The Centralized Partnership Audit Regime (CPAR), established by the Bipartisan Budget Act of 2015 and effective since 2018, changed how the IRS audits partnership tax returns. Under CPAR, the IRS audits the partnership as a whole and assesses any resulting tax adjustments directly to the partnership, simplifying audit enforcement but potentially creating significant upfront tax liabilities for partnerships.
However, eligible partnerships can choose to opt out of this centralized audit system to maintain the traditional approach, where each partner is audited individually. This opt-out provision is designed for smaller partnerships that prefer direct partner-level audits rather than entity-level adjustments.
Eligibility Criteria for Opting Out
To qualify for the opt-out, a partnership must meet these key conditions:
- Have 100 or fewer eligible partners. Eligible partners include individuals, C corporations, S corporations, and estates with valid taxpayer identification numbers.
- Exclude ineligible partners such as other partnerships, trusts, or foreign entities, as their presence can disqualify the opt-out.
- Provide the IRS annually with a complete list of all partners’ names, addresses, and Taxpayer Identification Numbers (TINs).
- File an opt-out statement with its annual tax return, formally declaring the election to avoid the centralized audit regime.
How the Opt-Out Changes the Audit Process
When a partnership opts out, the IRS must examine each partner’s tax return separately in the event of an audit, rather than auditing the partnership’s return entity-wide. This shifts the responsibility for any tax deficiency or adjustments directly to the partners instead of the partnership, potentially avoiding large lump-sum payments from the partnership itself.
While this can be advantageous for partnerships that want to avoid having to pay additional taxes collectively, it can also mean more complicated and prolonged IRS examinations for individual partners. Partners remain individually liable for resulting tax deficiencies, penalties, and interest.
Practical Example
Consider a partnership named Community Consulting with 50 individual partners. Because it has fewer than 100 eligible partners and properly submits the required partner information to the IRS annually, it chooses to opt out. If audited, the IRS will examine each partner’s personal tax returns separately instead of conducting one centralized audit of the entire partnership. This approach may better suit small partnerships wanting to avoid a large, consolidated tax adjustment at the entity level.
Important Considerations and Common Pitfalls
- Partnerships that exceed 100 eligible partners during the taxable year lose the ability to opt out for that year and must undergo the centralized audit process.
- Failing to timely provide the IRS with complete partner information or neglecting to file the opt-out election statement results in automatic application of CPAR audits.
- Opting out does not necessarily make audits simpler; instead, it transfers audit complexity from the partnership to individual partners.
Strategic Considerations
Partnerships with a limited number of mostly individual or corporate partners may find the opt-out favorable, especially if they want to avoid having to pay substantial tax liabilities collectively upfront. However, continued compliance with filing and disclosure requirements is critical to maintain eligibility.
Tax professionals often recommend consulting with a qualified tax advisor to evaluate which audit regime aligns best with a partnership’s specific circumstances, long-term financial implications, and administrative capacity.
Summary Table of Opt-Out Eligibility
| Criteria | Requirement |
|---|---|
| Number of partners | 100 or fewer |
| Eligible partners | Individuals, C corporations, S corporations, estates |
| Partner info submitted to IRS | Annually, with names, addresses, and TINs |
| Opt-out statement filed | With each annual tax return |
For more detailed information, review the official IRS guidance on Partnership Audit Procedures and the Bipartisan Budget Act of 2015.
Additionally, explore our in-depth glossary entry on the broader Centralized Partnership Audit Regime to understand the overall audit framework affecting partnerships.
Choosing the appropriate audit treatment can significantly impact a partnership’s tax risk, financial obligations, and administrative burden. Therefore, professional guidance is essential to make informed decisions.