A New BBA Audit Tool: When a “Positive Adjustment” May Not Mean More Tax
Under the centralized partnership audit regime created by the Bipartisan Budget Act of 2015 (“BBA”), one of the most counterintuitive rules involves non-income partnership-related items, things like capital accounts, liabilities, basis-related items, and other balance-sheet adjustments.
Here is the problem in plain English:
A Revenue Agent may determine that a partnership’s capital account is understated by $1 million. Even though that $1 million is not income, the BBA regulations can classify the adjustment as a “positive adjustment.” Once that happens, the default imputed-underpayment formula may effectively treat the $1 million like taxable income and multiply it by the highest applicable individual or corporate tax rate. Reg. §301.6225-1 generally calculates an imputed underpayment by grouping and netting partnership adjustments and applying the highest rate under §§1 or 11 to the resulting total netted partnership adjustment.
For example, a $1 million positive non-income adjustment exposed to a 37% rate can produce a $370,000 imputed underpayment, even though the partnership did not earn another $1 million of income.
That is the BBA default rule doing exactly what it was designed to do: produce a conservative partnership-level collection amount without first reconstructing every affected partner’s individual tax return. The problem is that the default result can be dramatically different from the actual Chapter 1 tax consequence to the partners.
The “Worst-Case” Default in Plain Language
Think of the default BBA calculation as an IRS shortcut.
Instead of asking:“What tax would each partner actually owe after considering that partner’s basis, deductions, losses, tax-exempt status, rates, and other individual circumstances?”
The default calculation often begins with a much simpler question:“What is the amount of the positive partnership adjustment, and what happens if we apply the highest tax rate to it?”
That shortcut makes administrative sense for a centralized audit regime, but it can produce unusual results with non-income items. Suppose the IRS reallocates $2 million of partnership capital from one partner to another. The partnership did not suddenly earn $2 million. No new cash came in. No sale occurred. No deduction necessarily disappeared. Yet because capital is a non-income partnership-related item, the adjustment can still enter the BBA computational machinery as a positive adjustment.
The distinction is critical: “Positive adjustment” is a BBA computational term. It does not necessarily mean “taxable income.”
A Significant May 2026 IRM Update
On May 8, 2026, the IRS updated IRM 4.31.9, its field-examination procedures for BBA partnership audits. The revised procedures include specific guidance for the Service’s discretion to treat certain adjustments as zero for purposes of computing an imputed underpayment. The underlying regulatory authority is Treas. Reg. §301.6225-1(b)(4). That regulation provides that when the effect of one partnership adjustment is reflected in another partnership adjustment, the IRS may treat one adjustment as zero solely for purposes of computing the imputed underpayment. It also generally permits one of two related positive adjustments to be treated as zero when one is related to or results from the other.
The updated IRM gives Revenue Agents a practical framework for exercising that discretion with non-income adjustments. Most importantly, the IRM instructs examiners that, in appropriate circumstances, they may review a material percentage of the impacted partners and consider whether a second or subsequent positive non-income adjustment would have no effect or only an immaterial effect on the partners’ Chapter 1 tax liability. If so, the examiner may treat that adjustment as zero for purposes of computing the imputed underpayment. That is a meaningful development.
From “Default Tax” to “What Actually Happens to the Partner?”
Consider a simplified example:
An individual contributes $1 million of cash to a partnership. Later, the IRS determines that the capital associated with that contribution should be attributed to a different partner. Under the default BBA calculation, a $1 million positive capital-account adjustment might appear to create: $1,000,000 × 37% = $370,000 imputed underpayment.
But now ask the partner-level question: What actually happens for federal income-tax purposes?
Does the impacted partner have:
$1 million of additional ordinary income? No.
$1 million of recognized gain? No, assuming there is no separate realization event.
A $1 million lost deduction? Not merely because the capital account changed.
A reduction in tax credits? No.
Instead, the principal consequence may simply be an adjustment to a partner-specific tax attribute, such as outside basis. And that distinction matters because the BBA rules themselves separate partnership-related items from partner-specific consequences.
Why This Matters for Revenue Agents
This update should not be viewed as “letting taxpayers off the hook.” Quite the opposite. It gives Revenue Agents a better tool for reaching the right tax result.
A Revenue Agent can still determine that:
a capital account was wrong;
ownership was incorrectly reported;
a liability was improperly allocated; or
another non-income partnership-related item must be corrected.
The partnership return can still be corrected. But the agent is not necessarily forced to conclude that the face amount of every resulting balance-sheet adjustment should be taxed at the highest rate through an imputed underpayment.
The updated IRM provides a path to ask: “After I look at the affected partners, does this particular non-income adjustment actually produce Chapter 1 tax?” If the answer is no, or the effect is immaterial, the agent may have discretion to treat that adjustment as zero for IU purposes, assuming the requirements of the regulation and IRM are otherwise satisfied. That can prevent the BBA default formula from transforming a bookkeeping or tax-attribute correction into an artificial income-equivalent assessment.
What Taxpayers and Representatives Should Do During a BBA Examination
This makes the preliminary examination stage more important. When a Revenue Agent identifies a large positive non-income adjustment, taxpayers should not limit the response to: “We disagree with the imputed underpayment.” Instead, build the partner-level tax analysis, and show the examiner the following:
What is the underlying partnership-related item?
Why is it non-income?
Which partners are actually impacted?
What happens to those partners’ Chapter 1 liability when the adjustment is taken into account?
Does the adjustment create income, gain, a lost deduction, a reduced credit, or merely change a tax attribute?
If the partner-level consequence is zero or immaterial, the May 2026 IRM procedures may give the Revenue Agent a practical way to reconsider the default imputed-underpayment computation before the case ever reaches Appeals or the statutory modification process.
The Bigger Lesson
The BBA regime intentionally uses a conservative default computation. That does not mean every default result is the final answer. The important distinction is: A positive partnership adjustment is not necessarily positive taxable income. For years, non-income adjustments have created some of the strangest results under the BBA regime because a balance-sheet correction can be forced through a formula designed primarily to collect tax efficiently at the partnership level.
The May 8, 2026 IRM update gives Revenue Agents a clearer path to move beyond that mechanical result in appropriate cases. For practitioners, the opportunity is to empower the examiner with the facts and analysis necessary to exercise that discretion. Instead of simply arguing that the default assessment is too harsh, show why the impacted partners’ actual Chapter 1 tax consequences tell a different story. Sometimes the best BBA defense is not proving that the partnership adjustment disappears. It is proving that the tax does.