The BBA was enacted on November 2, 2015, and was amended by the Protecting Americans from Tax Hikes Act of 2015, Public Law 114–113, div. Q (PATH Act) on December 18, 2015. Section 1101(a) of the BBA removes subchapter C of chapter 63 of the Internal Revenue Code (Code) effective for partnership taxable years beginning after December 31, 2017. Subchapter C of chapter 63 contains the unified partnership audit and litigation rules that were enacted as part of the Tax Equity and Fiscal Responsibility Act of 1982, Public Law 97–248 (TEFRA). These partnership audit and litigation rules are commonly referred to as the TEFRA partnership procedures or simply TEFRA.

Section 1101(b) of the BBA also removes subchapter D of chapter 63 of the Code (subchapter D) and part IV of subchapter K of chapter 1 of the Code (part IV of subchapter K), rules applicable to electing large partnerships, effective for partnership taxable years beginning after December 31, 2017. Subchapter D contains the audit rules for electing large partnerships, and part IV of subchapter K prescribes the income tax treatment for such partnerships.

Section 1101(c) of the BBA replaces the rules to be removed by section 1101(a) and (b) with a centralized partnership audit regime. Section 1101(c) adds a new subchapter C to chapter 63, consisting of sections 6221 through 6241 of the Code. The BBA also makes related and conforming amendments to other provisions of the Code.

Pursuant to section 1101(g)(1) of the BBA, the amendments made by section 1101, which repeal the TEFRA partnership procedures and the rules applicable to electing large partnerships and which create the centralized partnership audit regime, generally apply to returns filed for partnership taxable years beginning after December 31, 2017. Section 1101(g)(2) provides that, in the case of an administrative adjustment request under section 6227 as amended by the BBA, the amendments made by section 1101 apply to requests with respect to returns filed for partnership taxable years beginning after December 31, 2017. Similarly, section 1101(g)(3) provides that, in the case of an election to use the alternative to payment of the imputed underpayment by the partnership under section 6226 as amended by the BBA, the amendments made by section 1101 apply to elections with respect to returns filed for partnership taxable years beginning after December 31, 2017.

Section 1101(g)(4) provides that a partnership may elect (at such time and in such form and manner as the Secretary may prescribe) for the amendments made under section 1101 (other than the election out of the centralized partnership audit regime under section 6221(b) as added by the BBA) to apply to any return of a partnership filed for partnership taxable years beginning after November 2, 2015 (the date of the enactment of the BBA) and before January 1, 2018.

On December 18, 2015, President Obama signed into law the PATH Act. Section 411 of the PATH Act corrects and clarifies certain amendments made by the BBA. The amendments under the PATH Act are effective as if included in section 1101 of the BBA, and therefore, subject to the effective dates in section 1101(g) of the BBA.

On August 5, 2016, the Treasury Department and the IRS published temporary regulations (TD 9780, 81 FR 51795) and a notice of proposed rulemaking (REG–105005–16, 81 FR 51835) in the Federal Register. The temporary regulations set forth in § 301.9100–22T provide the time, form, and manner for a partnership to make an election pursuant to section 1101(g)(4) of the BBA to have the centralized partnership audit regime apply to any of its partnership returns filed for a partnership taxable year beginning after November 2, 2015 and before January 1, 2018. Section 301.9100–22T(a) provides the general rule that a partnership may elect at the time and in such form and manner as described in § 301.9100–22T for amendments made by section 1101 of the BBA, except section 6221(b) added by the BBA, to apply to any return of the partnership filed for an eligible taxable year (as defined in § 301.9100–22T(d)).

On December 6, 2016, Congress introduced the Tax Technical Corrections Act of 2016 (H.R. 6439, S. 3506) (Tax Technical Corrections Act) which contains what are described as technical corrections to the centralized partnership audit regime and other corrections to the Bipartisan Budget Act of 2015. The Tax Technical Corrections Act addresses a number of the provisions of the centralized partnership audit regime enacted as part of BBA. The Tax Technical Corrections Act, however, was not enacted by Congress.

