Part IV—Imputed Underpayment (IU) — 1025 Inst 1065-X (PDF)

Caution: BBA AARs must always include a computation of the IU (even when the IU is zero or less than zero, or the adjustments don’t result in an IU), as determined under section 6225(b) or when the partnership elects under section 6227(b)(2) to have its reviewed year partners take all the adjustments into account. See Figuring the Imputed Underpayment (IU), later, for information on how to figure the IU. Also, go to IRS.gov/Businesses/Partnerships/How- To-Figure-an-Imputed-Underpayment .

If the adjustments don’t result in an IU, the IU should be shown as zero. Documentation should be included with the AAR that supports the computation of the IU amount. If the resulting IU amount is zero or less than zero, or the adjustments don’t result in an IU, or if the partnership is making an election under section 6227(b)(2) to have the adjustments taken into account by the reviewed year partners, Part IV, line 1, should be shown as zero. Otherwise, the IU amount should be reported on Part IV, line 1.

If the adjustments requested in the AAR result in an IU, generally the partnership takes the adjustments into account and must pay the IU. Adjustments requested in the AAR that result in zero or less than zero, or that don’t result in an IU must be taken into account by each reviewed year partner as if the partnership had made an election under section 6227(b)(2) but only with regard to those adjustments that don’t result in an IU. In this instance, see Forms 8985 and 8986 and their related instructions for reporting amounts not included in the IU.

The partnership may elect under section 6227(b)(2) to have the reviewed year partners take into account adjustments resulting in an IU. If the partnership makes the election, the partnership isn’t liable for, nor required to pay, the IU related to the adjustments. Additionally, if the IU calculation results in an amount that is zero or less than zero, or the adjustments don’t result in an IU, then all adjustments are taken into account by the reviewed year partners. However, the partnership may have withholding and reporting obligations under chapter 3 or chapter 4 with respect to the adjustments taken into account by the reviewed year foreign partners. See the instructions for Form 8985 and Form 8986.

If the partnership validly elects under section 6227(b) (2) to have its reviewed year partners take all the adjustments into account, any modifications applied to the IU submitted on Form 8980 will be disregarded.

Under section 6227(b)(1), the partnership may modify the IU in accordance with the provisions under section 6225(c), disregarding the provisions under sections 6225(c)(2), (7), and (9).

If modifications are applied to the IU, complete and attach Form 8980 and report the modified IU amount on Part IV, line 1. See Part I, Section 1, Item E , earlier, for more information on modification.

Caution: If the partnership makes an election to push out the adjustments rather than pay an IU but the election is determined to be invalid, the partnership remains liable for the IU and such IU potentially may be assessed. In such a case where the partnership filed Form 8980 to request permitted modifications be applied to the IU calculation, those modifications will be considered in determining the IU.

The applicability of interest and penalties is discussed under Interest and penalties applicable to the IU, earlier. The BBA AAR may include a prepayment for interest and penalties. If making such prepayments, the AAR should include documentation that supports the calculations. A payment made with Form 1065-X should detail the portions of the payment that are for the IU, prepaid estimated interest, and prepaid estimated penalties. The total of all three should be reported on Part IV, line 2.

Under section 6232(a)(2), partnerships filing a BBA AAR that has adjustments resulting in an IU, and that don’t elect the alternative to payment of the IU, must pay the IU at the time of filing the AAR. The IU should be shown on Form 1065-X, Part IV, line 1. When making an electronic payment, choose the payment description “BBA AAR Imputed Underpayment” from the list of payment types. The payment amount, including any amount paid toward

8 Instructions for Form 1065-X (Rev. 10-2025)

the IU, prepaid estimated interest, and penalties, should be reported on Part IV, line 3. If you qualify for an exception to paying electronically, include the notation “BBA AAR Imputed Underpayment” with your payment. See Making a Payment , earlier.

Figuring the Imputed Underpayment (IU) For an example of how to figure an IU, go to IRS.gov/ Businesses/Partnerships/How-To-Figure-an-Imputed- Underpayment .

Definitions

Adjustments not resulting in an IU. If, after grouping, subgrouping, and netting, the amount in any grouping or subgrouping is a net negative or the calculation of the IU is zero or less than zero, then the adjustments in those net negative groups or in the calculation of the IU are adjustments that don’t result in an IU. Any adjustments that don’t result in an IU are taken into account by the reviewed year partners in accordance with Regulations section 301.6227-3.

