In the U.S., the Internal Revenue Service (IRS) can audit partnerships at the entity level, rather than auditing each individual partner. This process is made possible by the Bipartisan Budget Act of 2015 (BBA), and it can help partnerships to improve their efficiency and streamline tax compliance.
But what triggers a partnership audit by the IRS, and what happens if the IRS decides the partnership has failed to pay enough tax? Below, our tax attorneys break down the IRS partnership audit process so you’re clear on what to expect if you capture IRS interest and how you might respond to proposed payment adjustments.
What Is an IRS Partnership Audit?
An IRS partnership audit allows the IRS to collect taxes from partnerships directly, rather than auditing individual partners.
Why would the IRS choose to audit partnerships this way? Well, for the IRS, it’s essentially easier to focus on auditing the entity as a whole, especially if there are multiple partners. But it also allows them to use AI tools, and algorithms, to detect potential compliance issues more readily. This reduces the likelihood of partnerships, especially large partnerships with complex structures or high-value transactions, underpaying tax.
- This centralized audit regime, enacted by the BBA, applies to tax years commencing after December 31, 2017.
- If the audit identifies possible tax owed, the IRS calculates what’s known as an “imputed underpayment”, or IU.
- The partnership, rather than individual partners, is liable for any underpaid tax owed.
- The IRS does not negotiate with each individual partner. Instead, it communicates with one individual, known as the partnership representative.
What Triggers a Partnership Audit By the IRS?
IRS partnership audits are more likely to affect larger partnerships (those with over 100 partners) or partnerships of any size with reporting discrepancies including:
- Confusing business and personal expenses
- Reporting errors or inconsistencies
- Significant reported losses
- Foreign transactions
- Crypto transactions
- Unreported income
- Missing forms e.g. missing K-1s
That being said, selection can be entirely random or based on minor data-matching issues, so any partnership could face a formal IRS audit.
Can Partnerships Opt Out of IRS Partnership Audits?
Possibly, yes. It depends on the partnership’s eligibility. Partnerships may elect out of IRS partnership audits for the taxable year if they have 100 or fewer partners and the partners are eligible partners:
- C corps
- Individuals
- C corporations
- Foreign entities treated as a C corporation if it was a domestic company
- S corps
- Deceased partner estates
Gordon Law attorneys can help you determine if opting out is possible, or even desirable, for your partnership.
Who Is the Partnership Representative?
Think of the partnership representative as the voice of the partnership. They are solely responsible for guiding the partnership through the IRS audit, from the moment you receive notification that an audit is imminent, to finalizing any adjustments.
- The representative has sole authority to act on the partnership’s behalf.
- The partnership representative can take various actions, including entering a settlement agreement, disputing proposed adjustments, and extending the time limit for making agreed adjustments.
- Under the BBA, partners are bound by the representative’s actions and decisions.
- To be eligible for appointment, the representative must have a substantial US presence e.g. have a US address, telephone number, and tax identification number.
- Appointments only last for one taxable year. Meaning, the representative must be selected and appointed annually.
Given the power and responsibility the representative has, it’s crucial they have the knowledge and experience to make effective decisions, which is where the Gordon Law tax attorneys can help. Our experienced team will always act in your partnership’s best interests.
The IRS Partnership Audit Process
Helpfully, every IRS partnership audit typically follows the same timeline. The key stages to an IRS partnership audit are as follows:
- Initial Notice of Examination: The IRS issues a Letter 2205-D to the partnership, confirming that the IRS has selected its return for an audit. You should select a partnership representative at this point if you have not done so––more on this below.
- Notice of Administrative Proceeding (NAP): Around 30 days later, the IRS issues a Letter 5893 or Letter 5893-A, called the “Notice of Administrative Proceeding”. This notice signals the start of the audit process.
- Summary Report: The IRS sends the partnership representative a summary report, or initial overview, of its findings. These are only preliminary findings and the representative may have the right to appeal any proposed tax adjustments at this stage.
- Notice of Proposed Partnership Adjustments (NOPPA): Next comes the Notice of Proposed Partnership Adjustments (NOPPA) which is a more detailed summary of IRS findings. It breaks down proposed underpayments and how they are calculated, but don’t worry––again, this is not a final calculation. It’s still possible to challenge the IRS calculations.
- Final Partnership Adjustment: This is the final tax calculation and concludes the IRS partnership audit. We reach this stage when the representative either agrees with the IRS initial findings or makes a successful challenge, such as negotiating payment adjustments or correcting minor errors rather than submitting a new return.
What Is a Notice of Proposed Partnership Adjustments?
