North Carolina Adopts New Procedures for Partnerships to Report Federal Changes
On July 2, 2026, Governor Stein signed Senate Bill 595, an omnibus tax bill that includes a major change to how the state responds to federal adjustments to a partnership’s income.[1] The new law is effective retroactively to January 1, 2026, and applies to federal partnership adjustments that became or become final on or after that date.[2]
Introduction
Partnerships present difficult audit issues for the IRS and state taxing authorities. Because a partnership is not itself a taxpayer, deficiencies in partnership income traditionally have had to be collected from individual partners. This is inefficient and particularly difficult if the partnership is a multistate taxpayer or has many partners or partners which are themselves partnerships or other pass-through entities.
To ease these difficulties at the federal level, in 2015 Congress enacted a centralized partnership adjustment regime.[3] The regime generally applies to all partnerships[4] and applies to adjustments resulting from an audit initiated by the IRS as well as adjustments resulting from partnership-initiated amended returns.
The Federal Centralized Partnership Adjustment Regime
In the context of a partnership-level audit, if the audit adjustments result in an “imputed underpayment” of tax, the default rule under the federal regime requires the partnership to pay the imputed underpayment at the entity level. This is treated as a tax imposed for the year the adjustment was made (the “adjustment year”), not the year under audit (the “reviewed year”).
An audited partnership may, however, elect to “push out” the adjustments to those who were partners for the reviewed year. This is done by the partnership sending each such partner a statement of such partner’s share of the partnership adjustment. Each reviewed year partner must then adjust its tax liability for the reviewed year by taking its share of the partnership adjustments into account. Any additional tax due is treated as additional tax for the year in which the partner received the push-out statement, and the partner does not amend its return for the reviewed year.[5]
If the audit adjustments do not result in an imputed underpayment (i.e., when they benefit the taxpayers), the partnership makes “true up” adjustments to its income for the adjustment year.[6] There is no option to push out the adjustments to the reviewed year partners.[7]
A partnership that is not under audit but wishes to correct an error on a previously filed return files a document referred to as an “administrative adjustment request” in lieu of an amended return.[8] As in the audit context, if the adjustments result in an imputed underpayment, the partnership may either pay the amount due or push out the adjustment to the reviewed year partners. The partners then pay any amount due as an additional tax for the in which they received the push-out statement.[9]
If the adjustments do not result in an imputed underpayment, the partnership is required to push out the adjustment to the reviewed year partners who can individually claim any resulting tax benefits by making adjustments to their returns for the year in which they receive the push-out statement.[10]
Partnerships subject to the centralized adjustment regime are required to designate a partnership representative to act on behalf of the partnership with respect to matters covered by the regime.[11]
State Tax Implications of the Federal Regime
North Carolina, like most states, generally adopts the federal income tax base (federal adjusted gross income for individuals and federal taxable income for corporations) as the starting point and then makes modifications to arrive at state taxable income. Adjustments to a taxpayer’s federal income will therefore often affect the taxpayer’s state tax liability.
North Carolina, again like most states, therefore requires a taxpayer whose income has been adjusted for federal purposes to report the change to the Department of Revenue. Specifically, a reporting obligation is triggered if a taxpayer’s federal income has been “changed or corrected” by the IRS or the taxpayer amends his federal return, in either case in a way that affects the taxpayer’s state tax liability. In these cases, the taxpayer is required to file an amended North Carolina return reporting the change. The Department then proposes an assessment to recover any underpayment or pays a refund of any overpayment.[12]
The federal centralized partnership adjustment regime complicates the states’ reliance on these reporting procedures. For instance, the federal default rule shifts the burden of correcting an underpayment from the partners to the partnership. States without a similar rule must rely on collecting state tax underpayments from the partners, but because the partners’ returns have not been audited or amended, the requirements for reporting federal changes are not triggered. Even when a federal push-out election is made, and the federal underpayment is collected from the partners, this is done by imposing an additional tax on the partners for the year in which the push-out statements are received rather than by a partner-level audit or amended return.
The states’ need to respond to the federal centralized adjustment regime, and the possibility that an uncoordinated response could create bewildering compliance problems for multistate taxpayers, led to a remarkable cooperation between the Multistate Tax Commission (“MTC”) and various taxpayer-aligned industry and professional organizations to developed model legislation for state legislatures to consider.[13]
The MTC Model Act
The MTC Model Act, adopted in 2019 and revised in 2020, includes the following key features for reporting federal partnership adjustments and making corresponding state adjustments.
