OPT IN OR OPT OUT?
Demystifying the BBA Centralized Partnership Audit Regime
If I asked you, “Would you like to opt in or opt out?” you would most likely ask, “Opt in or out of what?” To which I would reply: the Audit Regime under the BBA — for a partnership. To which you might reply: “What the [colorful metaphor] is that?”
Fair question. Most partners — and more than a few tax professionals — go their entire careers without ever thinking hard about how the IRS actually audits a partnership. That changed in 2018, when a quiet-sounding piece of budget legislation rewired the plumbing of partnership taxation and, in the process, created one of the most consequential elections a partnership will ever make: whether to stay inside the new centralized audit regime, or opt out of it entirely.
This report walks through what the BBA regime is, how it actually works when the IRS comes knocking, who is even allowed to opt out, and — the question that actually matters to you and your partners — why a partnership would (or would not) want to.
A Short History: From TEFRA to BBA
Before 2018, most partnerships were audited under a regime created by the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA). TEFRA required the IRS to chase down adjustments partner by partner, using a “Tax Matters Partner” as a point of contact. In practice, this was a mess. Partners came and went, K-1s got amended years after the fact, and the IRS often couldn’t collect additional tax efficiently when a partnership had dozens or hundreds of partners scattered across the country.
Congress replaced TEFRA with the Bipartisan Budget Act of 2015 (BBA), effective for partnership tax years beginning on or after January 1, 2018. The stated goal was to make partnership audits easier for the IRS to administer — and, not coincidentally, to make audits of partnerships more common. Under the BBA, the default rule is a dramatic departure from prior law: the partnership itself, not the individual partners, is generally responsible for paying any additional tax resulting from an audit adjustment, in the year the audit concludes rather than the year the underlying income was earned.
The core shift: under BBA, the IRS collects from the entity, in the current year, even though the error occurred in a prior year with a different partner group.
How the Centralized Regime Actually Works
The Reviewed Year vs. the Adjustment Year
Two years matter in a BBA audit. The “reviewed year” is the tax year under examination — the year the disputed item was originally reported. The “adjustment year” is the year the audit concludes and any additional tax is actually assessed and paid. Because partnership ownership frequently changes, these are often not the same partners. A partner who bought in last year can end up economically bearing tax on income earned, and enjoyed, by someone who sold out three years ago. This mismatch is the single biggest planning issue the BBA regime creates.
The Imputed Underpayment
When an audit results in adjustments, the IRS calculates an “imputed underpayment” (IU) by netting the adjustments and applying the highest individual or corporate tax rate in effect for the reviewed year — currently 37%. Because that flat top rate ignores each partner’s actual bracket, character of income, losses, and credits, the IU as first calculated is almost always higher than what the partners would have owed had the adjustment simply flowed through their individual returns.
Modifying the Imputed Underpayment (Section 6225)
The partnership representative can request that the IRS “modify” the IU to reflect partner-specific facts — for example, that a reviewed-year partner was a tax-exempt entity, filed an amended return and paid its share individually, or that a portion of the adjustment is capital gain rather than ordinary income. Modification can meaningfully reduce the bill, but it is document-intensive, requires cooperation from reviewed-year partners (some of whom may no longer have any relationship with the partnership), and runs on IRS-imposed deadlines.
The Push-Out Election (Section 6226)
Instead of paying the IU at the entity level, the partnership representative can elect to “push out” the adjustment to the people who were partners during the reviewed year, each of whom then reports and pays their own share on their individual returns (with a modest interest surcharge). This preserves the TEFRA-like result of imposing tax on the year’s actual partners — but it is not automatic. The election must be made within 45 days of the IRS’s final partnership adjustment notice, statements must be furnished to every reviewed-year partner, and once made it is irrevocable.
Miss the 45-day push-out window, and the partnership is stuck paying the imputed underpayment itself — no do-over.
The Partnership Representative
The BBA replaced the TEFRA “Tax Matters Partner” with the “partnership representative” (PR), who does not even need to be a partner. The PR has sole and exclusive authority to bind the partnership and every partner in it during an audit — no partner consent required, and in many cases no partner notice required, unless the partnership agreement says otherwise. That is an enormous amount of unilateral power to hand one person or entity, and it is the reason a well-drafted partnership agreement is no longer optional.
Who Can Even Opt Out?
Not every partnership gets a choice. Section 6221(b) allows an eligible partnership to elect out of the centralized regime entirely, year by year, reverting to a version of the old partner-level audit procedures. But “eligible” is a defined, and fairly narrow, term.
| Requirement | What It Means |
| 100 or fewer partners | Counted by the number of Schedules K-1 the partnership is required to issue for the year — not the number of individual people. |
| Only “eligible partners” | Individuals, C corporations, S corporations, foreign entities that would be treated as a C corp if domestic, and estates of deceased partners. |
| No ineligible partners | Partnerships, trusts, disregarded entities (e.g., single-member LLCs), nominees, and estates other than a deceased partner’s estate all disqualify the election. |
| S corp shareholder wrinkle | An S corporation partner still counts as one partner for the 100-partner test, but each of its shareholders must also be reported and separately counted toward the total. |
| Annual and affirmative | The election is not permanent. It must be made fresh, on a timely filed return (including extensions), by checking the box on Form 1065, Schedule B, and attaching Schedule B-2 listing every partner. |
If a partnership has even one ineligible partner — say, a revocable trust used for estate planning, or an LLC taxed as a partnership sitting in the ownership chain — the door to opting out is closed, full stop, regardless of how small or simple the partnership otherwise is.
