Accounting
Partnership pitfalls under the centralized partnership audit regime
Six years of the Centralized Partnership Audit Regime have elucidated a central understanding: the Bipartisan Budget Act provisions present plenty of potential pitfalls for partnerships, partnership representatives and the partners. The BBA creates a fictitious partnership level tax, imbues the partnership representative with authoritarian control, threatens to create conflict between partners and overhauls the partnership examination requiring key decisions at various stages of the examination process.
BBA examination overview
BBA examinations begin with a Notice of Administrative Proceeding, which is sent only to the partnership representative, who is appointed by the partnership on a timely filed original return for each tax year and charged with the responsibility of representing the partnership in matters involving the Internal Revenue Service. (The partnership representative does not have to be a partner and can be an entity. In the context of an entity representative, the partnership must appoint a representative of the entity – a designated individual – as the point of contact for the IRS.)
Then the IRS will issue a Notice of Preliminary Partnership Examination Changes that gives the PR the ability to raise any disputes with the proposed changes with the IRS Office of Appeals. Next, the IRS will issue a Notice of Proposed Partnership Adjustment. The NOPPA asserts a fictitious partnership-level tax called the imputed underpayment and starts a 270-day clock during which the partnership, working with the individual partners, can request a modification of the imputed underpayment. After the close of that period, the IRS will issue a Final Partnership Adjustment (FPA) that asserts an imputed underpayment (less any adjustments for modifications) and penalties, if applicable. The FPA also starts both a 45-day clock for making a push-out election and a 90-day clock for filing a suit to challenge the IRS determinations. Only the PR acting on behalf of the partnership can bring an action and may do so in the Tax Court or, after making a deposit of the imputed underpayment, penalties, additions to tax and additional amounts, through the U.S. District Court or Court of Federal Claims.
There are a number of pitfalls in the BBA process, but perhaps the most important are those associated with the PR, which replaced the prior tax matters partner (TMP) under the Tax Equity and Fiscal Responsibility Act (TEFRA) partnership regime.
TMP versus PR
Under TEFRA, the TMP, as representative of the partnership, could only bind the non-notice partners, leaving notice partners with options to fight — even to the point of litigation — on their own. A notice partner was any partner in a partnership with 100 or fewer partners. For partnerships larger than that, notice partners were any partners owning 1% or more of the partnership. Partners who owned less than 1% could form a notice group that collectively owned 5% of the partnership (notice group) to obtain notice partner rights.
Under TEFRA, notice partners could file a petition with the U.S. Tax Court if the TMP failed to bring such an action, intervene in any Tax Court settlement, pay their share of any flow-through adjustments and file a claim for refund (and suit for refund). Notice partners were not inherently bound by the decisions of the TMP.
Pitfall 1: The BBA regime eliminates that individualism, imbuing the PR with complete control over the partnership. Under the BBA, notice partners are no more; only the partnership representative can bring a court action, and no partner has a right to intervene in a settlement or litigation. Individual partners no longer have the ability to pay their share and file a suit for refund. The partnership representative has complete authority to bind the partnership, exposing the partnership and the partners.
Modifications: An opportunity for individualism
The modification process offers a glimpse at TEFRA-era individualism. During the 270-day post-NOPPA period, an individual partner can request a modification by filing amended returns for the tax year under audit (and any other affected tax years) to account for their share of the partnership adjustments. The partner must also pay all taxes, penalties and interest associated with the amendments. Once a modification has been made, the imputed underpayment at the partnership level is reduced by the amount allocated to the individual partner. However, the individual partner cannot later file a second amended return to undo the adjustments until or unless a court determines that the partnership-level adjustments were incorrect.
For partnerships, modifications make sense if there is no defense to the adjustments raised by the NOPPA, the modification reduces the effective tax owed by the partners for those that are tax-exempt entities or the long-term strategy involves filing an action in the District Court or Court of Federal Claims. Modifications may help reduce the amount the partnership has to pay to file an action in those courts. For partners that do not trust the PR, this could be the first point of dissension from the partnership because partnerships and partners must work together to facilitate a modification.