Default Rule: Partners Pay. Within 90 days after a final federal partnership adjustment, a partnership must report the federal adjustments to the state taxing authority and notify the partnership’s direct partners of their distributive shares of the federal adjustments. The direct partners have 180 days from the final federal adjustment date to report their distributive shares of the federal adjustments to the state taxing authority and pay any tax due, along with any interest and penalties. If the partnership return for the reviewed year was a composite return (i.e., a return filed by the partnership on behalf of its nonresident partners and remitting tax on their behalf), the partnership must amend this return and pay any additional tax, penalty and interest with respect to such nonresident partners within this 180-day period.[14]
Partnership Pays Election. The partnership may elect to pay an amount “in lieu of taxes” (similar to the federal imputed underpayment amount). This relieves the reviewed year partners from having to account for their respective shares of the adjustments. Rules are provided for calculating this amount based on factors such as the taxable or exempt status of each partner, whether the partners are residents or nonresidents and the tax rates applicable to the various categories of partners.[15]
Tiered Partners. Partners that are themselves partnerships or other pass-through entities are referred to as “tiered partners.” Tiered partners are subject to the reporting and payment obligations under the default rule and are entitled to make the partnership pays election rather than passing the adjustments through to their partners.[16]
Final Determination Date. The reporting obligations for partnerships and partners are keyed to the date the federal adjustments become final, referred to as the “final determination date.” This is the date when all federal adjustments are final and all appeal rights have been waived or exhausted. If a federal adjustment results from the partnership filing an administrative adjustment request, the final determination date is that date on which the administrative adjustment request is filed.[17]
De Minimis Exception. The state taxing authority is authorized to issue rules establishing an exception to the state reporting and payment obligations for de minimid adjustments.[18]
Alternative Reporting Arrangements. The state taxing authority is also authorized to enter into an agreement to permit a partnership or tiered partner to employ a reasonable alternative to the statutory reporting and payment methods.[19]
State Partnership Representative. The federal partnership representative serves as the state partnership representative by default, but the partnership may designate another person to serve as the state representative.[20]
Statute of Limitations. If a taxpayer files a timely report of federal adjustments, the state taxing authority must propose any assessment and the taxpayer must request any refund within the later of the expiration of the normal limitation period and one year after the report is filed. If the taxpayer does not file a timely report of federal adjustments, the state taxing authority may propose an assessment within six years of the final determination date.[21] Absent a waiver, any adjustments made by the state or the taxpayer after the expiration of the normal statute of limitations are limited to adjustments resulting from the federal adjustment.[22]
Estimated Payments. In order to limit interest accruals on underpayments, the taxpayer is permitted to make estimated state tax payments before the due date of the federal adjustments report and have these payments credited against any additional state tax liability that may result from the federal adjustments.[23]
Over half the states have adopted legislation based on, or in general alignment with, the Model Act.[24] North Carolina has now done so as well.
Senate Bill 595
Like the Model Act, the partnership audit provisions included in Senate Bill 595 resulted from a cooperative effort by the Department of Revenue and industry and professional groups including the North Carolina Chamber, the Council on State Taxation, and the North Carolina Association of Certified Public Accountants. The key provisions of the new law are summarized below.