Credit grouping. Any adjustment to a PRI that is reported or could be reported by a partnership as a credit on the partnership’s return, including a reallocation adjustment to such PRI, is placed in the credit grouping.

Creditable expenditure grouping. Any adjustment to a PRI where any person could take the item that is adjusted (or item as adjusted if the item wasn’t originally reported by the partnership) as a credit, including a reallocation adjustment to a creditable expenditure, is placed in the creditable expenditure grouping.

Negative adjustment. A negative adjustment is any adjustment that is a decrease in an item of gain or income; an increase in an item of loss or deduction; an increase in an item of credit or creditable expenditure; a decrease in an item of tax, penalty, addition to tax, or additional amount for which the partnership is liable under chapter 1; or a decrease to an IU calculated by the partnership for the tax year.

Net negative adjustment. Any amount which results from netting adjustments within a grouping or subgrouping that isn’t a net positive adjustment. A net negative adjustment includes a negative adjustment that wasn’t netted with any other adjustment.

Net positive adjustment. An amount that is greater than zero which results from netting adjustments within a grouping or subgrouping. A net positive adjustment includes a positive adjustment that wasn’t netted with any other adjustment. A net positive adjustment includes a net decrease in an item of credit (or creditable expenditure).

Positive adjustment. A positive adjustment is any adjustment that isn’t a negative adjustment.

Reallocation grouping. In general, any adjustment that allocates or reallocates a PRI to and from a partner or partners is a reallocation adjustment, except for an adjustment to a credit or to a creditable expenditure. Each reallocation adjustment generally results in at least two separate adjustments, each of which becomes a separate subgrouping.

Residual grouping. Any adjustment to a PRI that doesn’t belong in the reallocation, credit, or creditable expenditure grouping is placed in the residual grouping. This grouping also includes any adjustment to a PRI that derives from an item that wouldn’t have been required to be allocated by the partnership to a partner under section 704(b), such as an adjustment to a liability amount on the balance sheet.

Subgrouping. Each adjustment is subgrouped according to how the adjustment would be required to be taken into account separately under section 702(a). In general, a subgrouping follows Schedules K, K-1, K-2, and K-3 line items, including any alpha codes related to a Schedule K-1 line item.

Total netted partnership adjustments (TNPA). The sum of all net positive adjustments in the reallocation grouping and the residual grouping.

Formula for Figuring the IU

Figuring the IU

TNPA x rate* =

Sum of net positive adjustments

to creditable expenditure and

credit groupings:

= Total IU

Highest rate in effect for the reviewed year under section 1 or 11.

The process of taking the adjustments shown on the AAR and inputting them into the formula above requires an understanding of the concepts of grouping, subgrouping, and netting. There are seven steps necessary in figuring an IU. The first three steps focus on grouping, subgrouping, and netting.

Steps in Figuring the IU

Step 1—Grouping

Place each adjustment into one of the following four groupings: reallocation, credit, creditable expenditure, or residual grouping.

Note: Under Regulations section 301.6225-1(b)(4), a partnership that files an AAR may treat a positive adjustment as zero (solely for purposes of calculating any IU) if the positive adjustment is related to, or results from, a positive adjustment to another item. The IRS may later determine that the adjustment should not have been treated as zero by the partnership in its calculation of the IU. Go to IRS.gov/Businesses/Partnerships/How-To- Figure-an-Imputed-Underpayment .

Reallocation grouping. A reallocation adjustment generally consists of at least two adjustments, one positive and one negative, with each in a separate subgrouping.

One part of the reallocation adjustment reverses the effect of the improper allocation of a PRI.

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The other part of the adjustment makes the proper allocation of the PRI.
Under Regulations section 301.6227-2(d), if one of the reallocation adjustments is negative, such negative adjustment must be pushed out to the proper partner(s).

Caution: Don’t net reallocation adjustments. Because each part of a reallocation adjustment is placed in a separate subgrouping within the reallocation grouping, those adjustments can’t be netted in accordance with the netting rules.

Example. $100 of ordinary income is being reallocated from Partner A to Partner B. For purposes of figuring the IU, there will be two adjustments, each in a separate subgrouping: a negative adjustment of $100 (reversing improper allocation to Partner A) and a positive adjustment of $100 (making proper allocation to Partner B). These two adjustments can’t be netted. As a result, the total net positive adjustment in the reallocation grouping is $100 and will be included in the TNPA. The net negative adjustment of $100 is an adjustment that doesn’t result in an IU and will be pushed out to the proper partner(s).