Issued under section 6231 of the Internal Revenue Code, the Notice of Proposed Partnership Adjustments, or NOPPA, is confirmation of the initial audit findings. It’s issued to the partnership, and the representative, once the initial audit is complete.
The NOPPA itself includes the following key information:
- Alleged imputed underpayment (IU) i.e. the amount the partnership has underpaid
- Explanation of the calculation
- Proposed adjustments i.e. the amount the partnership must pay to make up for underpaid tax, based on changes to e.g. income, partner allocations, credits, or deductions
- Options for how to respond to the NOPPA, including the appeals process
The NOPPA is not the final word—it’s merely the first real opportunity for the representative to engage with the IRS and determine whether the proposals are fair or if, after more scrutiny, they should be challenged. So, don’t worry if you receive a NOPPA. The partnership is not yet obligated to make the proposed adjustments.
Options for Responding to an IRS NOPPA
There are four main options for responding to a NOPPA once received:
- Agreement: The partnership does not contest the findings which are then finalized.
- Administrative Adjustment Request (AAR): Filing an administrative adjustment request (AAR) allows the partnership to correct discrepancies rather than filing a full amended tax return. Should the IRS reject the request, your Gordon Law tax attorney can advise you on next steps.
- Push Out: The representative can elect to push out liability to individual partners. Each partner is then responsible for paying their respective share—not the partnership.
- Appeal: If the partnership representative disagrees with the NOPPA proposals and IRS findings, they can appeal to the IRS Office of Appeals, or U.S. Tax Court. The appeal must clearly state why the IRS findings are incorrect. The Appeals Office may attempt to settle the case prior to any Appeals Conference; however, you should seek legal advice before agreeing a settlement and potentially paying more than necessary.
In most cases, regardless of the chosen response, partnerships have 270 days from the NOPPA date to respond. Without a response, the IRS will simply go ahead and apply the proposed adjustments.
Should you appoint a Gordon Law tax attorney as your partnership representative, we’ll explain the options and which decision we believe is in the partnership’s best interests. We will ensure we have the evidence required to submit an appeals request, should this be considered the best way forward.
How Can Partnerships Avoid an IRS Partnership Audit?
There’s never a guarantee that a partnership can avoid IRS audit selection. However, partnerships can reduce the likelihood of being selected for an IRS partnership audit by taking the following steps:
- Review Reporting Practices: The IRS uses complex AI tools to identify reporting discrepancies. Audit your own reporting practices so you might identify, in advance, discrepancies likely to trigger an audit.
- Streamline Your Structure: Complex partnership arrangements can put the IRS on alert. The Gordon Law tax attorneys can help identify ways to streamline your business structure and simplify reporting requirements. You may also consider changing your partnership agreement specifically to address BBA rules.
- Assess Data Accuracy: Seemingly minor errors can trigger IRS scrutiny. Double-check all data for consistency, especially if you operate across jurisdictions.
- Always Be Proactive: Know your desired partnership representative, stay ahead of your filing deadlines, and contact our tax attorneys with any concerns you have before a small issue leads to potential penalties—these are likely to invite IRS interest.
As your partnership representative, Gordon Law will help you plan for the future to reduce the likelihood of IRS auditing or to at least reduce its impact on your operations.
Do You Need a Tax Attorney to Handle IRS Partnership Audits?
Of course, every partnership can manage its own tax returns with the IRS. However, it’s crucial to consider how having tax attorneys from Gordon Law on your side can help:
- Planning: We will evaluate the proposed adjustments and explain the options for moving forward, based on the partnership’s overall financial position and objectives. We can also identify any errors or inconstancies and how best to remedy them.
- Advice: Our team is always happy to answer questions the partners have regarding the auditing process to provide confidence and peace of mind every step of the way.
- Compliance: Our attorneys can ensure your partnership complies with documentation requirements and any applicable deadlines.
- Support: Not only can we help you respond to IRS proposals, but we can negotiate with the IRS on your behalf to potentially reduce any applicable penalties. We can also support you through any appeals process to the tax court.
As your partnership representative, we will handle the entire IRS partnership audit on your behalf, allowing you to focus on building your business and pursuing your commercial goals.
Need Help Handling an IRS Partnership Audit? Contact Gordon Law Today!
The IRS will not hesitate to use every power at its disposal to increase your partnership’s tax liability. The effectiveness of the negotiations between your tax representative and the IRS is critical to securing the best possible outcome. And that’s where the Gordon Law team can help.
As experienced tax attorneys, we will use our knowledge of IRS procedures, and our understanding of your partnership goals, to help you reduce your tax liability or challenge proposed adjustments. To learn more about our IRS tax services, and to explore your options for handling IRS partnership adjustments and avoiding tax debt, give us a call or reach out to the team online.
