Audit Shock: When the Partnership Pays the Tax
The Bipartisan Budget Act of 2015 (BBA) fundamentally changed how the IRS audits partnerships. Under the old TEFRA rules, tax adjustments flowed through to individual partners – and in many cases, the IRS had to coordinate with all of them. For large or shifting partnerships, this process was slow, inconsistent, and often collapsed under its own complexity.
The BBA was designed to fix that. Instead of chasing down dozens or hundreds of partners, the IRS now has a single point of collection – the partnership itself. But while this simplifies enforcement for the government, it introduces new risks for taxpayers. The partnership-level tax assessment – often called the imputed underpayment – means today’s partners could be stuck paying for mistakes from years past, even if they weren’t partners at the time.
The “audit shock” has caught many taxpayers and practitioners off guard. Understanding the mechanics of the BBA’s rules is essential to avoid unnecessary surprises.
From Flow-Through to Entity-Level Tax
Partnerships are generally flow-through entities: income, deductions, and credits pass through to partners. But when an IRS audit adjustment increases taxable income for prior years, collecting tax directly from prior-year partners can be messy – on many levels.
The BBA solves this by shifting the collection burden to the partnership. Instead of chasing down past partners, the IRS assesses an “imputed underpayment” at the partnership level in the adjustment year – the year that concludes the audit. This means the current partners – not necessarily the ones who benefited in the year under audit – may end up footing the bill.
Key Concepts
Under TEFRA, audit adjustments flowed through to the partners from the start, so the IRS collected tax directly at the partner level – meaning each partner’s liability reflected their own rate and circumstances. With the BBA turning that system on its head, concepts like the imputed underpayment, the timing mismatch between the reviewed year and the adjustment year, and the push-out election are central, because they determine who ultimately bears the tax and when. In other words, these mechanics replace TEFRA’s individualized partner assessments with a partnership-centered model that can create both efficiencies and inequities. Let’s tackle each of these to better understand them.
Imputed Underpayment
The imputed underpayment is the additional tax calculated on audit adjustments, using the highest applicable tax rate for individuals or corporations. Unless the partnership takes steps to modify it, this rate often overstates the true liability. We’ll discuss modifications in a subsequent article in this series.
Reviewed Year vs. Adjustment Year
The “reviewed year” is the year under IRS audit. The “adjustment year” is the year the IRS finalizes the adjustment and collects tax. Why is this important?
BBA audits are never quick. Large partnership examinations can stretch on for several years, meaning the reviewed year may be long past by the time the IRS finalizes an adjustment in the adjustment year. This lag creates real-world problems: partners may have sold their interests, new partners may have joined, and the economic benefits of the original understatement may no longer match up with who ultimately bears the cost.
Without careful planning or use of the push-out election, today’s partners could be left paying for yesterday’s mistakes.
Push-Out Election
To align tax liability more closely with those who benefited, partnerships can make a push-out election. Instead of paying the imputed underpayment at the partnership level, the adjustments are “pushed out” to the reviewed-year partners, who then take the adjustment into account on their own returns.
While this can relieve current partners, it comes with additional compliance obligations and interest computations. Partnerships must weigh whether the administrative complexity is worth the fairness gained.
Practice Pointer: Addressing the Timing Mismatch
Because BBA audits often conclude years after the reviewed year, partnerships should build protections into their governing agreements. Consider implementing indemnification clauses, push-out election, and capital accounting tracking.
Indemnification Clauses – Require former partners to reimburse the partnership (or current partners) if an imputed underpayment arises from years they benefited.
Push-Out Election Readiness – Decide in advance whether the partnership will default to pushing out adjustments to reviewed-year partners.
Capital Account Tracking – Maintain detailed records to support allocation of liabilities if the IRS adjustment affects ownership changes.
Why It Matters
For many partnerships, especially those with shifting ownership or complex allocations, the BBA rules can create unintended winners and losers. Without proper planning, current partners may be left paying for the mistakes of former partners.
Your tax advisor should:
Review your partnership agreement to address how audit liabilities are allocated.
Consider provisions requiring former partners to indemnify current partners if an imputed underpayment is assessed.
Educate you about modification options and the push-out election.
Final Takeaway
The BBA shifted the audit landscape from individual to entity-level responsibility. Partnerships must now be proactive – both in drafting agreements and in responding to IRS examinations. Otherwise, what begins as an audit adjustment can quickly escalate into a partnership-level tax shock.