One adjustment reverses the improper characterization of the PRI.

Step 2—Subgrouping

Determine if any adjustment, within one of the four groupings, needs to be subgrouped. Subgrouping is generally required within a grouping if there’s a negative partnership adjustment within that grouping. Each adjustment is subgrouped according to how the adjustment would be required to be taken into account separately under section 702(a). If any adjustment could be subject to any preference, limitation, or restriction under the Code (or not allowed, in whole or in part, against ordinary income) if taken into account by any person, the adjustment is placed in a separate subgrouping from all other adjustments within the grouping.

Generally, each separate line item of Schedules K, K-1, K-2, and K-3 or return schedule (for example, Schedule L) represents a separate and distinct subgrouping.

Example. Adjustments to ordinary income must be placed in a different subgrouping than capital gain income or interest income because each of those items is required to be separately stated under section 702(a).

Subgroupings generally reflect a line item from Schedules K, K-1, K-2, and K-3, including any subcategories of those lines (for example, alpha codes per the Schedule K-1 instructions or activities broken out via attached statements). If any line item on Schedules K and K-1 or other schedules consists of multiple items and the components are required to be taken into account separately under the Code, regulations, forms, instructions, or other IRS guidance, then such line item must be further subgrouped.

Example. 2019 Schedule K-1, box 13, code A (cash contributions 60%), and box 13, code B (cash contributions 30%), are two separate subgroupings.

The ordinary income (loss) amount reported on Schedule K, line 1, and in box 1 of Schedule K-1 is sourced from Form 1065, page 1, and is a net amount consisting of various page 1 line items of income and expenses. Although those separate page 1 line items are distinct items of income and expenses, if they are appropriately netted and included on Schedule K, line 1, and in box 1 of Schedule K-1, the net amount will be considered a single subgrouping, except when such amount is required to be separately allocated, such as when the partnership has more than one trade or business. If the partnership has more than one trade or business reported on Form 1065, page 1, the net income (loss) from each trade or business must be separately reported on Schedule K-1. Each separate activity will constitute a separate subgrouping and it must be determined which activity an adjustment to the page 1
The other adjustment makes the proper characterization of the PRI.
The adjustments that result from a recharacterization are placed into separate subgroupings.

Credit grouping.

Generally, a decrease in credits is treated as a positive adjustment, and an increase in credits is treated as a negative adjustment.
A reallocation adjustment relating to the credit grouping is placed into two separate subgroupings and won’t be netted together nor will they be netted with other credit adjustments.

Note: A change made to a previously reported IU (for example, an IU reported on a prior AAR by the partnership) is placed in the credit grouping and isn’t permitted to be pushed out to the partners as it’s a liability of the partnership.

Creditable expenditure grouping.

Generally, a decrease in creditable expenditures is treated as a positive adjustment, and an increase in creditable expenditures is treated as a negative adjustment.
A reallocation adjustment relating to a creditable expenditure grouping is placed into two separate subgroupings and won’t be netted together.
A creditable expenditure is treated in this manner even if the partners claimed a deduction in lieu of a credit.
Each adjustment to a creditable expenditure is subgrouped based on the separate category of income to which the creditable expenditure relates and to account for any different allocation of the creditable expenditure between partners. Two or more adjustments to creditable expenditures are included within the same subgrouping only if each adjustment relates to creditable expenditures in the same separate category, and each adjusted PRI would be allocated to the partners in the same ratio had those items been properly reflected on the originally filed partnership return.

Residual grouping. The residual grouping contains all adjustments that don’t fit into one of the other groups.

Recharacterization adjustments. A recharacterization adjustment may result in two separate adjustments within the residual grouping.

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item of income and expense relates to for subgrouping purposes.

If you have a negative adjustment along with a positive adjustment in the same line item of Schedules K and K-1, you must consider whether they may be properly netted at the partnership level or whether they are required to be taken into account separately by any partner. The adjustments may be subject to a limitation or preference under the Code before you can place them in the same subgrouping (for example, passive and nonpassive activities).
A negative adjustment that isn’t otherwise required to be placed in its own subgrouping must be placed in the same subgrouping as another adjustment if the negative adjustment and the other adjustment would have been properly netted at the partnership level or such netted amount would have been required to be allocated to the partners of the partnership as a single item for purposes of section 702(a) or other provision of the Code and regulations.

