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Recent Developments in Partnership Audits (Part 2)

Posted on Nov. 2, 2021

In yesterday’s post Rochelle Hodes, Principal with Crowe LLP, provided background on BBA, emphasizing what makes its rules unique in tax procedure. Today’s post will briefly discuss two important BBA developments, the IRS’s Large Partnership Compliance Program and significant ABA Tax Section comments on proposed BBA regulations. Les

Large Partnership Compliance (LPC) Program

The IRS is scheduled to begin the LPC Program this month, starting with the 2019 tax year. The LPC Program is modeled off of the Large Corporate Compliance (LCC) Program, which replaced the Coordinated Industry Case (CIC) Program.

LB&I has provided its employees interim guidance dated October 21, 2021 to implement an LPC Pilot Program. The four-part framework for the Pilot set forth in the interim guidance is consistent with the information IRS executives have previously provided regarding the program.

1. Identification

According to the interim guidance, the first part of the framework is “[i]dentifying the largest partnership cases by focusing on the characteristics of the largest Form 1065 filers.” The IRS will identify “large partnerships” and then use data analytics to determine partnership returns with compliance risk.   When asked at a recent ABA Tax Section panel about what factors contribute to a partnership being included in LPC (and thus being considered “Large”), the IRS official identified factors such as asset and revenue size, volume and size of foreign investments/investors, as well as items reflected on the Schedule K-1. The interim guidance notes that the identification process and factors to determine what is a large partnership may change as more information is gained through the examination process.

2. Modeling and Classification

The second part of the framework is “[d]eveloping improved methods to identify and assess the compliance risk presented by [large partnerships].” The IRS official at the ABA Tax Section panel explained that after the identification of the partnership as “large”, a human “classifier” does a further risk assessment. In addition, the assigned revenue agent will do her own risk assessment of the return.

The IRS official also provided color around the use of data analytics, stating that IRS is using information that it has been gaining from partnership examinations and, presumably, returns and Schedules K-1. The IRS has recently required more detailed information be included with partnership tax returns and Schedules K-1. That data will only be enhanced when the Schedules K-2 and K-3 are filed with 2021 partnership tax returns.

3. Exam Procedures

The third part of the framework is “[c]onsidering examination processes and tools that will allow [the IRS] to better audit this population.” According to the interim guidance, IRM procedures applicable to LB&I, partnerships, and the BBA will generally be followed, including LB&I exam planning procedures in IRM  The interim guidance identifies exceptions to the procedures, including one that provides that LPC returns cannot be merely “surveyed”; they must be examined.  Another exception provides that the exam team must consider or develop all issued identified ahead of time by the classifiers. This will limit the assigned revenue agent’s discretion and could result in longer, more detailed examinations than might otherwise be warranted.

4. Feedback

The fourth part of the framework is enhancing the IRS’ understanding of large partnership compliance issues through feedback. The interim guidance describes procedures whereby technical and procedural feedback will be gathered to improve data analytics and risk identification, including a sharepoint site for LPC, as well as LPC networking calls.

One of the things that representatives can expect from BBA examinations, regardless of whether the examination is under LPC, is an early request for what might seem as a longer extension of the period of limitations on adjustment. The reason for this is largely a function of the statutory requirement that partnerships must be allowed 270 days after the notice of proposed partnership adjustment is issued to request modification.  Additional time constraints on the examination include two opportunities for the PR to request Appeals consideration (the first to request Appeals consideration of the adjustments and the second to request Appeals consideration of a denial of a request for modification). For more on these processes, see the graphic the IRS has posted on its website depicting the BBA examination process.

Representatives should be prepared for revenue agents who lack experience with BBA, and in some cases, who lack experience in partnership tax.  The IRS official at the ABA Tax Section panel stated that they have hired a number of new revenue agents with partnership experience and assigned experienced revenue agents to partnership audits.  It is too early to evaluate how this will affect BBA examinations.

Even before this month, representatives have seen a significant uptick in the number of partnership audits. It is likely that this trend will continue, amped up by the rollout of the new LPC Program.

ABA Tax Section Comments on the November 2020 Proposed Regulations

As Greg Armstrong and I discussed in our prior blog post entitled Treasury and IRS Release New Round of BBA Partnership Audit Proposed Regulations, on November 24, 2020, Treasury and the IRS published proposed regulations under the centralized partnership audit regime enacted by the Bipartisan Budget Act of 2015 (BBA). The ABA Tax Section provided comments on the proposed regulations in a letter dated October 8. The comments address provisions in the proposed regulations that would implement special enforcement provisions enacted as part of the technical corrections, proposed changes to the cease to exist rules under section 6241(7), and proposed changes that would include partnership-related items that do not result in an adjustment to income, gain, loss, deduction, or credit (“non-income adjustments”) to be included in the imputed underpayment, among other topics. Following are some highlights of the comments:

Special enforcement matters

Section 6241(11), providing rules for special enforcement matters, was added to the BBA regime as part of the technical corrections enacted in 2018. Essentially, these rules allow the IRS to adjust a partnership-related item at the partner level without having to open an examination of the entire partnership. Prop. Reg. § 301.6241-7 implements this provision. The comments include several recommendations regarding Prop. Reg. § 301.6241-7, including recommendations not to finalize three areas identified as special enforcement matters: Prop. Reg. § 301.6241-7(b) regarding partnership-related items underlying or related to non-partnership-related items; Prop. Reg. § 301.6241-7(f) allowing adjustment of partnership-related items at the partner level even if the period for adjustment at the partnership level has expired if the period of limitations at the partner level is still open or they agree in writing; and Prop. Reg. § 301.6241-7(g) regarding a partnership’s liability for chapter 1 taxes, penalties and interest.

Cease to exist

The cease to exist rules under section 6241(7) generally provide that if the partnership is unable to pay the imputed underpayment, the adjustments are allocated to former partners who will have to pay tax due as a result of taking these adjustments into account. This is a round-about way for the IRS to collect tax if the partnership won’t pay because it requires allocation of the adjustments to the former partners and computation of the tax due from each partner as a result of taking the adjustments into account. The technical corrections added section 6232(f) which allows collection of an unpaid imputed underpayment from the former partners. There are no regulations describing how section 6232(f) will work.

The proposed regulations make several revisions to the cease to exist regulations to, as the Preamble explains, coordinate the cease to exist rules with section 6232(f). The primary recommendation made by the comments is to provide guidance on section 6232(f) before changing the regulations under section 6241(7).

Non-income item adjustments

Adjustment of certain partnership-related items do not result in a change to any party’s tax liability. For instance, a change to a partner’s capital account maintained by the partnership, by itself, does not result in a change in a partner’s tax liability unless and until an event occurs that causes that capital account information to matter in determining tax liability. Prior to the proposed regulations, there was no guidance specifically addressing non-income item adjustments. The proposed regulations would include non-income item adjustments in the computation of the imputed underpayment, regardless of whether the adjustment results in a change in tax liability of any party. This means that if the only adjustment to the 2018 return is a $100 positive adjustment to a non-income item, there would be a $37 imputed underpayment. This is true even if no partner’s tax liability would have change had the item, as later adjusted, been taken into account when the 2018 return was filed.


For many years, the partnership audit rate was very low, especially when compared to corporations. All that is changing. With LPC and BBA, IRS is increasing its focus on partnership compliance and enforcement. Taxpayers and practitioners should be prepared for increased partnership audits and compliance initiatives.

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