Push-out elections
During the 45-day period starting with the issuance of the FPA, the partnership may elect to push out the partnership adjustments to its partners. Push-out elections push the adjustments to the individual partners on a pro-rata basis. Unlike modifications, push-outs do not require consent from the individual partners.
Push-outs can be beneficial if individual partners have tax attributes that would lower the effective tax rate. For example, for an individual partner with large capital gains or loss carryovers, the adjustment may have a lower tax impact than the maximum individual default rate of 37%. Push-out elections may also be beneficial to partnerships with a large number of disassociated partners. Otherwise, the partnership as a whole is on the hook for the imputed underpayment and may lack the funds to cover that tax, forcing a capital call that may produce mixed results.
Pitfall 2: Push-out elections require an intensive process that carries administrative burdens. If any mistakes are made in that process, the IRS can void the election.
Pitfall 3: If the partnership elects to push out the adjustments, the IRS will increase interest on any balance by an additional 2% over the going rates. This could result in increased exposure for the partner.
Pitfall 4: The individual allocations and additional interest could cause inconsistent results among partners. Unlike modifications, push-outs affect every partner. Situations may arise where a push-out helps a partner with a lower effective tax rate but increases out-of-pocket costs for a partner at a 37% effective rate that now has to contend with 2% additional interest.
Pitfall 5: Push-out elections shift responsibility for the adjustment to the partners that make up the partnership in the adjustment year, which is defined as the year in which the adjustment is finalized (the year the FPA is accepted or the year a court decision becomes final). This creates a situation where a partner in the partnership during the year under audit subsequently sells its partnership interest to another taxpayer and avoids liability while sticking the new partner with a liability from a year when they were not even a partner, creating a disconnect between benefits and burdens associated with the adjustments.
This means that each partnership needs to think about the administrative burdens of trying to collect contributions from each partner to pay the tax, the likelihood of a push-out reducing the collective tax by amounts sufficient to offset the additional 2% interest and the possibility that some partners will be worse off with such a decision while others benefit.
The International Auditing and Assurance Standards Board is proposing to tailor some of its standards to align with recent additions to the International Ethics Standards Board for Accountants’ International Code of Ethics for Professional Accountants when it comes to using the work of an external expert.
The
- ISA 620, Using the Work of an Auditor’s Expert;
- ISRE 2400 (Revised), Engagements to Review Historical Financial Statements;
- ISAE 3000 (Revised), Assurance Engagements Other than Audits or Reviews of Historical Financial Information;
- ISRS 4400 (Revised), Agreed-upon Procedures Engagements.
The IAASB is asking for comments via a digital response template that can be found on the
In December 2023, the IESBA approved an exposure draft for proposed revisions to the IESBA’s Code of Ethics related to using the work of an external expert. The proposals included three new sections to the Code of Ethics, including provisions for professional accountants in public practice; professional accountants in business and sustainability assurance practitioners. The IESBA approved the provisions on using the work of an external expert at its December 2024 meeting, establishing an ethical framework to guide accountants and sustainability assurance practitioners in evaluating whether an external expert has the necessary competence, capabilities and objectivity to use their work, as well as provisions on applying the Ethics Code’s conceptual framework when using the work of an outside expert.
President Donald Trump’s tariffs would effectively cause a tax increase for low-income families that is more than three times higher than what wealthier Americans would pay, according to an
The report from the progressive think tank outlined the outcomes for Americans of all backgrounds if the tariffs currently in effect remain in place next year. Those making $28,600 or less would have to spend 6.2% more of their income due to higher prices, while the richest Americans with income of at least $914,900 are expected to spend 1.7% more. Middle-income families making between $55,100 and $94,100 would pay 5% more of their earnings.