Section 6221(a), as added by the BBA, provides the scope of items that are subject to adjustment under the centralized partnership audit regime. That section provides that any adjustment to items of income, gain, loss, deduction, or credit of a partnership for a partnership taxable year (and any partner’s distributive share thereof) shall be determined, and any tax attributable thereto shall be assessed and collected, at the partnership level. The applicability of any penalty, addition to tax, or additional amount which relates to an adjustment to any such item or share shall also be determined at the partnership level.

Prior to the enactment of TEFRA, any adjustment to an item attributable to a partner’s interest in a partnership required the IRS to open an examination for each partner and follow deficiency procedures to adjust items from a partnership and determine the resulting tax. Separate proceedings for each partner often resulted in inconsistent treatment of various partners with respect to the same items from a partnership. In some cases, inconsistent results occurred in the partner-level examinations themselves. In other cases, not all partners allocated the same items from the partnership were subject to an IRS examination because, for instance, the period of limitations on assessment had expired for some, but not all, partners. In addition, each partner could challenge the IRS adjustment in separate partner-level proceedings in different litigation forums and appellate venues, resulting in different outcomes with respect to the same partnership item. Over time, the size and complexity of partnerships increased, multiplying the disparate treatment of partners with respect to the same items from a partnership and increasing the burden on the IRS in examining and assessing tax related to partnership issues at the partner level.

In 1982, in response to these difficulties, Congress enacted the TEFRA partnership procedures to establish unified rules to allow the IRS to make adjustments to “partnership items” at the partnership level in one proceeding. Partnership items are those items that are more appropriately determined at the partnership level than at the partner level, as provided by regulation. Section 6231(a)(3) (prior to amendment by the BBA). The regulations under section 6231 (prior to amendment by the BBA) define partnership items by listing the items that are more appropriately adjusted at the partnership level within the framework of TEFRA. § 301.6231(a)(3)–1. Items on a partner return that are not partnership items are not subject to adjustment at the partnership level by the IRS under TEFRA, but rather are adjusted with respect to each partner at the partner level in a proceeding outside of the TEFRA regime (generally, under deficiency procedures).

Once a TEFRA proceeding is final, the IRS makes corresponding computational adjustments to each partner’s return to reflect the proper treatment of partnership items. Section 6230(a)(1) (prior to amendment by the BBA). A computational adjustment may include adjustments to “affected items” of the partner. § 301.6231(a)(6)–1. An “affected item” is any item on a partner’s return that is affected by a partnership item. Section 6231(a)(5) (prior to amendment by the BBA). When making a computational adjustment, if partner-level factual determinations are necessary to properly determine the tax, the IRS is required to follow the deficiency procedures at the partner level. Section 6230(a)(2)(A)(i) (prior to amendment by the BBA). Any item on the partner’s return that is neither a partnership item nor an affected item is not subject to TEFRA and must be adjusted in a separate deficiency proceeding. See, e.g., Bedrosian v. Commissioner, 144 T.C. 152, 159 (2015); see also section 6230(a)(2)(B) (prior to amendment by the BBA), Desmet v. Commissioner, 581 F.3d 297, 302 (6th Cir. 2009).

The TEFRA partnership procedures automatically exempt certain partnerships with ten or fewer direct partners. Section 6231(a)(1)(B) (prior to amendment by the BBA). For those small partnerships, the IRS must follow deficiency procedures for each partner, which requires the IRS to adjust items from the partnership on each partner’s return and to assess the resulting tax subject to the deficiency procedures in a separate proceeding at the partner level.

