Tiered partnerships and pass-through partners under the BBA

Who is a pass-through partner

Appeals guidance defines a pass-through partner as a pass-through entity holding an interest in the partnership, and “A pass-through entity is a partnership, an S corporation, a trust (other than a grantor trust), and a decedent's estate.” The Form 8985 instructions exclude disregarded entities and trusts wholly owned by one person. A person holding an interest through one or more pass-through partners is an indirect partner.

The Form 8985 instructions add a nuance for trusts, estates and similar entities: “An entity partner can be both a non-pass-through partner and a pass-through partner.” Adjustments taxed at the entity level are reported on Form 8978 with the entity's return; adjustments that flow to its owners or beneficiaries follow the pass-through rules (Form 8986 instructions).

The two options when a Form 8986 arrives

IRC 6226(b)(4)(A) gives a partnership or S corporation that receives a push-out statement two choices, and in either case it must file a partnership adjustment tracking report, which is Form 8985:

The IRS's audit page summarizes the deadline and the default: pass-through partners that do not push the adjustments out by the extended due date of the audited partnership's adjustment-year return “must compute and pay an imputed underpayment (IU) calculated on the adjustments contained in the push out statement it received”.

The deadline: extended due date

The statute sets it: “the partnership adjustment tracking report shall be filed, and the imputed underpayment shall be paid or statements shall be furnished, not later than the due date for the return for the adjustment year of the audited partnership.” (IRC 6226(b)(4)(B)). The regulation uses the extended due date: “For purposes of this section, the extended due date is the extended due date under section 6081 regardless of whether the audited partnership is required to file a return for the adjustment year or timely files a request for an extension under section 6081.” The date appears in Part II, item F, of the Form 8986 the tier received.

The Form 8985 instructions' example: an audited partnership furnishes Forms 8986 on October 12, 2027 for a 2024 reviewed year; the extended due date of its 2027 return is September 15, 2028, so a partnership-partner that received a Form 8986 must push out or pay by September 15, 2028. Corrections to a timely Form 8985 can be made within 60 days of the due date without IRS permission.

The deadline is independent of the tier's own tax year and of how far down the chain it sits; every tier in the chain works against the same date. Lower tiers therefore have less time, because the upper tier's statements reach them only after it acts.

Computing and paying an IU at the tier

A tier that pays computes the IU the way the IRS does under Treas. Reg. 301.6225-1, treating all adjustments on the Form 8986 it received as partnership adjustments for its first affected year (the tier's year that includes the end of the audited partnership's reviewed year). Approved modifications involving the tier's partners from the audited partnership's modification process are taken into account. Adjustments that do not result in an IU are taken into account by the tier in the year that includes the payment date (Form 8985 instructions).

Penalties are computed by treating the amounts as IUs for the first affected year, using the penalty information on the Form 8986. Interest runs from the due date of the tier's first-affected-year return, compounded daily, at the IRC 6621(a)(2) underpayment rate with 5 percentage points substituted for 3, for audit push-outs (Form 8985 instructions). A tier that pays should not issue Forms 8986 for the paid adjustments but still completes Part IV of Form 8985.

Payment goes by EFTPS or card under the type BBA Exam Push Out, or by check with Form 8985-V mailed to Ogden, UT 84201-0011 (IRS audit page; IRM 5.19.27.2 lists it as designated payment code 74). Form 8985 is then submitted electronically.

Pushing out further

A tier that pushes out furnishes a Form 8986 to each affected partner and files Form 8985 with all of them. Its own partnerships, S corporations and trusts then face the same choice, by the same extended due date. Individual and C corporation partners at the bottom report their shares on Form 8978 for the reporting year that includes the date they were furnished the statement. Audited BBA partnerships and their pass-through partners must submit Forms 8985 and 8986 electronically (Form 8985 instructions); see Forms 8985 and 8986.

If the tier's PR or DI has changed, a Form 8979 for an audit push-out is faxed separately to 888-981-6982, with a statement in Part V of the electronically filed Form 8985 giving the fax date (Form 8985 instructions).

Tiers receiving statements from an AAR

When the source is an AAR rather than an audit, the options are the same with three differences. Adjustments that do not result in an IU must always be pushed out, even if the tier pays an IU on the rest. “Pass-through partners of an AAR partnership cannot include modifications in the calculation.” Interest for a tier paying on an AAR uses the IRC 6621(a)(2) rate without the substitution. And submission is by fax to 888-981-6982 for packages of 100 pages or less, otherwise by mail to the Ogden M/S 4705 address (IRS AAR page). See administrative adjustment requests.

Tiers in modification, elections out and consistency

Modification. IRC 6225(c)(2)(F) lets a relevant partner anywhere in the chain file a modification amended return or use the alternative procedure if the required information is furnished and, to the extent required, each partnership in between complies. An S corporation and its shareholders are treated like a partnership and its partners. Partnership-partners file modification amended returns on Form 1065-X. See modification requests.

Elections out. A partnership with a partnership partner cannot elect out (Treas. Reg. 301.6221(b)-1(b)(3)(ii)(A)). A partnership that does elect out still answers for its interests in BBA partnerships: “The fact that a partnership has made an election under this section does not affect whether the provisions of subchapter C of chapter 63 apply to any other partnership, including a partnership in which the partnership making the election is a partner.” IRC 6226(b)(4)(C) applies the tracking report rules to it notwithstanding its election.

Consistency. “The consistency principle applies to all pass-through partners.” A BBA partnership-partner that reports inconsistently can be assessed an IU through math error procedures under IRC 6232(d)(1)(B), which is not an FPA and cannot be petitioned; a partnership-partner can cure the inconsistency within 60 days of notice by filing an AAR, or an amended return if not subject to BBA (IRM 4.31.9.8.2 and 4.31.9.8.2.3).

What happens if a tier does not act

Failing to comply with IRC 6226(b)(4)(A)(ii) is a special enforcement matter under IRC 6241(11)(B)(i). Treas. Reg. 301.6226-3(e) says a tier that fails to timely file and furnish correct statements must compute and pay an IU, and the IRS may assess it without the usual restrictions of IRC 6232(b). The IRS's page warns: “If the Pass-through partner does not further push out the adjustments or submit Form 8985 by the extended due date, the IRS may calculate the imputed underpayment and mail a balance due notice to the entity.”

BBA Operations starts completeness checks within 60 days after the extended due date, compares filings to the chain-of-ownership report, and sends Letter 6210 with a computed IU statement to tiers that did not file (IRM 4.31.13.11.4). A package that is not timely is rejected, and the tier is assessed the IU on the adjustments it received plus its share of penalties (IRM 4.31.13.11.3). Because Form 8985 is treated as a return for IRC 6501(a), a tier that never files it has no limitation period for its share of the IU (IRM 4.31.13.5.1). If the tier does not pay, IRC 6232(f) can reach its own partners; see collection and partner liability.

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