IRS Instruction 1065 (Schedule B-2) – Partnerships filing Form 1065 can avoid the complex centralized partnership audit regime (also known as the BBA regime) by making a valid election out using Schedule B-2 (Form 1065). This election, available under IRC Section 6221(b), lets eligible small partnerships with 100 or fewer qualifying partners handle tax adjustments at the individual partner level instead of the partnership level.
The IRS still uses the December 2018 version of the Schedule B-2 instructions (no updates issued for 2025), and the 2025 Instructions for Form 1065 explicitly reference it. This guide explains everything you need to know, based directly on official IRS sources including the instructions PDF, the 2025 Form 1065 instructions, and the IRS Elect Out page (last reviewed January 2026).
What Is the Centralized Partnership Audit Regime (BBA)?
The Bipartisan Budget Act of 2015 (BBA) replaced the old TEFRA rules for partnership tax years beginning after 2017. Under the BBA regime:
- The IRS audits at the partnership level.
- Any underpayment (imputed underpayment) is typically paid by the partnership in the adjustment year.
- The partnership must designate a Partnership Representative (PR) with substantial U.S. presence.
Electing out shifts audits and adjustments back to the partner level (similar to pre-BBA rules). The election is annual and must be made on a timely filed return (including extensions). It is irrevocable for that tax year.
Important: If you do not elect out (or if the election is invalid), you must designate a PR on Form 1065 and remain under BBA rules.
Who Can Elect Out? Eligibility Rules for Schedule B-2
A partnership qualifies as an eligible partnership if both conditions are met for the tax year:
- It has 100 or fewer partners (using a special counting rule).
- Every partner is an eligible type.
Eligible partner types (use these codes on Schedule B-2):
- I – Individual
- C – C corporation
- S – S corporation
- E – Estate of a deceased partner
- F – Foreign entity that would be treated as a C corporation if it were domestic
Partner-counting rule (look-through for S corporations):
Add (1) the number of Schedules K-1 the partnership issues to its direct partners plus (2) all Schedules K-1 that each S corporation partner must issue to its shareholders for the S corp’s tax year ending with or within the partnership’s tax year.
Ineligible partners (any one disqualifies the election):
- Partnerships (including LLCs taxed as partnerships)
- Trusts
- Foreign entities not treated as C corporations if domestic
- Disregarded entities (single-member LLCs, etc.)
- Estates of living individuals (other than deceased partners)
- Nominees or persons holding interests on behalf of others
REMICs: Use the same election rules but attach Schedule B-2 to Form 1066 and check the box on Question G.
If the total on Schedule B-2, Part III, line 3 exceeds 100, the partnership is not eligible.
Step-by-Step: How to Complete Schedule B-2 (Form 1065)
Download the form and instructions here:
Schedule B-2 (Form 1065) PDF
Instructions for Schedule B-2 (Form 1065) PDF (user-provided link)
Part I – List of Eligible Partners (up to 15; use Part IV for continuation)
- Column 1: Partner’s name
- Column 2: Partner’s TIN (SSN, EIN, or ITIN)
- Column 3: Type code (I, C, S, E, or F)
Part II – List of S Corporation Shareholders (for each S corp partner; use separate Part II for each; use Part V for continuation if >12 shareholders)
- Top: Name and TIN of the S corporation partner
- Then list each shareholder: Name, TIN, and type code (I, T, E, or O)
Part III – Total Number of Schedules K-1 Required To Be Issued
- Line 1: Total partners from Part I + Part IV
- Line 2: Total shareholders from all Part II + Part V (do not include the S corps themselves)
- Line 3: Add lines 1 + 2 → This must be ≤ 100 and goes on Schedule B, Question 33
By completing Part I, you affirm that all partners meet the eligibility requirements under section 6221(b)(1)(C).
How to Make the Election on Form 1065 (2025)?
- Complete Schedule B-2 fully and accurately.
- On Schedule B (Form 1065), Question 33:
- Check “Yes” if electing out.
- Enter the total from Schedule B-2, Part III, line 3.
- Attach the completed Schedule B-2 to your Form 1065 (or Form 1066 for REMICs).
- File by the due date (including extensions). The election is only valid on a timely filed original return.
Note for 2025 filings: The question number is confirmed as Question 33 in the 2025 Form 1065 and instructions.
Common Mistakes That Invalidate the Election
- Including an ineligible partner type
- Exceeding 100 when counting S corp shareholders (look-through)
- Failing to list all required shareholder information for S corp partners
- Filing late (even with extensions, must be timely)
- Not attaching Schedule B-2 or incomplete form
- Using the wrong type codes
If the IRS determines the election is invalid, it will notify the partnership in writing, and the BBA regime will apply.
Benefits of Electing Out
- Avoids partnership-level imputed underpayments and interest/penalties.
- Adjustments flow through to partners on their individual returns.
- No need to designate a Partnership Representative for that year.
FAQs About IRS Schedule B-2 and the Election Out
- Is the election permanent?
No — it must be made every year you qualify. - Can tiered partnerships elect out?
Only if the top partnership meets the 100-or-fewer rule with look-through and has no ineligible partners at any level that would require a K-1 to an ineligible entity. - What if my partnership has foreign partners?
Only certain foreign entities (those that would be C corps if domestic) are eligible. - Where do I find the latest information?
Always check IRS.gov/Form1065 for updates.
Official Resources (Trusted & Current as of February 2026)
- 2025 Instructions for Form 1065 (PDF)
- Elect Out of the Centralized Partnership Audit Regime
- About Form 1065
- Schedule B-2 Form & Instructions (December 2018 – still current)
Pro Tip: Work with a tax professional familiar with BBA rules, especially if you have S corporation partners or complex ownership structures. Proper completion of Schedule B-2 can save significant time and money during an IRS audit.
By following these IRS Schedule B-2 instructions, eligible partnerships can confidently elect out of partnership-level tax treatment and maintain control at the partner level. Always verify the latest Form 1065 instructions on IRS.gov before filing.
This article is for informational purposes only and is not tax or legal advice. Consult a qualified tax advisor or the IRS for your specific situation.