Default Rule: Partners Pay. The new law generally follows the Model Act by providing that, as a default rule, when a partnership doing business in North Carolina receives a final federal partnership adjustment, the partnership has 90 days to file an amended state return reflecting the final federal adjustments, with North Carolina modifications.[25] The partnership must also notify its direct partners of their respective distributive shares of those adjustments, including any information necessary for the partners to prepare their state returns.[26]
Each direct partner subject to North Carolina tax has six months from the date the federal adjustment became final to file a state return reporting its distributive share of the federal adjustments and to pay any additional tax due.[27]
Partnership Pays Election. Also like the Model Act, the new law authorizes the Secretary of Revenue to prescribe procedures under which a partnership may elect to report final federal adjustments resulting from an audit and pay an amount “in lieu of taxes.”[28] Such a “partnership pays” election is irrevocable and is not available if the partnership made a pass-through entity tax election for the year under review, the federal adjustment resulted from an administrative adjustment request, or the partnership was not doing business in the state in the reviewed year.[29]
The amount in lieu of taxes is calculated as the sum of (i) the distributive shares of the federal adjustments (with North Carolina modifications) reported to direct partners who are resident individuals or resident grantor trusts multiplied by the individual income tax rate and (ii) the distributive shares of the federal adjustments (with North Carolina modifications) reported to direct partners that are corporations, nonresident individuals or nonresident grantor trusts, allocated and apportioned to the state, and then multiplied by the applicable tax rate.[30]
The partnership must also notify each tiered partner of its share of the federal adjustments, including any information necessary for the tiered partner to file a state income tax return.[31]
If these reporting and payment requirements are satisfied, the electing partnership’s direct and indirect partners are effectively relieved of liability for North Carolina tax resulting from the federal adjustments.[32] If an electing partnership fails to pay the amount due, the Department may issue a notice of collection against the partnership, and, if the partnership does not pay within 60 days, the Department may issue notices of proposed assessment to the partners.[33]
“Tiered” Partners. Like the Model Act, the new law refers to partners that are pass-through entities (specifically, partnerships, S corporations, estates and non-grantor trusts) as tiered partners. All tiered partners and all of their owners or beneficiaries that are otherwise subject to North Carolina tax are subject to the reporting and payment obligations described above, and each tiered partner is entitled to make a partnership pays election for itself.[34] This is true even if the partnership has made a partnership pays election.[35] The electing partnership is required to notify its tiered partners of their shares of the federal adjustments, including any information necessary for the tiered partner to file a state income tax return, within six months of the date the federal adjustments become final.[36]
Final Federal Partnership Adjustment. The triggering event for the reporting and payment obligations under the new law is a “final federal partnership adjustment.” This is defined as a federal partnership adjustment that that is not subject to administrative or judicial review.
If a federal partnership adjustment results from a partnership level audit, the adjustment is considered final (i) when the time for the taxpayer to file a timely administrative appeal with the IRS expires without an appeal being filed or (ii) when the taxpayer consents to any of the audit findings for the tax period and all rights of appeal have been waived or exhausted through a final decision or written agreement with the IRS.[37]
If a federal partnership adjustment results from an administrative adjustment request, the adjustment is considered final when the request is filed.[38]
State Partnership Representative. Under the new law, and like the Model Act, the federal partnership representative is, by default, the state partnership representative but the partnership is free to designate a separate state partnership representative under procedures to be established by the Department.[39] The state partnership representative is specifically empowered to bind the partnership’s direct and indirect partners and to act on behalf of the partnership, to bring a contested case hearing to the Office of Administrative Hearings and to make requests for judicial review.[40]
Statute of Limitations. If a taxpayer files a timely North Carolina return reflecting a final federal partnership adjustment, an assessment must be proposed within one year after the return is filed or three years after the original return was filed or due, whichever is later. If the taxpayer does not file a timely return after a final federal partnership adjustment, the Department may propose an assessment within six years of the date the Department received the final report of the final federal partnership adjustment. [41]
If a taxpayer files a timely return reflecting a final federal partnership adjustment, the taxpayer may file a refund request within one year after the return is filed or three years after the original return was filed or due, whichever is later. [42]
Departures from the Model Act. The New North Carolina law departs from the Model Act in several respects. For instance, the new law does not (i) authorize exceptions to the reporting and payment requirements for de minimis adjustments, (ii) allow for estimated payments to be made during the federal audit in order to limit the accrual of interest, or (iii) limit assessments that can be proposed (or refunds that can be requested) after the expiration of the normal limitations period to matters resulting from the federal adjustments.
Conclusion
Senate Bill 595’s new partnership reporting provisions are a welcome step toward greater uniformity in the state response the federal centralized partnership adjustment regime, and the law’s relatively close adherence to the Model Act will allow the Department and North Carolina taxpayers to benefit from the experience of other states that follow the Model Act. Nevertheless, the new law brings an additional layer of complexity to partnership management, given the ability of partnerships to shift the economic burden of assessments between reviewed-year and adjustment-year partners by election - a complexity heightened by the ability to make different elections for federal and state purposes, and the ability of different representatives to control those elections. In the short term, taxpayers also face uncertainties over matters such as the exact content of the reports and notices required to be sent to the Department and to partners. This is particularly significant considering that the new law applies to any partnership that has received a final federal adjustment on or after January 1, 2026. The author understands that the Department plans to issue an FAQ dedicated to the partnership audit rules and welcomes input from the taxpayer community as to issues they would like to see addressed.
