According to a recent report in Financial Advisor, the Internal Revenue Service plans to ramp up audits of partnerships and wealthy individuals in 2021.
The IRS initiative to audit large partnerships will use the powerful centralized tools Congress gave the agency when it enacted the Bipartisan Budget Act of 2015 (BBA). The BBA generally applies to partnership taxable years beginning on or after Jan. 1, 2018.
The IRS said that it will use data analytics as part of its partnership audit selection and issue identification processes similar to the Large Corporate Compliance audit procedures.
At a recent American Institute of Certified Public Accountants event, the IRS deputy commissioner of examination for small businesses, De Lon Harris said, “the IRS is focusing our efforts to increase compliance activity in this area of not only partnerships, but also investor returns related to pass-throughs. For 2021, we are planning for 50% more than we had in the previous year.”
The IRS is hiring 50 more specialized auditors to work these cases, with the aim of having them in place by February, Harris said.
Pass-through entities, which include partnerships, limited-liability companies, and sole-proprietorships, are difficult for the IRS to audit because they frequently have complex structures that can involve dozens of inter-related entities. These entities don’t pay taxes themselves, but “pass” along the profits and tax liabilities to investors — who then pay the taxes on their individual returns.
The result of the IRS initiative could be a surge in audits of companies that have rarely faced audits. These targets range from small retail stores and technology startups to investment funds.
In response to criticism that high-income individuals are not being audited at the same rate as low-income individuals, the IRS launched a new campaign aimed at auditing hundreds of high-net-worth taxpayers.
The new high-income program is a joint effort between the Small Business/Self-Employed Division (SB/SE) and the Large Business and International Division (LB&I).
There is some overlap of this initiative with the existing global high-wealth program within LB&I, which began in 2009. But, the global high-wealth program is focused on the entire enterprise associated with a wealthy individual whereas the high-income audits will be focused on individual taxpayers, though they will include at least one related entity such as a partnership or an S corporation.
The chart below provides a recap of both programs.
|High-income initiative||Global high-wealth program|
|Audit program launched||2020||2009|
|IRS Division||Joint effort: LB&I and SB/SE||LB&I|
|# of returns audited||1040 & at least one related entity||Avg. of 4 returns – enterprise approach|
|Measures for inclusion||Based on income||Based on income and assets|
|Avg. Audit time (per IRS)||18 months||24 months|
Taxpayers identified for audit are not notified under which program the audit is being conducted. This is unfortunate given the differences in the two programs, most notably the complexity of the audit and the anticipated length of the time to complete.
With the high-income and global high-wealth programs focusing on related entities, many of which are partnerships, how these audits will be affected by the Bipartisan Budget Act of 2015 (BBA) remains to be seen.
LB&I is expected to begin a large partnership BBA audit initiative in 2021. It is possible that wealthy individuals with interests in these partnerships already could be under audit under one of these initiatives.
With an expected timeframe of 18 months or longer and the inclusion of related entities in the audit, taxpayers should be prepared for a long, complex process with many issues to work through.
With both programs now running and an increased focus on compliance and audits of the wealthy, more taxpayers are likely to receive audit notices. Taxpayers should consult with their tax advisers now to understand how to be prepared if the IRS selects them for one of these audits.
Please reach out to your RINA tax professional to understand how to be prepared if you are selected for one of these audits.