partners can now elect out of the BBA regime entirely, but only if every partner is an individual, a C corporation, a foreign entity that would be treated domestically as a C corporation, an S corporation, or the estate of a deceased partner. Any trust, partnership, or disregarded entity as a partner disqualifies the election regardless of size.¹⁷¹⁸

TEFRA has not gone quiet. The IRS continues to work examinations and court cases involving pre-2018 tax years under the old rules, and partners in those matters still need to know what a partnership item is, what an FPAA does, and when the petition clock runs out.

1
GovInfo. 26 CFR 301.6231(a)(3)-1 – Partnership Items
2
eCFR. 26 CFR 301.6231(a)(3)-1 – Partnership Items
3
Office of the Law Revision Counsel. 26 US Code 6222 – Partners Return Must Be Consistent With Partnership Return
4
Internal Revenue Service. Instructions for Form 8082, Notice of Inconsistent Treatment or Administrative Adjustment Request
5
Internal Revenue Service. Publication 502 – Medical and Dental Expenses
6
Internal Revenue Service. IRM 8.19.8 Collection Cases
7
Internal Revenue Service. IRM 4.29.5 PCS TEFRA/ILSC Notices and Cover Letters
8
Internal Revenue Service. IRM 8.19.12 Final Partnership Administrative Adjustment
9
Internal Revenue Service. IRM 8.21.6 Statute Information on TEFRA Cases
10
Internal Revenue Service. Tax Matters Partners Authority to Sign a Form 872-P
11
Internal Revenue Service. IRM 8.6.4 Reaching Settlement and Securing an Appeals Agreement Form
12
Internal Revenue Service. IRM 8.19.6 Partner Cases
13
Internal Revenue Service. IRM 8.19.1 Procedures and Authorities
14
Internal Revenue Service. BBA Centralized Partnership Audit Regime
15
Internal Revenue Service. BBA Partnership Audit Process
16
Internal Revenue Service. Designate or Change a Partnership Representative
17
Internal Revenue Service. Elect Out of the Centralized Partnership Audit Regime
18
Office of the Law Revision Counsel. 26 US Code 6221 – Determination at Partnership Level