For questions or guidance related to this legal alert or other tax matters, contact Bill Nelson or your regular Smith Anderson attorney.
[1] S. 595, §2; S.L. 2026-31.
[2] Id., at §2.(g).
[3] See Internal Revenue Code (“Code”) §§6221-6241 enacted as part of the Bipartisan Budget Act of 2015, P.L. 114-74. The new rules became effective for most partnerships on January 1, 2018.
[4] See Code §6221(b) permitting partnerships with not more than 100 partners, each of whom is an individual, corporation, or estate to elect out of the centralized regime on an annual basis.
[5] Code §6226(b)(1).
[6] Code § 6225(a)(2).
[7] Code §6226(a)(1).
[8] See Code §6227.
[9] Treas. Reg. §301.6227-2(b)(1) and (c).
[10] Treas. Reg. §301.6227-3(a).
[11] Code §6223(a).
[12] See N.C. Gen. Stat. §§105-130.20 and 105-159. The taxpayer is permitted but not required amend its North Carolina return if changes reported on an amended federal return would reduce its North Carolina tax liability.
[13] See Multistate Tax Commission, Model Uniform Statute for Reporting Adjustments to Federal Taxable Income and Federal Partnership Audit Adjustments (2019, with technical corrections as of November 2020) available at: https://www.mtc.gov/Uniformity/Uniformity-Developments/. (the “Model Act”). The development of the Model Act won support from the Council on State Taxation, the Tax Executives Institute, the American Institute of Certified Public Accountants, the American Bar Association Tax Section and the Master Limited Partner Association. See H. Hecht, Report of the Hearing Officer to the Multistate Tax Commission on the Proposed Model Uniform Statute for Reporting Adjustments to Federal Taxable Income and Federal Partnership Audit Adjustments (Oct. 26, 2018).
[14] Model Act, §C(2).
[15] Id., §C(3).
[16] Id., §C(4).
[17] Id., §A(9).
[18] Id., §D.
[19] Id., §C(5).
[20] Id., §C(1).
[21] Id., §§E and G.
[22] Id., §H.
[23] Id., §F.
[24] See Map of States That Enacted or Need to Enact MTC Consensus Model for Federal Audit Change Reporting and Partnership Audits maintained at the AICPA-CIMA website: https://www.aicpa-cima.com/advocacy/download/map-of-states-adopting-mtc-model-on-federal-partnership-audit-adjustment.
[25] Given the new law’s effective date, a partnership that received a final federal adjustment early in 2026 will not be able to satisfy this requirement. The Department presumably will issue transitional guidance on this point.
[26] N.C. Gen. Stat. §105-154.2(c)(1).
[27] N.C. Gen. Stat. §§105-153.5(c2). Each partner’s share of these adjustments are treated an addition to or subtraction from the partner’s federal adjusted gross income (for individuals) or federal taxable income (for corporations) in computing the state tax base. N.C. Gen. Stat. §§105-130.5(a)(33) and (b)(33) and 105-154.2(c)(2).
[28] N.C. Gen. Stat. §§105-154.2(d).
[29] N.C. Gen. Stat. §105-154.2(d)(2).
[30] N.C. Gen. Stat. §105-154.2(d)(1)c.
[31] N.C. Gen. Stat. §105-154.2(d)(1)b.
[32] N.C. Gen. Stat. §105-154.2(d)(1)c.
[33] N.C. Gen. Stat. §105-154.2(e).
[34] N.C. Gen. Stat. §105-154.2(f).
[35] The distributive share of federal adjustments reported to partners not subject to North Carolina income tax, including pass-through entities, is not included in the calculation of the payment in lieu of taxes made by electing partnerships. See N.C. Gen. Stat. §105-154.2(a)(5) and (d)(1)c.1.
[36] N.C. Gen. Stat. §105-154.2(d)(1)b.
[37] N.C. Gen. Stat. §105-154.2(a)(8).
[38] N.C. Gen. Stat. §105-154.2(a)(8).
[39] N.C. Gen. Stat. §105-154.2(a)(12).
[40] N.C. Gen. Stat. §105-154.2(h).
[41] N.C. Gen. Stat. §105-241.8(b)(6).
[42] N.C. Gen. Stat. §105-241.6(b)(7).
Professionals
Attorney