Step 3—Netting

Net all adjustments within each of the groupings and subgroupings.

Positive adjustments may be netted with other positive adjustments only if they are in the same grouping.
Negative adjustments may be netted with other negative adjustments only if they are in the same subgrouping.
Positive and negative adjustments may only be netted against each other if they are in the same subgrouping.
An adjustment in one grouping or subgrouping may not be netted against an adjustment in any other grouping or subgrouping.

treated as zero by the partnership in its calculation of the IU. Go to IRS.gov/Businesses/Partnerships/How-To- Figure-an-Imputed-Underpayment .

Step 5—Determine the Highest Tax Rate in Effect Under Section 1 or 11 in the Reviewed Year

Step 6—Determine the Sum of Net Positive Adjustments to Creditable Expenditures and Credit Groupings That Will Increase the Product of the TNPA Multiplied by the Highest Rate in Effect

A net decrease to creditable expenditures is treated as a net positive adjustment and increases the product of the TNPA multiplied by the highest tax rate in effect. A net increase to creditable expenditures is treated as a net negative adjustment, including net negative adjustments resulting from a creditable expenditures reallocation adjustment, and is excluded from the calculation of the TNPA and is an adjustment that doesn’t result in an IU.
For the credit grouping, a net positive adjustment will increase the product of the TNPA multiplied by the highest tax rate in effect. A net negative adjustment, including net negative adjustments resulting from a credit reallocation adjustment, will be treated as an adjustment that doesn’t result in an IU.

Step 7—Figure the IU Based on the Results of Steps 4 Through 6 and Insert Those Results Into the IU Formula

Figuring the IU

All adjustments within a subgrouping are netted to determine whether there is a net positive adjustment or net negative adjustment for that subgrouping.
Net positive adjustments from subgroupings or positive adjustments within a grouping (if subgroupings are unnecessary) are netted to determine the net positive adjustment for that grouping. Net negative adjustments from subgroupings within a grouping are netted to determine the net negative adjustment for that grouping.

TNPA x rate* =

+ Sum of net positive adjustments to creditable expenditure and credit groupings:
= Total IU
* Highest rate in effect for the reviewed year under section 1 or 11.

Step 4—Figure the Total Netted Partnership Adjustments (TNPA)

Each net positive adjustment in a grouping or subgrouping in the residual or reallocation grouping that results after netting the adjustments is included in the calculation of the TNPA.
Each net negative adjustment in a grouping or subgrouping that results after netting the adjustments is excluded from the calculation of the TNPA because those adjustments don’t result in an IU.

Partnership-Partner Modification Amended Return Related to Modification Partnership-partners who are filing amended returns as part of the modification of the IU during examination under section 6225(c)(2) will report the applicable payment of tax on Part IV, line 1. The pass-through partner will compute the amount like an IU on the adjustments allocated to it and make the payment with the filing of Form 1065-X. A payment made with Form 1065-X should detail the portions that are for the payment of the IU, the interest, and the penalties. The partnership should consider all available guidance issued by the IRS when figuring the amount due. In general, the partnership should compute its amount due in accordance with the IU computation in these instructions. See Steps in Figuring the IU, earlier. The total of the IU, penalties, and interest should be reported on Part IV, line 2. When making an electronic payment, choose the payment description “Partner Pymnt for BBA Modification” from the list of payment types. The payment amount, including any

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amount paid toward the IU, interest, and penalties, should be reported on Part IV, line 3. If you qualify for an exception to paying electronically, include the notation “Partner Payment for BBA Modification” with your payment. See Making a Payment , earlier.

Partnership-Partners Who Are Allocated Adjustments That Don’t Result in an IU If a partnership-partner is paying an amount due as part of an amended return submitted for purposes of modification during examination under section 6225(c)(2), any adjustments that don’t result in an IU must be taken into account in the tax year that the amount is paid by the partnership-partner. However, if there are only adjustments that don’t result in an IU, those adjustments are subject to modification by the ultimate taxpayers who reported the original amounts and not by the partnership-partner itself. See Regulations section 301.6225-2(d)(2)(vi)(B) for further guidance.