IRS Funding Freeze Puts Future of Partnership Audits in Limbo

The centralized partnership audit regime, codified in 2015 to help the IRS audit partnerships more efficiently, was delayed for nearly decade for a variety of reasons, including the Covid-19 pandemic, before the agency finally began CPAR examinations in earnest last year.

Two recent developments threaten to once again delay the CPAR. First, there will be a new IRS commissioner who—whether it’s current nominee Billy Long or someone else—may not make CPAR a priority.

Second, and perhaps more important, the IRS is in jeopardy of losing a large portion of its funding. There is a hiring freeze and the strong possibility of more funding clawbacks, with $20 billion already rescinded and $20 billion more in jeopardy.

Without financial resources, CPAR may remain stuck on the sidelines, a comprehensive piece of legislation and administrative guidance with no enforcement mechanisms and no further clarity on future compliance.

Complex and Cumbersome

CPAR remains misunderstood and controversial. Perhaps the most controversial aspect of CPAR is the creation of the imputed underpayment, or IU.

When the IRS makes a positive adjustment to Form 1065—the federal tax return for partnership income—the IU allows the IRS to assess an income tax against a partnership. This approach runs afoul of the pass-through nature of partnerships. If a partnership doesn’t wish to pay an IU, CPAR creates a complex and administratively cumbersome process that allows adjustments to be pushed out to partners.

This is a particularly difficult process for tiered partnership structures—that is, partnerships owned by other partnerships. Each tier of the partnership structure must make its own pushout election via specific IRS forms and within specific timeframes. A pass-through partner’s failure to push out any adjustment to its partners creates an IU assessment for the pass-through partner.

CPAR also created the important partnership representative. In some respects, a partnership representative is analogous to the former tax matters partner under CPAR’s predecessor, the Tax Equity and Fiscal Responsibility Act.

But unlike tax matters partners, partnership representatives command great power in an IRS examination. They are the only ones who can bind a partnership to any proposed IRS adjustments and effectuate a pushout election, among other responsibilities.

The representative is designated through Form 1065, but IRS examinations take place well after Form 1065 is filed. As a result, partnerships may have to address an estranged or no longer interested partnership representative.

Delays and Developments

While CPAR was created by 2015’s Bipartisan Budget Act, it became mandatory for 2018 Forms 1065, which were filed in 2019. Most professionals expected CPAR examinations to begin in 2020. But the IRS created the People First Initiative in response to the Covid-19 pandemic, under which the IRS chose not to initiate new examinations.

The Inflation Reduction Act of 2022 helped get things rolling by initially allocating close to $80 billion to the IRS over a 10-year window. Lawmakers have clawed back nearly a quarter of that funding and Republicans have threatened further reductions in future appropriations negotiations or in the budget reconciliation process. The agency released formal plans to use the new funds to update its systems, hire more people, and improve operations.

The IRS even created a Partnership Audit Task Force and finally initiated its first CPAR examinations in late 2023. Last year, tax practitioners started to see more partnerships identified for audits. Tax practitioners and the IRS spent 2024 conducting CPAR examinations for the first time. Like any new initiative, it was a learning experience for all parties.

Tax practitioners were forced to work through various new administrative procedures. For example, there was great confusion with the IRS’s required wording on a power of attorney, and IRS agents weren’t always aware of the proper way to populate a POA. Consequently, POAs were often resubmitted (multiple times in some cases).

Similarly, tax practitioners wrestled with IRS processes to administer new ones such as the pushout elections themselves and the modification procedures. The IRS created a CPAR team internally, and front-line IRS agents had to consult with this group throughout examinations to ensure full compliance with these new rules.

With a full year of CPAR examinations already initiated, the IRS and tax practitioners were expecting more clarity and continued development in 2025. We learned a lot but had only begun to scratch the surface of the new system.

While there are no proposals or plans to repeal CPAR, effective enforcement requires adequate funding, technology, and personnel. The funding aimed to fix these issues and position the IRS to implement new enforcement initiatives. CPAR was at the top of the list, but where it’s positioned now is anyone’s guess.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Colin Walsh is a tax principal at Baker Tilly and practice leader of its tax advocacy and controversy services group.

Write for Us: Author Guidelines