IRS Ramping Up Compliance of Partnerships

Historical insight — Originally published July 31, 2024. Preserved as historical content; information may have changed.

The Internal Revenue Service (IRS) has recently taken significant steps to combat abusive partnership transactions, a move aimed at ensuring that high-income taxpayers and corporations pay their fair share of taxes. This announcement is part of a broader initiative to address high-income compliance issues, spurred by funding from the Inflation Reduction Act. The IRS’s new measures focus on curbing complex tax avoidance strategies used by wealthy individuals and entities through partnerships.

The IRS has established a dedicated group within the Office of Chief Counsel to develop guidance specifically for partnerships, aiming to close existing loopholes. This group will collaborate with a new pass-through work group in the IRS’s Large Business and International division, which will be officially formed this fall.

The IRS and the Department of the Treasury have also issued three pieces of guidance to address these issues, particularly targeting “basis shifting” transactions. These transactions involve high-income taxpayers and corporations moving the basis of assets between related-party partnerships to generate tax benefits without significant economic changes, allowing them to avoid taxes.

The Treasury Department estimates that these abusive transactions could cost taxpayers over $50 billion in the next decade.

To counter this, the IRS is ramping up audits on complex partnerships and enhancing the skills of their examiners to better identify these issues.

This effort is supported by the new guidance, which aims to clarify the rules for both taxpayers and IRS examiners. When final regulations are issued, increased reporting requirements under the Transactions of Interest (TOI) will provide the IRS with greater insight into these complex arrangements.

The IRS’s renewed focus on partnerships marks a significant shift in its compliance strategy. Over the past decade, budget cuts have hampered the agency’s ability to effectively oversee partnerships, leading to a decline in audit rates despite a sharp increase in filings from high-asset pass-through businesses.

To address this, the IRS is leveraging Inflation Reduction Act funds to bolster enforcement and add expertise in this area. This includes launching audits on some of the largest partnerships, such as hedge funds, real estate investment partnerships, and publicly traded partnerships.

As part of these efforts, the IRS Chief Counsel Margie Rollinson announced the creation of a new Associate Office focused exclusively on partnerships, S-corporations, trusts, and estates.

This office will work closely with IRS business units to enhance compliance in these areas.

Additionally, the IRS plans to bring in external experts with private-sector experience to complement the in-house knowledge of current IRS employees.

Investors in partnerships need to be acutely aware of the recent IRS steps to combat abusive partnership transactions, as these measures could significantly impact their financial and tax planning strategies. The IRS’s new focus includes identifying and addressing “basis shifting” transactions, where high-income taxpayers and corporations manipulate asset bases within related-party partnerships to generate tax benefits without substantial economic change.

Investors should understand that such practices, if part of their strategy, are now under increased scrutiny and could lead to substantial tax liabilities, penalties, and interest if deemed abusive by the IRS.

In addition, investors should expect more rigorous oversight and a higher likelihood of audits. Investors should ensure that their partnership dealings are fully compliant and well-documented, as the IRS will be focusing on uncovering complex arrangements designed to avoid taxes.

Finally, investors in partnerships should work closely with their financial and tax professionals to review their current structures and strategies to ensure they are not inadvertently engaging in practices that could be interpreted as abusive.

In light of these developments, investors should also prepare for the possibility of increased reporting requirements. When the final regulations are issued, the Transactions of Interest (TOI) guidelines will require more detailed disclosures, giving the IRS greater insight into partnership arrangements.

By staying informed and proactive, investors can mitigate risks, ensure compliance, and navigate the evolving regulatory landscape effectively.

Content in this material is for educational and general information only and not intended to provide specific advice or recommendations for any individual.

This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.

This article was prepared by FMeX.

LPL Tracking #593922