Why Does the Partnership Pay the Tax? The History Behind the BBA Audit Regime
By Cody Heimerdinger, CPA, Director
Partnerships generally do not pay federal income tax. Instead, they are pass-through entities: partnership income, deductions, gains, losses, and credits flow through to the partners, who report those items on their own tax returns. So one of the strangest features of the modern centralized partnership audit regime is this:
Why can the IRS assess and collect tax directly from the partnership?
The Problem Behind the BBA
The answer is largely historical. The Bipartisan Budget Act of 2015, or “BBA,” was not simply a rewrite of partnership audit procedure. It was Congress’s response to a longstanding administrative problem: partnership tax issues could be determined centrally, but collecting the resulting tax from the correct partners could become extraordinarily difficult.
Before BBA: More Than One Partnership Audit System
Before the BBA regime became effective, partnership audits could fall under several different procedural systems.
The Joint Committee on Taxation explained that, under prior law, larger partnerships generally operated under the TEFRA unified audit rules enacted in 1982, while certain partnerships with more than 100 partners could elect into a separate large-partnership audit regime enacted in 1997.
Smaller partnerships that did not fall within those systems could instead be subject to ordinary partner-level deficiency procedures. That meant the tax law had multiple procedural systems operating side by side. The reason those systems evolved becomes clearer when we look at the problem Congress was trying to solve.
TEFRA Solved One Problem: Determining Partnership Items Once
Before unified partnership audit procedures, the IRS could be forced to address the same partnership issue repeatedly at the individual partner level.
TEFRA changed that by allowing partnership items to be determined in a unified partnership-level proceeding. That reduced duplication, inconsistent results, and repeated litigation over the same underlying partnership issue. Under TEFRA, the IRS could determine the correct treatment of a partnership item once and bind the affected partners to that determination. That was a major administrative improvement. But TEFRA did not fully solve the next question:
Once the partnership adjustment is determined, who actually pays the resulting tax?
Under TEFRA, the additional tax generally still had to be assessed against the partners who were partners in the year the understatement arose. The Joint Committee noted that the additional tax attributable to partnership-level adjustments was assessed against the individual taxpayers who were partners in the relevant year.
That distinction is important. TEFRA centralized the determination of partnership items. It did not fully centralize the assessment and collection of the resulting tax.
Why Large Partnerships Became a Bigger Problem
Congress revisited the issue in 1997 when it created the elective large-partnership audit regime. The stated rationale is remarkably direct. The Joint Committee explained that large-partnership audit procedures were considered inefficient because the IRS had to assess deficiencies against large numbers of partners, some of whom could be difficult to locate and some of whom might no longer even be partners. It also noted that audits could become more cumbersome when partners intervened individually.
That is the core administrative problem. Imagine an IRS audit of a partnership with hundreds or thousands of partners, multiple ownership changes, and several tiers of pass-through entities. Even if the IRS successfully determines the correct partnership adjustment, it may still need to determine:
- Who the reviewed-year partners were
- How much of the adjustment belonged to each partner
- Whether any of those partners were themselves partnerships
- Who owned those lower-tier partnerships
- What tax attributes were affected
- And how much tax each ultimate taxpayer actually owed.
That can become a much larger project than the original partnership audit itself. The 1997 rules attempted to simplify that process for electing large partnerships.
They also allowed a partnership, in certain cases, to pay an imputed underpayment instead of pushing adjustments through to partners. But there was a practical problem: the regime was elective, and the Joint Committee noted that relatively few partnerships elected into it.
BBA Changed the Default
The BBA took a much more aggressive approach. Rather than maintaining multiple partnership audit systems, Congress repealed the TEFRA and electing-large-partnership regimes and replaced them with a centralized system for partnership audit, adjustment, assessment, and collection. That final word, collection, is what makes BBA fundamentally different.
Under the centralized regime, partnership items are generally determined at the partnership level, and any tax attributable to those adjustments is generally assessed and collected at the partnership level as an “imputed underpayment.” In other words, Congress effectively changed the default from:
“Determine the partnership adjustment, then chase the partners for the tax”
to:
“Determine the partnership adjustment, then collect the tax from the partnership.”
That is why the partnership can end up paying tax even though it normally functions as a pass-through entity.
The Imputed Underpayment Is an Administrative Shortcut
The imputed underpayment is not necessarily intended to replicate the exact aggregate tax that every partner would have owed had the adjustment originally been reported correctly.
Instead, it is a centralized collection mechanism. The Joint Committee described the imputed underpayment as being generally determined by netting partnership adjustments and applying the highest applicable federal income tax rate. That approach favors administrative efficiency. The IRS does not initially need to reconstruct the exact individual tax situation of every reviewed-year partner.
But Congress also recognized that this default calculation could overstate the actual tax, which is why the statute includes alternatives. And this is where the BBA starts to feel a little like a tax version of the classic “Would You Rather?” party game: would you rather pursue modification and potentially reduce the imputed underpayment before the FPA, or elect push-out and move the tax consequences back to the reviewed-year partners—while accepting the additional interest premium and future reporting obligations? Thanks, Congress, for inviting partnerships to this party.
Modification and Push-Out Are the Pressure-Relief Valves
The BBA regime allows a partnership to seek modification of the imputed underpayment by providing information about the tax status of partners, the character of items, amended partner returns, or other relevant facts. The regime also allows the partnership to elect an alternative under §6226, often referred to as the “push-out” election. Under that approach, reviewed-year partners receive statements reflecting their share of the adjustments and take the resulting tax consequences into account themselves.
So, the BBA architecture can be understood as three layers:
- Default: The partnership pays the imputed underpayment.
- Modification: The partnership demonstrates that the default amount should be reduced.
- Push-out: The partnership shifts the tax consequences back to the reviewed-year partners.
Seen through that lens, the system starts to make more sense.
Why This History Matters
Understanding the history of partnership audit rules helps explain why the BBA can sometimes produce results that initially seem counterintuitive.
The statute was designed around an administrative concern: the government wanted a practical way to assess and collect tax arising from partnership adjustments without having to trace every adjustment through every partner and every tier. That explains why the default rule places the burden on the partnership. It also explains why modification and push-out are very much so important.
Those mechanisms are not side issues. They are the tools Congress provided to reconcile the administratively convenient default with the actual tax consequences to the partners. And that distinction becomes especially important when a partnership adjustment is positive on paper but does not necessarily create additional Chapter 1 tax. In those cases, the real question is not simply:
Was there a positive partnership adjustment?
It may be:
Did that adjustment actually produce additional federal income tax, and if so, who should pay it?
That is where the BBA regime moves from procedural mechanics into strategy. And, as anyone who has spent a full day reading §§6221 through 6241 can confirm, there is no shortage of strategy hiding in those pages.