The Internal Revenue Service is ramping up its scrutiny of large partnerships, leveraging increased funding under the Inflation Reduction Act of 2022.
Last year, the IRS announced a restructured leadership to support its Strategic Operating Plan and use the increased funding from the IRA. The new structure aligns with the agency’s initiative to beef up enforcement for large corporations, complex partnerships, and high-net-worth individuals. To facilitate this, the IRS established a new team within its Large Business and International Division, focusing on audits and compliance for partnerships and similar entities, with more agents trained to handle complex partnership returns, a key enforcement priority for the agency.
“There is a special initiative with the large partnership compliance program, and for that the IRS announced they have selected 76 entities, and they’re doing large partnership audits,” said Rochelle Hodes, principal in the Washington national tax office at Crowe LLP, a Top 25 Firm based in Chicago. “But that’s a special category. What we’ve seen in partnership audits is generally an increase.”
She recently shared her insights with Accounting Today on the main takeaways for taxpayers involved in partnerships to ensure compliance and successfully navigate partnership audits amid increased scrutiny. She also recently discussed this topic in an Insight article for Crowe that can be found here.
The IRS headquarters in Washington, D.C.
Andrew Harrer/Bloomberg
“I expect that we’ll start to see the results of the IRS having better trained agents and better behind-the-scenes issue selection,” she added. “I expect we’re going to start seeing that in the examinations as well.”
The IRS has been training more people to do these types of complex examinations and audits thanks to the Inflation Reduction Act funding. “They were working with a very skinny staff before the IRA money allowed them to hire, so they were basically operating, in some respects, with one hand behind their back,” said Hodes. “Because partnerships are sophisticated and because they have the various operating divisions in LB&I, they were taking their auditors who were more experienced, who basically were corporate. They knew issues that corporations had, and so you’re taking these people who had been doing exams in a certain way and focusing on certain issues, and they moved them over, and they didn’t provide very much training.”
The IRS had also been auditing partnerships in its Small Business/Self-Employed Division. “Then you have the small business auditors who were focusing on a lot of their bread and butter issues, which if the partnership you selected was an operating partnership that operated a business that made sense,” said Hodes. “Issues like employment, tax and certain accounting method things, those would be normal for them, but I think that they just completely missed the mark because they were not trained either on partnership issues. Now we have a change.”
A new Pass-through Entities Practice Area group in LBI led by Cliff Scherwinski is combining the SB/SE and the LBI resources for audition and training those personnel.
Rochelle Hodes
“I think the result is going to be potentially a better trained examination workforce for partnerships, more agents focused on partnerships, and more consistency in what the taxpayer experiences when they have an examiner doing the partnership exam, and I think that’s a good thing,” said Hodes.
The new approach overlaps with the implementation of a centralized partnership audit regime at the IRS. The Bipartisan Budget Act of 2015 allowed the IRS to set up a centralized partnership audit regime, although the process took much longer than expected.
“The other thing that we saw in the beginning of this whole thing with BBA coming in, the BBA procedures for conducting an examination are different in a number of ways, and my experience was most of the agents had no idea what the BBA procedures were, and I think they were given very few tools to help them with that,” said Hodes. “There also was not a lot of process, so there wasn’t a lot of consistency. I think we’ve started to see much more consistency. We’ve started to see teams training. Being an auditor, being an examiner, is a skill set in itself, notwithstanding the subject matter that you do it in or the division that you’re in. We’re seeing some of this knowledge transfer. We’re seeing some consistency, and I think the IRS will proceed further with that. Truthfully, that’s a good thing for the taxpayer as well. At least if you’ve got to be audited, you want to be audited by people who know what they’re talking about, who know what the procedures are supposed to be, because for a lot of taxpayers, this will be their first exam for many partnerships, and it will be their first exams under the BBA procedures. So it’d be very nice if they could rely on the IRS knowing what they’re doing. And I think we’re going to see a smoother process. While it’s not wonderful to be audited, at least if the process is smoother, and you have knowledgeable folks who are performing the exam, it can take that little bit of pain out of the examination.”
She is seeing more consistency under the BBA regime.