The Case for Opting Out
For partnerships that qualify, opting out has real appeal — particularly for smaller, closely held entities with a stable partner group:
- No entity-level liability. Any audit adjustment is pursued against the individual partners for the reviewed year, under standard deficiency procedures, rather than assessed against the partnership as a single imputed underpayment.
- No mismatch between who benefited and who pays. Because opted-out partnerships are examined more like individuals, there is less risk of a current partner absorbing tax on income earned by a prior owner.
- Cleaner M&A due diligence. Buyers and lenders increasingly ask how a target partnership would handle a BBA adjustment discovered after closing. An opt-out (where available) removes an entire category of successor-liability negotiation.
- No unilateral partnership representative exposure. Without a PR wielding centralized authority, there is no single point of failure who can bind every partner to a settlement or a push-out decision they never agreed to.
- Simplicity for small, static partnerships. A two- or three-partner real estate or professional partnership with no plans to add complex entities as partners often has little to gain from centralized treatment and a real administrative headache to avoid.
The Case for Staying In (or Opting In by Default)
Opting out is not automatically the right move even for partnerships that qualify, and it is simply unavailable to many others. Reasons a partnership might stay inside the regime include:
- Ineligibility. Any partnership with a trust, another partnership, or a disregarded entity as a partner cannot opt out — this covers a large share of investment funds, real estate partnerships, and family-office structures by design.
- The push-out election offers a middle path. A partnership does not have to choose between full entity-level liability and full opt-out. Push-out under Section 6226 lets a partnership stay in the centralized regime for administrative purposes but still shift ultimate tax liability to reviewed-year partners when it matters.
- Administrative simplicity for the IRS relationship. One negotiation, one representative, one set of workpapers — rather than the IRS separately examining and pursuing each partner. For large partnerships, this can actually shorten and simplify an exam.
- Modification opportunities. Staying in preserves access to Section 6225 modification procedures, which can meaningfully reduce the imputed underpayment when partner-specific facts (tax-exempt status, capital gain character, amended returns) are favorable.
- Avoiding the all-or-nothing partner cooperation problem. An opt-out or a push-out both depend on being able to locate and get cooperation from every reviewed-year partner, including ones who have since sold out or become estranged from the partnership. A partnership with a complex ownership history may find it easier, in practice, to just pay the imputed underpayment and move on.
There is no universally “right” answer. The correct choice depends on partner composition, ownership turnover, deal activity, and how much control the partners are comfortable handing to one representative.
Why Your Partnership Agreement Needs to Catch Up
Whether a partnership opts out, stays in, or plans to rely on push-out, the partnership agreement should not be silent on any of it. At a minimum, a modern agreement should address:
- Who serves as partnership representative, how they are selected and removed, and what qualifications they must have.
- Whether the PR needs partner consent before making a push-out election, agreeing to a settlement, or extending the statute of limitations.
- How the annual opt-out election decision is made — automatically, by vote, or at the PR’s discretion — for partnerships that remain eligible.
- Indemnification and reimbursement provisions addressing who bears an imputed underpayment when reviewed-year and adjustment-year partners are not the same people.
- Information and cooperation covenants requiring exiting or former partners to assist with modification requests or push-out statements after they’ve left.
- Tax distribution provisions sized to cover a potential BBA assessment, not just ordinary annual tax liabilities.
Partnerships that drafted their agreements before 2018 — or that adopted a generic template since without revisiting this section — are very often silent on all of the above. That silence defaults to the partnership representative having essentially unchecked authority, which is rarely what the partners actually intended.
A Practical Decision Framework
Before advising a partnership on this election, walk through these questions in order:
- 1. Eligibility gate: Does the partnership have 100 or fewer K-1 recipients, and are all partners eligible partner types? If no, opting out is off the table — skip to push-out and agreement planning.
- 2. Ownership stability: How often does partner composition change? Frequent turnover increases the value of opting out or preserving a push-out strategy.
- 3. Deal activity: Is a sale, refinancing, or capital raise likely in the next few years? Buyers and lenders will ask about this — have an answer ready.
- 4. Partner sophistication and cooperation: Can the partnership realistically get cooperation from former partners years after they’ve left, if a push-out or modification becomes necessary?
- 5. Risk tolerance and cash position: Can the partnership absorb an entity-level imputed underpayment in a future year without disrupting operations or unfairly burdening current partners?
- 6. Governance readiness: Does the partnership agreement actually address PR authority, consent rights, and indemnification? If not, that gap needs to close regardless of which audit election is chosen.
The Bottom Line
The BBA centralized partnership audit regime is not going anywhere, and IRS audit activity aimed at partnerships has only grown since the regime took effect. “Opt in or opt out” is not a throwaway checkbox on Form 1065 — it is a substantive decision about who bears the risk of a future audit, how much authority one representative should hold, and how the partnership agreement needs to be written to protect everyone at the table.
The partnerships that handle this well are the ones that decide deliberately, before an audit notice ever arrives — not the ones scrambling to figure out what “imputed underpayment” means after the IRS letter shows up. If your partnership hasn’t revisited its BBA election, its partnership representative designation, or its partnership agreement since 2018, now is the time, not during an active exam.
Questions about whether your partnership should opt in or opt out, who should serve as your partnership representative, or how to prepare for a BBA exam? That’s exactly what our tax preparation and tax representation practice is built to help with. Reach out and let’s map out the right approach for your partnership before the IRS makes the decision for you.
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