Our upper-tier partnership received Form 8986 from a lower-tier fund. Do we pay or pass adjustments to investors?
The upper-tier partnership cannot put an incoming Form 8986 in its file and wait for a corrected K-1. It generally must submit Form 8985 by the extended due date shown in Part II, item F, of the incoming Form 8986. Depending on whether the statement came from a BBA audit or an administrative adjustment request (AAR), and whether the adjustments create an imputed underpayment (IU), it may calculate and pay an IU or push adjustments through to its affected owners on new Forms 8986. An AAR's adjustments that do not result in an IU must be pushed out. The IRS Form 8985 instructions set out those branches and the deadline.
The choice belongs to the upper-tier entity's authorized decision-maker or partnership representative, with advisers who can reconstruct the affected year. It can change who funds the tax, how investors report it, and whether penalties, interest, basis and passive-loss attributes must be tracked across multiple tiers. Do not assume that amending the upper-tier's old Form 1065 or mailing corrected K-1s satisfies the BBA push-out procedure.
Read the incoming form before choosing a route
Identify whether the Form 8986 comes from an audited partnership or a BBA AAR, its reviewed year, adjustment-year extended due date in Part II, item F, furnished date in item G, incoming tracking number, each adjusted item, and whether any adjustment does not result in an IU. Then identify who owned the upper-tier partnership during its first affected year, not merely who owns it today. The IRS definition of affected partner covers owners who held an interest at any time in that affected year.
AE's established Form 8986 recipient guide addresses an individual's or other terminal recipient's Form 8978 reporting-year decision. This page addresses the different intermediate entity duty to make an IU payment or transmit Forms 8985/8986 to another ownership tier before the deadline. The AAR-versus-amended-Form-1065 guide addresses the original partnership's correction route, not what an upper-tier investor must do after receiving a push-out statement.
Decision tree: pay an IU or push out?
- Was the source an audit or AAR? Read the incoming form rather than inferring from a partner email. The rules for tax, modifications, interest and non-IU adjustments differ. The Form 8985 instructions describe the separate audit and AAR treatments.
- Are any AAR adjustments non-IU? Those adjustments must be pushed out even when the upper-tier partnership pays an IU on other AAR adjustments. Do not use a single “pay everything” checkbox for a mixed statement.
- If paying an IU is permitted, can the entity fund and support it? Calculate IU, applicable penalty and interest under the instructions, document any allowed audit modifications, make the payment, and submit Form 8985. A pass-through partner that pays on audited adjustments ordinarily does not send related Forms 8986 to owners, subject to the instruction's exceptions. Paying at the entity level can have economic and agreement consequences among investors; it is not automatically cheaper than push-out.
- If pushing out, can all affected owners and items be traced? Allocate all pushed-out adjustments to the reviewed-year affected partners, furnish each a Form 8986, submit those forms with Form 8985, and retain the incoming and outgoing tracking numbers. The package is due by the lower-tier audited or AAR partnership's adjustment-year extended return due date, not simply the upper-tier partnership's next normal K-1 date. See the IRS BBA process.
Illustration: a lower-tier adjustment reaches two investors
Assume Lower Fund furnishes Upper Fund a Form 8986 showing a $200,000 increase in reviewed-year ordinary income. Upper Fund had two equal owners in its first affected year, and for this simplified illustration its governing tax allocations properly assign $100,000 of the adjustment to each. If Upper Fund chooses a valid push-out, it prepares Form 8985 and two Forms 8986 reflecting the owner-level adjustments, files the package with the IRS, and furnishes each owner their statement by the deadline from the incoming form. The two investors then determine their own downstream reporting; an individual terminal partner generally uses Form 8978 and Schedule A on the reporting-year return, not an automatically amended reviewed-year K-1. See the IRS Form 8978 instructions.
The $200,000 adjustment is not a $200,000 tax bill, and $100,000 allocated to an investor is not necessarily that investor's tax due. If the source was an AAR and the packet includes non-IU adjustments, those must be separately tracked and pushed even if an IU on other items is paid. Actual ownership changes, Section 704 allocations, tax attributes, investor type, multiple incoming Forms 8986, and state adjustments can change both the transmission package and economics. Do not infer a deadline from the illustration; copy Part II, item F, and verify the legal date for the actual packet.
What to gather and reconcile
- Every incoming Form 8986, Form 8985 cover statement, correction notice, tracking number, source audit or AAR notice, and correspondence with the lower-tier partnership.
- Upper-tier Forms 1065, K-1s, ownership and transfer ledger for the first affected year, partnership agreement, Section 704 allocation records, and basis and suspended-loss schedules.
- IU, penalty and interest calculations if paying; investor-level adjustment workpapers, Forms 8985/8986 and proof of furnishing/submission if pushing; payment confirmation and state-tax analysis where relevant.
Failure points include missing the Part II, item F, deadline; treating Form 8986 as an amended K-1; passing adjustments to current rather than affected-year partners; omitting non-IU AAR adjustments from a mixed packet; losing the incoming/outgoing tracking chain; or assuming the electronic submission succeeded without checking IRS acceptance. The IRS electronic-submission guidance describes package tracking and acceptance dependencies. If the due date has already passed, obtain procedural advice promptly rather than manufacturing a late push-out; the correction and penalty rules are fact-specific.
This is a federal decision framework, not a universal election recommendation. The audit/AAR source, adjustments, upstream modifications, entity agreement, investors, and payment timing control the outcome. AE can review the incoming form, model both routes, and coordinate the upper-tier return and investor statements before the responsible person commits to a payment or push-out.