Partnerships may become the next target of IRS audits

The Senate Permanent Subcommittee on Investigations has been on the hunt for those that avoid paying taxes. The committee has focused attention on offshore bank accounts over the last few years. Swiss banks have spent time in the hot seat and several have agreed to pay large fines for their participation in concealing U.S. taxpayer assets.

Recent hearings targeted Caterpillar's offshore profit shifting. A portion of Caterpillar's replacement-parts business profits were routed through a Swiss affiliate, which allowed the company to avoid $2.4 billion in U.S. taxes from 2000 to 2012. The company has argued that it simply used a tax loophole and what it did was legal. The committee is investigating whether what occurred was tax evasion instead of legal tax avoidance measures as the company argues.

Audit rate of large partnerships under scrutiny

The next target may be partnerships. The Government Accountability Office just released a report that found the Internal Revenue Service fails to audit the tax returns of 99 percent of large partnership that hold assets of more than $100 million. The number of partnerships has exploded and IRS audits have not kept pace.

According to GAO data, between 2002 and 2011, the number of partnerships with more than 100 partners or assets of more than $100 million increased more than 200 percent. The amount of assets held in these business organizations is staggering - approximately $2.3 trillion in assets and $68.9 billion in net income. The average number of direct partners and asset size increased during this time frame.

The preliminary report found that in 2012, IRS field agents reviewed the records of less than one percent of large partnership returns. In fiscal year 2007, there were only 11 field audits of large partnerships. That number increased to 31 in fiscal 2013. Campus audits which are not as comprehensive and do not include a review of books and records increased from 42 to 143 over the same period of time.

Tighter budgets and fewer staff effects number of audits

The GAO will look at why so few audits have been conducted and whether it has to do with the Tax Equity and Fiscal Responsibility Act contributing to expensive, time-consuming audits of partnerships. The IRS is also limited in its audit efforts by budget constraints. IRS commissioner John Koskinen noted in hearings that individual tax return audits were at the lowest rate since 2005 due to cuts in the budget over the last several years.

Even though the number of partnership audits has been low, with new congressional scrutiny these entities may expect closer oversight similar to offshore bank accounts. If your partnership receives a letter from the IRS, contact an experienced tax attorney to discuss your next steps and what to expect in dealing with an IRS revenue agent or officer.