When people in Southern California think of an Internal Revenue Service audit, they may picture an agent grimly scrutinizing a taxpayer's Form 1040, inquiring perhaps whether the person was eligible to claim certain deductions. While the IRS does perform tax audits of individual tax returns, it also spends a significant percentage of its resources on examining the returns of corporations.
In fact, approximately one-fifth of the IRS's examination budget is allocated to auditing the returns of over 800 large C corporations. But these audits return a disproportionately large amount of revenue in proportion to the resources devoted to them. The IRS creates nearly 66 percent of its adjustments to taxes from audits of these companies
A "C corporation" is a particular tax classification that determines a business's tax treatment under the Internal Revenue Code. The distinguishing feature of a C corporation is double taxation. Businesses under this heading are considered their own taxable entities, and they pay taxes just like an individual person. And when a company distributes profits to shareholders, that gain is considered taxable to the recipients, resulting in the double tax.
There are other classifications available under the IRC. For example, partnerships are largely taxed according to distinct and highly complex rules found in Subchapter K of the IRC. Tax treatment is just one thing to consider among a host of other legal issues when deciding whether to organize a business as a partnership, a corporation or a limited liability entity.
According to a recent article in Tax Notes, the IRS is currently unable to devote as much auditing capacity to large partnerships, which include a number of investment funds. It is unknown whether the IRS would shift more resources to audit some of these entities if more businesses were to adopt the partnership structure of organization as opposed to the corporation structure.
Source: Accounting Today, "Large Investment Fund Partnerships Elude IRS Audits," Michael Cohn, July 24, 2012.