U.S. Budget Clears Way for IRS Audits of Partnerships

U.S. Budget Clears Way for IRS Audits of Partnerships

The new rules will shift some of the burden of auditing and dividing up the tax liabilities among partners from the IRS to the partnership itself.

Tucked away near the very end of the Bipartisan Budget Act of 2015 is a section that could make it easier for Internal Revenue Service agents to audit private-equity firms, hedge funds, and other large, intricately structured partnerships.

Seen as an attempt to raise revenue for the politically imperiled Congressional budget deal that finally became law on Monday, the provision would shift certain administrative burdens from the IRS to partnerships of 100 or more partners.

Often constructed in complex organizational “tiers” of partners and administrative entities, large partnerships have been increasingly resistant to audits by the IRS, according to a widely cited 2014 report by the U.S. Government Accountability Office. From 2002 to 2011, the number of these organizations more than tripled to 10,099, according to the report.

Almost two-thirds of them had more than 1,000 direct and indirect partners (partners that have an interest in a partnership through interest in another partnership) and had six or more tiers. Most are in the finance industry, including private equity firms and hedge funds, and in insurance.

As a result of the challenges presented by the complexity of the entities and the cumbersomeness of its own audit procedures, the IRS audits few large partnerships. Citing IRS data for fiscal year 2012, the GAO reported that the federal tax service completed a mere 84 field audits, or a 0.8% audit rate. That audit rate is well below the 27.1% rate for the same year for C corporations with $100 million or more in assets. Read more on CFO.