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Tax & AccountingOctober 27, 2023

IRS uses new funding to target tax evasion by large partnerships

By: CCH AnswerConnect Editorial

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The IRS said on September 8 that it will pay more attention to partnerships issues and will use artificial intelligence (AI) with funds from the 2022 Inflation Reduction Act (IRA) to expand a pilot partnership project that started two years ago. Then, on September 20, the IRS announced a new work unit targeting large partnerships that the IRS thinks may be shielding income to avoid taxes.

IRS will leverage AI to expand pilot focused on largest partnerships

In 2021, the IRS launched the first stage of a Large Partnership Compliance (LPC) program by placing “some of the largest and most complex partnership returns” under audit.

The IRS is now expanding that program to sweep in more large partnerships through the help of AI, thanks to the 2022 IRA’s boost in IRS funding. IRS Commissioner Dan Werfel said in a September 7 conference call that the new technology will help the agency see patterns in partnership returns that it couldn’t spot before.

The IRS said in its September 8 press release that it planned to open examinations of 75 large partnerships—each with assets over $10 billion on average—by the end of September. Commissioner Werfel, however, cautioned that these audits are going to take a long time.

The partnerships targeted will represent a cross-section of industries—from hedge funds, real estate investment partnerships, and publicly traded partnership, to large law firms and other partnerships.

IRS will scrutinize returns showing discrepancies between end-of-year balances and following-year beginning balances

The IRS says that for many years it has seen partnership returns showing discrepancies “in the millions of dollars” between end-of-year balances on one year’s returns and beginning balances on the following year’s returns—and believes the number of these discrepancies has been growing. It also said that many of these partnerships are failing to attach statements explaining the discrepancies.

The IRS thinks these discrepancies may suggest cheating, especially in the case of partnerships with more than $10 million in assets. But the IRS simply “did not have the resources” to follow up with partnerships suspected of noncompliance. Commissioner Werfel said the agency had been “overwhelmed” in the partnership area.

The IRS says it has the needed resources now and will start work on the problem by sending special alerts in the mail beginning in October to around 500 large partnerships.

Depending on the response,” the September 8 press release states, “the IRS will add these to the audit stream for additional work.

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IRS is setting up a new work unit to focus on large and complex partnerships

A partnership (or other passthrough entity) is not a taxable entity. Its tax items—e.g., income, gain, loss, deduction, and credit—are allocated to the partners. The partners then report on their own returns. Using a partnership or other passthrough instead of a C corporation therefore avoids a second layer of tax on the business’s income.

The IRS said in its September 20 press release that it is concerned taxpayers looking for ways to “shield income to avoid paying the taxes they owe” are using partnerships and other passthrough entities, like S corporations, to do that. 

As part of its new compliance efforts, the IRS says it’s setting up a new unit, to be housed in the IRS Large Business and International (LB&I) division, that will use some of the IRA funding “to disrupt efforts” by large partnerships to avoid taxes.

The new unit, which will work with the National Treasury Employees Union (NTEU) and other external partners, will “formally ‘stand up’” in late 2024—although work on passthroughs “will continue to intensify in the meantime.

The passthrough-compliance unit will be staffed with employees hired in an initiative—also announced in September—to open 3,700 new IRS positions. But current LB&I workers will also staff the new group. The IRS says that “IRS employees, no matter if they are just joining the IRS or have years of IRS experience, can expect expanded opportunities for development wherever they are in the agency.

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