Some partnerships will be authorized under the Centralized Partnership Audit Regime (CPAR) to elect to opt out of the centralized exams if they meet certain requirements. Reg. 301.6221(b)-1 (TD 9829) provides the details for which partnerships can opt out and how they will go about doing so.

CPAR, which takes effect for returns filed for years beginning on or after January 1, 2018, represents a major change in how partnership returns will be examined. By default, a tax will be determined and assessed at the partnership level (IRC §6221(a)). In the alternative, a partnership subject to CPAR can elect to push out the adjustments to the partners in the year under review (IRC §6226).

Congress provided an option for some partnerships to elect out of CPAR and instead be taxed under traditional partnership exam rules (what were the small partnership examinations under the now repealed TEFRA rules). Note that the election is an annual election, so electing to opt out of CPAR for 2018 does not require the partnership to opt out for 2019, nor will the partnership be opted out for 2019 unless the partnership both qualifies to make the election and files a timely election.

To be eligible to elect out of CPAR under IRC §6221(b) for a tax year a partnership cannot have any partners other than eligible partners as provided at IRC §6221(b)(1)(C) as well as any additional types of partners the IRS may designate as eligible under the authority granted to the agency in IRC §6221(b)(2)(C).

The IRS has not exercised its authority to expand the list of eligible partners beyond those provided in the statute. Thus, per Reg. §301.6221(b)-1(b)(3) the following are the eligible partners:

Individual,
A C corporation,
A foreign entity would be treated as a C corporation if it were a domestic entity.
An S corporation, or
An estate of a deceased partner.

The regulations provide specifically that the following partners are not eligible partners. If any partners of the partnership are one of these entity types, the partnership will not be eligible to opt out of CPR:

A partnership,
A trust,
A foreign entity that would not be taxed as a C corporation if it were a domestic entity,
A disregarded entity described in §301.7701-2(c)(2)(i),
An estate of an individual other than a deceased partner, or
Any person that holds an interest in the partnership on behalf of another person. [Reg. §301.6221(b)-1(b)(3)(ii)]

However, an S corporation remains an eligible partner even if one of its shareholders would not itself be an eligible partner. [Reg. §301.6221(b)-1(b)(3)(i)] So any of the above entities that would be an eligible S partner (like a revocable living trust treated as owned entirely by a U.S. citizen) could indirectly hold an interest via an S corporation without having an effect on the ability of the partnership to election to opt out of CPAR.

The IRS provides the following examples of applying the eligible partner rules:

Example 1. During the 2020 taxable year, Partnership has four equal partners. Two partners are individuals. One partner is a C corporation. The fourth partner, D, is a partnership. Because D is a partnership, D is not an eligible partner under paragraph (b)(3)(i) of this section. Accordingly, Partnership is not an eligible partnership under paragraph (b)(1) of this section and, therefore, cannot make the election under paragraph (a) of this section for its 2020 taxable year.

Example 2. During its 2020 taxable year, Partnership has four equal partners. Two partners are individuals. One partner is a C corporation. The fourth partner, S, is an S corporation. S has ten shareholders. One of S’s shareholders is a disregarded entity, and one is a qualified small business trust. S is an eligible partner under paragraph (b)(3)(i) of this section even though S’s shareholders would not be considered eligible partners if those shareholders held direct interests in Partnership. See paragraph (b)(3)(i) of this section. Accordingly, Partnership meets the requirements under this paragraph (b)(3) for its 2020 taxable year.

Example 3. During its 2020 taxable year, Partnership has two equal partners, A, an individual, and C, a disregarded entity, wholly owned by B, an individual. C is not an eligible partner under paragraph (b)(3)(i) of this section. Accordingly, Partnership is not an eligible partnership under paragraph (b)(1) of this section and, therefore, is ineligible to make the election under paragraph (a) of this section for its 2020 taxable year.

Aside from not having an ineligible partner, a partnership must meet certain other requirements to opt out of CPAR. Specifically, the following must be both be true:

The partnership has 100 or fewer partners, and
Each K‑1 the partnership is required to furnish for the partnership taxable year is furnished to a partner that was an eligible partner for the partnership’s entire taxable year. [Reg. §301.6221(b)-1(b)(1)]

A partnership is considered to have 100 or fewer partners if it is required to furnish 100 or fewer K‑1s for the taxable year. However, if any of the partners are S corporations, the partnership must add to the K‑1s it is required to issue for the year (including those to S corporation partners) the number of K‑1s issued by the S corporation(s) for the taxable year of the S corporation ending with or within the partnership’s taxable year.

The partnership does not need to “look through” a decedent’s estate and count any K‑1s issued by the estate for the 100 K‑1 test [Reg. §301.6221(b)-1(b)(2), Example 5]. If a spouse has a community property interest in a partnership interest held by his/her spouse, only one K‑1 is required to be issued and therefore the couple counts as only a single partner for the 100 K‑1 test. [Reg. §301.6221(b)-1(b)(2), Example 2] However, if each spouse holds an interest in the partnership other than a community property interest, two K‑1s are required to be issued to the couple and that counts as 2 K‑1s for purposes of the 100 K‑1 test. [Reg. §301.6221(b)-1(b)(2), Example 1]

Reg. §301.6221(b)-1(c) gives information on how the election is to be made. The regulation provides generally “An election under this section must be made on the eligible partnership’s timely filed return, including extensions, for the taxable year to which the election applies and include all information required by the Internal Revenue Service (IRS) in forms, instructions, or other guidance.” [Reg. §301.6221(b)-1(c)(1)] An election once made cannot be revoked without the permission of the IRS. [Reg. §301.6221(b)-1(c)(1)]

The partnership must disclose the following information about each partner to the IRS for the year in which it makes the election:

Each partner’s name,
Each partner’s correct U.S. taxpayer identification number (TIN) (or alternative form of identification required by forms, instructions, or other guidance),
Each partner’s Federal tax classification,
An affirmative statement that the partner is an eligible partner under paragraph (b)(3)(i) of this regulation, and
Any other information required by the IRS in forms, instructions, or other guidance. [Reg. §301.6221(b)-1(c)(2)]

If any partner is an S corporation, the partnership must also disclose the following information about each shareholder of the S corporation that was a shareholder at any time during the taxable year of the S corporation ending with or within the partnership’s taxable year:

Each shareholder’s name,
Each shareholder’s correct TIN (or alternative form of identification as prescribed by forms, instructions, or other guidance),
Each shareholder’s Federal tax classification, and
Any other information required by the IRS in forms, instructions, or other guidance. [Reg. §301.6221(b)-1(c)(2)]

A partnership that makes this election must notify each partner within 30 days of making the election. However, the form and manner of the notification is to be determined by the partnership. [Reg. §301.6221(b)-1(c)(3)] In the preamble, the IRS also noted that while the partnership must send a notice to any S corporation partner(s), the S corporation(s) will determine how (or presumably if) it will notify any shareholders of the election.

Any election made by a partnership only applies to that partnership, and does not apply to any partnership of which the electing partnership may be a partner. [Reg. §301.6221(b)-1(d)]

The partnership and the partners are bound by the election unless and until the IRS determines an election is invalid. [Reg. §301.6221(b)-1(d)(1)] If the IRS determines that an election is not valid, it will notify the partnership in writing and the partnership will be subject to a standard CPAR examination for the year in question. [Reg. §301.6221(b)-1(d)(1)]