Since the enactment of TEFRA, the number and complexity of partnerships have continued to increase. The number of large partnerships, in particular, has increased dramatically. In 1997, Congress recognized some of the difficulties facing the IRS under TEFRA when auditing complex, large partnership structures and in response enacted a streamlined, elective audit regime for certain large partnerships (ELP regime). Sections 6240 through 6255 (prior to amendment by the BBA). The ELP regime allowed certain partnerships with 100 or more partners to elect the application of simplified reporting rules and a centralized audit regime with features similar to the regime enacted under the BBA. The ELP regime was a legislative response to the recognition that:

Joint Comm. on Taxation, JCS–23–97, General Explanation of Tax Legislation Enacted in 1997, 363 (1997).

Since 1997, the number and complexity of partnerships has continued to increase, reflecting a shift in how business entities are structured - toward partnerships and away from C corporations. The ELP regime attempted to address some of the difficulties the IRS faced auditing large partnerships under TEFRA; however, the ELP regime is elective and only a handful of partnerships elected application of the ELP regime.

In 2013, Congress requested that the Government Accountability Office (GAO) investigate partnerships and the IRS’s audit rate of partnerships. The GAO report concluded that from 2002 to 2011 ”the number of large partnerships with 100 or more direct and indirect partners as well as $100 million or more in assets more than tripled to 10,099—an increase of 257 percent.” U.S. Gov’t Accountability Office, GAO–14–732, Large Partnerships: With Growing Number of Partnerships, IRS Needs to Improve Audit Efficiency, 13 (2014) (GAO–14–732). And yet, as the number of large partnerships increased, the number of partnership audits did not keep pace. Compared to the audit rate for large corporations, which was 27.1 percent in 2012, the audit rate for large partnerships was much lower at 0.8 percent. (Large partnership is defined for purposes of the GAO report as a partnership with 100 or more direct and indirect partners and $100 million or more in assets.) GAO–14–732, cover page, summary.

When the IRS completes an examination of a large partnership under TEFRA, the IRS must pass the audit adjustments to partnership items on to the ultimate partners, a complex and time-consuming process. This requires the IRS to link potentially thousands of partner returns, including through tiers of partners that are themselves partnerships, to determine the proper share of the adjustments for each ultimate partner flowing from adjustments to partnership items. This process is “paper and labor intensive. When hundreds of partners’ returns have to be adjusted, the costs involved limit the number of audits IRS can conduct.” GAO–14–732, cover page, summary. In the meantime, while the IRS is determining these linkages, the period of limitations for the IRS to assess tax with respect to each partner continues to run.

Specifically, the GAO reported that without “legislative action, the IRS’s ability [to effectively audit]” partnerships would not improve. GAO–14–732, cover page, summary. At the time of the 2014 GAO report, Congress and the Administration had put forth legislative proposals that “would allow IRS to collect tax at the partnership level instead of having to pass it through to the taxable partners.” GAO–14–732 at 31.

In 2015, Congress enacted the BBA to replace the TEFRA partnership procedures and the ELP regime with the centralized partnership audit regime, which contained many aspects of the legislative proposals referenced in the GAO report. The centralized partnership audit regime, when fully effective for partnership taxable years beginning after December 31, 2017, will be the exclusive method by which the IRS may audit a partnership in one unified proceeding. For those partnerships that will be subject to the centralized partnership audit regime that were previously exempt from TEFRA (for example, a partnership with no more than 10 partners, none of which is a pass-through entity), the centralized partnership audit regime replaces the separate partner-level deficiency proceedings as the sole method for auditing the partnership unless an eligible partnership elects out of the centralized regime.

The centralized partnership audit regime enacted in the BBA addresses many of the shortcomings of TEFRA identified by the GAO and practitioners. For instance, “unlike prior law, distinctions between partnership items and affected items are no longer made” in the centralized partnership audit regime. Joint Comm. on Taxation, JCS–1–16, General Explanations of Tax Legislation Enacted in 2015, 57 (2016) (JCS–1–16). Instead, section 6221(a) provides that the centralized partnership audit regime applies to any adjustment to items of income, gain, loss, deduction, or credit of a partnership for a partnership taxable year and any partner’s distributive share thereof.

