The Overlooked Importance of Schedule B in Partnership Audits

Why Every Partnership Needs to Pay Attention to Audit Rules

As a CPA working with businesses, I often see partnership tax returns filed without much scrutiny given to Schedule B, which contains crucial questions about the audit regime under the Bipartisan Budget Act (BBA) of 2015. Many tax preparers rush through it, checking boxes without considering the long-term implications for the partnership and its partners.

This oversight can lead to unexpected liabilities, compliance risks, and financial consequences for partners, especially in the event of an IRS audit.

What Is Schedule B and Why Does It Matter?

Schedule B (Form 1065) contains key elections and representations about the partnership’s audit regime. The most critical question revolves around whether the partnership:

1. Elects out of the Centralized Partnership Audit Regime (CPAR)
2. Is subject to the default BBA audit rules

Under the BBA framework, if the IRS audits a partnership and finds adjustments, the partnership itself may be responsible for the tax liability—not the individual partners. This could be costly if current partners bear the burden of prior partners’ tax adjustments.

Key Issues Tax Preparers Often Overlook

1. The 100-Partner Rule for Opting Out of CPAR

Partnerships with 100 or fewer eligible partners can elect out of the centralized audit regime, but many fail to do so because tax preparers either:

• Don’t check the eligibility criteria properly
• Leave it blank, assuming it’s irrelevant
• Fail to advise clients on the implications of opting in vs. opting out

Electing out forces the IRS to audit partners individually, potentially reducing overall tax exposure. However, partnerships with ineligible partners (e.g., another partnership or a trust) cannot opt out, making Schedule B responses critical.

2. Who Bears the Tax in an Audit?

If a partnership does not opt out, any IRS tax adjustments are assessed at the partnership level rather than flowing through to individual partners. This means:

• Partners in future years might be paying for tax liabilities arising from past errors they had no involvement in.
• There is less flexibility in resolving audit issues since adjustments stay at the entity level.

Solution? Partnerships can elect to push adjustments to reviewed-year partners (Section 6226 election), but this requires careful planning.

3. The Partnership Representative’s Power

Under the BBA audit rules, the IRS only interacts with the designated partnership representative—not individual partners. This person has full authority to act on behalf of the partnership in an audit, making this choice one of the most important decisions for a partnership.

Risk: If Schedule B is not reviewed carefully, an incorrect or inactive representative could result in audit mishandling, penalties, or forced IRS decisions without partner input.

How to Avoid These Compliance Risks

? Review Schedule B Carefully – Ensure the partnership qualifies for audit opt-out if desired.

? Discuss Audit Elections with Partners – Consider the long-term impact of defaulting to CPAR.

? Choose a Competent Partnership Representative – Select someone knowledgeable in tax audits and IRS negotiations.

? Evaluate Partner Composition Annually – Ensure no ineligible partners (e.g., trusts or partnerships) inadvertently prevent opting out.

Final Thoughts: Proactive Planning Prevents Costly Surprises

Schedule B might seem like just another set of checkboxes, but it defines how your partnership will be audited and taxed in case of an IRS review. If your tax preparer isn’t discussing these elections with you, it’s time to ask questions.

As a CPA specializing in partnership taxation, I help businesses navigate tax complexities, reduce audit risks, and optimize financial structures. If you want to ensure your partnership is properly protected from unforeseen audit liabilities, let’s connect.

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