Trump has
Economists have warned that costs from tariff increases would ultimately be passed on to U.S. consumers. And while prices will rise for everyone, lower-income families are expected to lose a larger portion of their budgets because they tend to spend more of their earnings on goods, including food and other necessities, compared to wealthier individuals.
Food prices could rise by 2.6% in the short run due to tariffs, according to an
The Yale Budget Lab projected that the tariffs would result in a loss of $4,700 a year on average for American households.
Artificial intelligence is just getting started in the accounting world, but it is already helping firms like technology specialist
Schellman CEO Avani Desai said there have definitely been some shifts in headcount at the Top 100 Firm, though she stressed it was nothing dramatic, as it mostly reflects natural attrition combined with being more selective with hiring. She said the firm has already made an internal decision to not reduce headcount in force, as that just indicates they didn’t hire properly the first time.
“It hasn’t been about reducing roles but evolving how we do work, so there wasn’t one specific date where we ‘started’ the reduction. It’s been more case by case. We’ve held back on refilling certain roles when we saw opportunities to streamline, especially with the use of new technologies like AI,” she said.
One area where the firm has found such opportunities has been in the testing of certain cybersecurity controls, particularly within the SOC framework. The firm examined all the controls it tests on the service side and asked which ones require human judgment or deep expertise. The answer was a lot of them. But for the ones that don’t, AI algorithms have been able to significantly lighten the load.
“[If] we don’t refill a role, it’s because the need actually has changed, or the process has improved so significantly [that] the workload is lighter or shared across the smarter system. So that’s what’s happening,” said Desai.
Outside of client services like SOC control testing and reporting, the firm has found efficiencies in administrative functions as well as certain internal operational processes. On the latter point, Desai noted that Schellman’s engineers, including the chief information officer, have been using AI to help develop code, which means they’re not relying as much on outside expertise on the internal service delivery side of things. There are still people in the development process, but their roles are changing: They’re writing less code, and doing more reviewing of code before it gets pushed into production, saving time and creating efficiencies.
“The best way for me to say this is, to us, this has been intentional. We paused hiring in a few areas where we saw overlaps, where technology was really working,” said Desai.
However, even in an age awash with AI, Schellman acknowledges there are certain jobs that need a human, at least for now. For example, the firm does assessments for the FedRAMP program, which is needed for cloud service providers to contract with certain government agencies. These assessments, even in the most stable of times, can be long and complex engagements, to say nothing of the less predictable nature of the current government. As such, it does not make as much sense to reduce human staff in this area.
“The way it is right now for us to do FedRAMP engagements, it’s a very manual process. There’s a lot of back and forth between us and a third party, the government, and we don’t see a lot of overall application or technology help… We’re in the federal space and you can imagine, [with] what’s going on right now, there’s a big changing market condition for clients and their pricing pressure,” said Desai.
As Schellman reduces staff levels in some places, it is increasing them in others. Desai said the firm is actively hiring in certain areas. In particular, it’s adding staff in technical cybersecurity (e.g., penetration testers), the aforementioned FedRAMP engagements, AI assessment (in line with recently becoming an ISO 42001 certification body) and in some client-facing roles like marketing and sales.
“So, to me, this isn’t about doing more with less … It’s about doing more of the right things with the right people,” said Desai.
While these moves have resulted in savings, she said that was never really the point, so whatever the firm has saved from staffing efficiencies it has reinvested in its tech stack to build its service line further. When asked for an example, she said the firm would like to focus more on penetration testing by building a SaaS tool for it. While Schellman has a proof of concept developed, she noted it would take a lot of money and time to deploy a full solution — both of which the firm now has more of because of its efficiency moves.
“What is the ‘why’ behind these decisions? The ‘why’ for us isn’t what I think you traditionally see, which is ‘We need to get profitability high. We need to have less people do more things.’ That’s not what it is like,” said Desai. “I want to be able to focus on quality. And the only way I think I can focus on quality is if my people are not focusing on things that don’t matter … I feel like I’m in a much better place because the smart people that I’ve hired are working on the riskiest and most complicated things.”
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