Under TEFRA, the statute broadly defines a partnership item as any item more appropriately determined at the partnership level. Section 6231(a)(3) (prior to amendment by the BBA). In keeping with the statute, the regulations under TEFRA broadly define the term partnership item to include all items of income, gain, deduction, loss, or credit, as well as other related items such as expenditures, tax preferences, exempt income, partnership liabilities, guaranteed payments, certain basis adjustments, character and the percentage of partnership interests, and items arising from the determination at the partnership level of partnership assets, investments, transactions and operations, such as investment tax credits and at risk rules. See generally § 301.6231(a)(3)–1.

Nothing in the text or legislative history of the BBA, or the events leading to enactment of the new regime, indicates that Congress’s use of the phrase “income, gain, deduction, loss, or credit” in section 6221(a) was intended to adopt a more limited set of items to be adjusted at the partnership level than the items included in the broad definition of partnership items under the TEFRA regulations. It would be illogical to conclude that Congress intended to limit the scope of what the IRS could adjust at the partnership level under an expanded centralized partnership audit regime. Such a narrow interpretation could mean that rather than increase the ability of the IRS to audit large partnerships in one unified proceeding, BBA would significantly increase the number of issues affecting partnerships that the IRS would be required to audit at the partner level, meaning that in large partnerships with thousands of partners, the IRS would have to audit issues related to the same partnership multiple times, for each partner, rather than just once at the partnership level. Given the GAO’s criticism in GAO–14–732 of the low partnership audit rate, it does not follow that Congress enacted a new partnership audit regime that weakens the IRS’s ability to conduct audits at the partnership level and forces the IRS to open additional partner-level proceedings to re-audit the same partnership.

The centralized partnership audit regime purposefully avoids the terms partnership items, affected items, computational adjustments, and nonpartnership items that caused so much litigation under TEFRA and does so by adopting the single phrase “income, gain, deduction, loss, or credit” as the scope of the regime. Removing the distinctions between the different types of items and adjustments was an effort to streamline the examination and judicial process to allow centralized collection of the correct amount of tax had the partnership and the partners reported items from the partnership correctly. The centralized partnership audit regime limits the burden on the IRS in both the examination of partnerships and the judicial process – changes that were designed to increase the ability of the IRS to audit large partnerships. IRS received comments in response to Notice 2016–23, 2016–13 I.R.B. 490, that agreed that the use of the term “income, gain, deduction, loss, or credit” in the centralized partnership audit regime was an attempt to reduce the challenges the IRS faced under TEFRA and does not limit the scope of items subject to audit, assessment, and collection at the partnership level.

Under the centralized partnership audit regime, the IRS is no longer required to determine each partner’s share of the adjustments made to partnership items followed by a separate computational adjustment for each partner to assess the correct tax due as a result of the partnership audit. Instead, under the default rules of section 6225, the partnership is liable for an imputed underpayment based on the adjustments made at the partnership level. The imputed underpayment calculation may, for some partnerships, overstate the amount of tax due had the partnership and partners reported the partnership adjustments properly. To correct potential overstatements, the centralized partnership audit regime includes modification procedures and provides additional discretionary authority for the IRS to further modify imputed underpayments to carry out the function of the modification provision. The Joint Committee on Taxation observed that the intent of the modification provision is to “determine the amount of tax due as closely as possible to the tax due if the partnership and partners had correctly reported and paid while at the same time to implement the most efficient and prompt assessment and collection of tax attributable to the income of the partnership and partners.” JCS–1–16 at 65–66.

To reach the correct amount of tax, the IRS makes one set of adjustments at the partnership level and allows the partnership, through modification, to adjust the imputed underpayment amount down to the correct amount of tax. To determine the amount of an imputed underpayment that reflects “tax due as closely as possible to the tax due if the partnership and partners had correctly reported and paid,” the breadth of what the IRS must be able to adjust at the partnership level must be at least as broad as the different type of adjustments made under TEFRA.

