Title: Shift from Corporations to Partnerships Causes Challenges for IRS
Audits

Description: Businesses are increasingly shifting their legal structures
from corporations-- that are subject to corporate income taxes--to
partnerships. This shift has made it more difficult for the IRS to
identify taxable income and catch potential tax cheats. We'll find out
more from GAO's Jay McTigue.

Related GAO Work: GAO-23-106020, Tax Enforcement: IRS Audit Process Can
Be Strengthened to Address a Growing Number of Large, Complex
Partnerships

Released: July 2023

[Music]

[Jay McTigue:] The low rate at which IRS has audited large partnerships
does raise concerns about IRS's ability to ensure tax compliance among
these businesses.

[Holly Hobbs:] Hi and welcome to GAO's Watchdog Report. Your source for
fact-based, nonpartisan news and information from the U.S. Government
Accountability Office. I'm your host, Holly Hobbs. Businesses are
increasingly shifting their legal structures from corporations --that are
subject to corporate income taxes-- to partnerships. This shift has made
it more difficult for the IRS to identify taxable income and catch
potential tax cheats. We'll find out more about these increases in
partnerships and IRS's efforts to audit them from GAO's Jay McTigue, an
expert on federal tax policy. Thanks for joining us.

[Jay McTigue:] Thanks for having me, Holly.

[Holly Hobbs:] So, Jay, this isn't a small thing. It's a major shift
from the corporate model to partnerships. What can you tell us that
would help illustrate the scale of this shift?

[Jay McTigue:] Yes. This is a major shift. And I think that one of the
key measures here is that 20 years ago there were roughly 2 million C
corporations and about the same number of partnerships that file tax
returns with the IRS. But today, there are about a half million fewer
corporations, while the number of partnerships has nearly doubled to
about 4 million. And not only that, the number of large partnerships has
increased by nearly 600% to more than 20,000. 

[Holly Hobbs:] What do we know about the potential impacts of this shift
on tax revenues?

[Jay McTigue:] That's a great question, Holly, because partnerships
generally do not pay income taxes. Rather, they pass their income and
losses to their partners who report that income on their individual tax
returns. The partnership losses can also be used by partners to offset
other income and reduce their tax liability.

[Holly Hobbs:] Our report talks about not just these partnerships, but
large, complex partnerships. What does that mean and what does that look
like?

[Jay McTigue:] Right, right. So for our report, we defined large
partnerships as those with $100 million or more in assets and 100 or
more partners. And what we found is that the majority of these large
partnerships were in financial services, insurance, in real estate. And
so together, these three sectors accounted for about 84% of all large
partnerships. 

[Holly Hobbs:] So from the IRS's perspective, it seems like auditing one
corporation would be much easier, less work than auditing hundreds of
partnerships, right? 

[Jay McTigue:] Yes. You know. Many large partnerships have multiple
levels or what we call tiers of partnerships, each of which can have
hundreds or thousands of partners. And in fact, more than 6,000 large
partnerships that we looked at from tax year 2019 had more than 20 tiers
of partnerships. And then, in addition to tiers, partnerships can also
be structured so that income and business expenses from a partnership
might actually loop back into the structure or even into a different tax
year. So, the IRS must trace transactions or income and losses through
each of the tiers to get to the ultimate partners, who are going to
record any income or losses on their individual tax returns.

[Holly Hobbs:] So how often does IRS audit these partnerships, and what
were the results of those audits?

[Jay McTigue:] So actually, surprisingly, IRS audits fewer large
partnerships compared to large C corporations, even though, as we've
talked about, partnerships have become a more common type of business
entity. While, the audit rates for all taxpayers have fallen over the
past decade, the decline in audit rate for large partnerships has really
been dramatic. IRS has pointed to the reduced funding as the reason for
this decline. But while the decline is unsettling, the results of the
audits is also concerning. We found that about 80% of the partnership
audits did not find any tax noncompliance. That's about double what IRS
has been finding when it audits the large corporations. And this may
suggest that IRS isn't selecting the riskiest returns to audit or it
isn't able to find noncompliance in these businesses within the time it
has under law to examine these returns.

[Holly Hobbs:] So, the IRS has said it wants to audit more partnerships.
How is it planning to do this?

[Jay McTigue:] So in this area, there is some encouraging news because
IRS has taken some steps to counter the declining audit rate, and
Congress has provided funding to support these efforts. IRS is
establishing what it's calling the Large Partnership Compliance Program
to focus on the largest of the large partnerships. And then secondly,
IRS is also developing a broader partnership strategy to increase audit
rates for all partnerships. And these initiatives have been incorporated
into IRS's strategic operating plan that it released back in April. And
that plan outlines how IRS will use the resources Congress provided in
the Inflation Reduction Act, which included over $45 billion for
enforcement activities. 

{MUSIC}

[Holly Hobbs:] So Jay just told us that while the number of large,
complex business partnerships has grown dramatically, the number of
audits of these entities has shrunk. But that the IRS is taking action
to increase its audit efforts. So, Jay, what more do we think IRS should
be doing to improve its oversight of business partnerships?

[Jay McTigue:] So, Holly, in our report, we identified several actions
that Iris should take to increase the effectiveness of these large,
complex partnership audits and reduce the tax gap. First, we think that
IRS should develop a working definition of large, complex partnerships
to guide their enforcement and compliance initiatives. Secondly, IRS
should also refine the models and processes it uses to identify
compliance risks to better select partnerships for audit. And then
finally, IRS should develop and implement measures to track progress
toward the goals identified in the strategic operating plan in order to
track the resources use in the results achieved.

[Holly Hobbs:] And last question, what's the bottom line of our report?

[Jay McTigue:] The bottom line is that the low rate at which IRS has
audited large partnerships does raise concerns about IRS's ability to
ensure tax compliance among these businesses and reduce the tax gap,
particularly at a time when, you know, partnerships are becoming an even
more significant part of our economy and are increasing in size and
complexity. IRS has made expanding audits of large complex partnerships
a key part or a key focus of the investment Congress has provided in the
Inflation Reduction Act. And it can use the findings and recommendations
in our report to help ensure that it achieves that goal. 

[Holly Hobbs:] That was Jay McTigue talking about our new report on
large, complex partnerships. Thanks for your time, Jay.

[Jay McTigue:] Awe, thank you, Holly.

[Holly Hobbs:] And thank you for listening to the Watchdog Report. To
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