The Push-Out Election Under IRC Section 6226: Shifting a BBA Audit to the Partners

The audit is over, the IRS has issued its final notice, and the partnership owes an imputed underpayment at the top tax rate. The partners who are there now did not earn the income. The partners who did are long gone. Is the partnership stuck paying?

Not necessarily. IRC Section 6226 lets the partnership elect to push the adjustments out to the people who were partners in the year under audit. But the election has a 45-day window that cannot be extended, and the statements that follow have their own hard deadlines.

What the push-out election does

Under IRC 6226(a), if the partnership timely elects and furnishes the required statements, IRC 6225 does not apply to that imputed underpayment. The statute adds that no assessment, levy, or court collection proceeding for the underpayment may be made against the partnership. Each reviewed year partner takes his or her share of the adjustments into account instead.

Treas. Reg. 301.6226-1(b) confirms that the reviewed year partners become liable for the resulting tax, penalties, additions to tax, and interest. If a final notice contains more than one imputed underpayment, the partnership may elect for one or more of them.

If you need the background first, read our guides to the BBA partnership audit regime and the imputed underpayment.

The 45-day deadline

The election must be made no later than 45 days after the date of the notice of final partnership adjustment (FPA). Treas. Reg. 301.6226-1(c)(2) states flatly that the time may not be extended. The IRS's audit process page says the same thing.

The 45 days start on the FPA date, the same date that starts the 90-day window to petition a court under IRC 6234. Under Treas. Reg. 301.6226-1(f), electing push-out does not prevent the partnership from also filing a petition. You do not have to choose between pushing out and fighting.

How to make the election

According to the IRS, the partnership representative makes the election on Form 8988, the form for electing the alternative to payment of the imputed underpayment under IRC Section 6226. Under Treas. Reg. 301.6226-1(c)(3), it must be signed by the partnership representative and must include:

• The partnership's name, address, and TIN
• The taxable year involved
• A copy of the FPA
• If the FPA has more than one imputed underpayment, which one the election covers
• The name and TIN of each reviewed year partner
• The current or last known address of each reviewed year partner

Once made, the election can be revoked only with IRS consent under IRC 6226(a).

The partner statements: Forms 8986 and 8985

Electing is only half the job. The partnership must also furnish each reviewed year partner a statement of the partner's share of the adjustments and file those statements with the IRS.

Under Treas. Reg. 301.6226-2(b) and (c), the statements are due no later than 60 days after the adjustments are finally determined. Adjustments are finally determined when the time to petition a court expires, or, if a petition is filed, when the court's decision becomes final. The statements must be filed with the IRS electronically, with a transmittal.

The IRS identifies the forms:

• Form 8986, Partner's Share of Adjustment(s) to Partnership-Related Item(s), furnished to each reviewed year partner.
• Form 8985, Pass-Through Statement, Transmittal/Partnership Adjustment Tracking Report, which the partnership representative submits electronically with the Forms 8986.

The IRS says the 60-day period cannot be extended. A failure to furnish a correct statement is subject to penalty under IRC 6722, according to Treas. Reg. 301.6226-2(a).

Each statement must show the partner's share of items as originally reported, the partner's share of the adjustments, any approved modifications, any penalties determined at the partnership level with the Code section and rate, the date furnished, and the year involved. Adjustments are generally allocated the same way the original items were allocated on the reviewed year return.

Find your former partners

If a statement is mailed and comes back undeliverable, Treas. Reg. 301.6226-2(b)(2) requires the partnership to use reasonable diligence to find a correct address. The regulation's example shows that a partnership that skips that diligence has not properly furnished the statement. Keep current contact information for departing partners.

What the partners do with the statement

A partner who receives Form 8986 does not amend the reviewed year return. Under IRC 6226(b) and Treas. Reg. 301.6226-3(a), the partner's tax for the "reporting year," the year that includes the date the statement was furnished, is increased (or decreased) by the aggregate of correction amounts. Those correction amounts are:

• The change in tax for the partner's year that includes the end of the reviewed year, as if the adjustments had been reported then, and
• The change in tax for each later year through the reporting year caused by the resulting changes in tax attributes, such as carryforwards or basis.

The IRS says partners use Form 8978, Partner's Additional Reporting Year Tax, to calculate the effect and include it with the return for the year that includes the date the partnership furnished Form 8986.

Under Treas. Reg. 301.6226-1(e), the statement binds the partner. A partner may not report the items inconsistently with the statement filed with the IRS.

The cost of pushing out: higher interest

This is the trade-off. Under IRC 6226(c)(2), interest on pushed-out adjustments is determined at the partner level, runs from the due date of the return for the year the increase relates to, and is computed at the underpayment rate with 5 percentage points substituted for 3 in IRC 6621(a)(2)(B). That is two percentage points above the normal underpayment rate.

Penalties stay at the partnership level for purposes of deciding whether they apply, under IRC 6226(c)(1), but the reviewed year partners are liable for them. Treas. Reg. 301.6226-3(d) has each partner compute the penalty amount based on his or her own facts. A partner who wants to raise a partner-level defense must first pay the penalty and then file a claim for refund for the reporting year.

Paying versus pushing out

Issue	Partnership pays (IRC 6225)	Push-out (IRC 6226)
Who is liable	The partnership, so adjustment year owners bear the cost	Reviewed year partners
Tax rate	Highest rate for the reviewed year, unless modified	Each partner's own rates and tax attributes
Interest rate	Regular underpayment rate under IRC 6233	Underpayment rate plus 2 percentage points
Deadline	No election needed; the IRS assesses the partnership	Elect within 45 days of FPA; statements within 60 days of final determination
Administrative work	One payment	Statements to every reviewed year partner, filed electronically

Push-out often makes sense when ownership has changed since the reviewed year, when partners have losses or lower rates that the imputed underpayment ignores, or when the partnership cannot afford the payment. Paying may make more sense when the ownership has not changed and the partners' actual rates are near the top rate.

Tiered partnerships and S corporations

If a reviewed year partner is itself a partnership or S corporation, IRC 6226(b)(4) requires it to file a partnership adjustment tracking report and either push the adjustments further up the chain or compute and pay an imputed underpayment itself. That must be done by the due date of the audited partnership's return for the adjustment year. Under IRC 6226(b)(4)(C), this applies even if the upper-tier partnership elected out of BBA for its own year.

If the election is invalid

Treas. Reg. 301.6226-1(d) allows the IRS to find an election invalid without first giving the partnership a chance to fix it. If that happens, IRC 6225 applies as though the election were never made, and the IRS may assess the imputed underpayment against the partnership without waiting for the usual restrictions in IRC 6232(b) to lift. The IRS cannot invalidate an election based on errors the partnership timely corrected under Treas. Reg. 301.6226-2(d).

The partnership also remains responsible under Treas. Reg. 301.6226-2(g)(4) for any chapter 1 taxes and penalties it owes directly when it furnishes the statements.

Plan before the FPA

• Decide early, during the 270-day modification window after the NOPPA, whether push-out is likely. See our guide to modifications.
• Collect names, TINs, and addresses for every reviewed year partner.
• Check what the partnership agreement says about push-out and who decides.
• Confirm who the partnership representative is for that year and that he or she will sign on time.

The push-out election puts the tax back where it would have been, on the people who earned the income, but the window is 45 days and the IRS will not wait. If your partnership has received an FPA or expects one, call the Law Offices of Darrin T. Mish, P.A. in Tampa, Florida at 813-229-7100.