Furthermore, under the modification provisions, the partnership (and its partners if they may amend their returns) takes on the burden of further refining the adjustments to reflect the correct amount of tax. Where all partners amend their returns taking all of the adjustments into account, the IRS, the partnership and its partners have effectively mirrored the result of a TEFRA audit, including the final partner-level computational adjustments. This can only be possible if the scope of what the IRS may adjust at the partnership level is sufficiently broad.

As such, the proposed regulations take an expansive view of the scope of the centralized partnership audit regime to cover all items and information related to or derived from the partnership. Accordingly, under proposed § 301.6221(a)–1 all items required to be shown or reflected on the partnership’s return and information in the partnership’s books and records related to a determination of such items, as well as factors that affect the determination of items of income, gain, loss, deduction, or credit, are subject to determination and adjustment at the partnership level under the centralized partnership audit regime.

In general, the centralized partnership audit regime applies to all partnerships with partnership taxable years beginning after December 31, 2017 for any partnership (domestic or foreign) required to file a return under section 6031. Section 6241(1). Section 6221(b), as added by the BBA, allows eligible partnerships to elect out of the centralized partnership audit regime. The fact that all partnerships are covered by the centralized partnership audit regime unless they elect out distinguishes the centralized partnership audit regime from the TEFRA partnership procedures. Under TEFRA, only partnerships with more than 10 partners and partnerships with at least one partner that is not a U.S. individual, a C corporation, or an estate of a deceased partner are automatically covered by the regime. Section 6231(a)(1)(B) (prior to amendment by the BBA). However, partnerships not automatically subject to TEFRA can make an affirmative election into TEFRA. Section 6231(a)(1)(B)(ii) (prior to amendment by the BBA).

Partnerships that elect out of the centralized partnership audit regime are subject to the pre-TEFRA audit procedures under which the IRS must separately assess tax with respect to each partner under the deficiency procedures under subchapter B of chapter 63. As described in section 2.A. of the Background section of this preamble, enactment of TEFRA was a reaction to the complexity and burden of the pre-TEFRA deficiency procedures in the case of partnerships; however, since TEFRA was enacted, the IRS and taxpayers have identified numerous issues with that regime. The centralized partnership audit regime is intended to simplify TEFRA’s burdensome processes and to increase the IRS’s ability to examine partnerships, particularly large and tiered partnerships, and to make the process of assessing tax resulting from those audits more efficient. The limited opt-out nature of the centralized partnership audit regime, which requires the partnership to take affirmative action to elect out of the regime, increases the likelihood that a partnership will be subject to the more streamlined adjustment, assessment, and collection procedures of the centralized partnership audit regime, thereby increasing the number of partnerships the IRS is able to examine under the centralized partnership audit regime. Limiting the number of partnerships that can elect out of the centralized partnership audit regime to those entities specifically permitted under the statute is necessary to carry out this goal.

There are two conditions that must be met for a partnership to be eligible to elect out of the centralized partnership audit regime. First, a partnership must have 100 or fewer partners. Under the statute, a partnership has 100 or fewer partners when it is required to furnish 100 or fewer statements under section 6031(b), currently Schedule K-1, Partner’s Share of Income, Deductions, Credits, etc. (Schedules K-1), for the taxable year. Section 6221(b)(1)(B). For partnerships that have an S corporation as a partner (S corporation partner), special rules under section 6221(b)(2)(A) apply for purposes of determining the number of Schedules K-1 furnished by the partnership. Under that rule, the number of statements required to be furnished by the S corporation partner to its own shareholders under section 6037(b) for the taxable year, currently Schedule K-1, Shareholder’s Share of Income, Deductions, Credits, etc., are taken into account to determine the number of statements