“One of the things that is different is the idea of an examination is consistent throughout,” said Hodes. “You get selected, the IRS goes and asks you questions with information document requests, IDRs. And then the agent might go to specialists or not, but will identify issues that they’re concerned about. You talk about those issues, then the IRS agent will let you know what they think their issues are going to be. The way things worked in a corporate exam in LB&I, it was a notice of proposed adjustment. But before that, there was an informal process where the agent would give a draft and sort of write up their issues to the taxpayer, in order to get the taxpayer’s response and work through to see if there really are any issues, to get an idea of this potential agreement and to try to really fine-tune before they got to the notice of proposed adjustment, BBA has statutorily got this notice of proposed partnership adjustment, so that’s a similar process. But then LB&I put it into their processes. They formalized that preliminary or draft as a step in the BBA process, and that step starts the clock to request an appeal on the substantive issues, formalizing that sort of draft or preliminary NOPPA, but the names are different on these things, and the notice of proposed partnership adjustment also comes with a draft, as does the preliminary draft of the imputed underpayment computation as well. There are the substantive issues. And then how, under the uniqueness of BBA, they compute whatever tax is supposed to be due, which is the imputed underpayment. So those are other differences. And then, once the notice of proposed partnership adjustment is issued, that then starts a 270-day clock for the taxpayer to request modification.”
She noted that if a taxpayer requests a modification and it’s denied, the taxpayer will have another opportunity to go to the IRS Appeals office about the denial of the modification. “It’s not a second fight for issues that you already went into Appeals for, but it’s that two opportunities to go to Appeals that are unique,” said Hodes.
There are some similarities as well as differences. “After the modification process is over, then you get whatever now your adjustments and imputed underpayment is post modification,” said Hodes. “You’ve got this final partnership adjustment, which looks a little bit in the TEFRA [Tax Equity and Fiscal Responsibility Act of 1982] space like the final FPA. You’ve got the final notice, and that has an equivalent in the corporate space or the individual space with the notice of deficiency. And so those are your ticket to go to court. Within 90 days, you have to ask to go to court. That’s a similarity. There’s this final determination by the IRS, and once they give it to you, you get 90 days to say if you go to court. Another difference in BBA is you’ve got 45 days to make an election of whether or not you want to push out the adjustments, if you want to make that pushout election, and that 45 days is a strict date, and it runs concurrent with that 90 days. So in the first 45 days after you get an FPA, you’ve got to decide, am I going to push out, or is it possible I might want to push out. Then, if it is possible, you’ve got to make the election. And then within that 90-day period, which 45 days is running as well. So you’ve got these two time frames running at the same time. You then decide whether or not you want to go to court.”
She sees that as another major difference. “After you get your final partnership adjustment, you’ve got two decisions: Do I push out? Do I go to court? There’s a bunch of other stuff, but those are the big changes in process.”
However, the November election is likely to have an impact on partnership audits. “Depending who wins in Congress and the White House and whether and how the negotiations on TCJA expiring provisions go, we could see some form of partnership legislation,” said Hodes.
She pointed to several possible wrinkles. “Carried interest has been a hot issue for a long time,” said Hodes. “Senator [Ron] Wyden had a whole partnership reform bill at one point that could come back to life, and you have the administration’s Green Book that has a bunch of partnership updates, so there’s a lot of potential for continued change. And then you have the IRS SECA [Self-Employment Contributions Act] issue with LPs. That’s a super hot issue right now. A lot going on. You’ve got the basis-shifting proposed regs that they put out. That’s sort of bubbling up over there. You have IRS talking about being concerned with disguised sales and wanting to do new guidance on that. On the guidance front too, there’s potential for more change in the partnership space. And then the TCJA expiring provisions are mostly individual provisions, but 199(A) is supposed to expire at the end of 2025. Huge in the pass-through space. [Section] 461(l), which limits business losses that can be claimed by noncorporate taxpayers is a huge passthrough issue. 461(l) is supposed to expire, I think, at the end of ’28. Will that be extended as part of raising revenue in order to get to a deal in TCJA? Who knows? There are all kinds of passthrough-specific things that are also swirling around. If I’m in a partnership or passthrough or I am someone who is heavily involved in passthrough entities or has significant investments in passthrough entities, I’m watching all of this stuff, and there’s so much change.”
Her firm, Crowe, has a campaign called “Embrace Volatility.” “Certainly for passthrough entities, that is the way they should think about stuff,” said Hodes.
She also sees implications in the international space. “A lot of the international rules are going to be dealing with pass-through non-U.S. entities,” said Hodes. “How are global MNCs or MNEs [multinational companies or enterprises] going to be dealing with components of their structure that are pass-through entities? The rules are, in some cases, very uncertain, and in other cases very unfavorable. There’s a lot affecting pass-through entities in the international space. One of the biggest tax issues right now is the taxation of passthrough entities. I think that’s just huge right now, because everything’s so up in the air, and the IRS is really starting to focus.”
The House unanimously passed four bipartisan bills Tuesday concerning taxes and the Internal Revenue Service that were all endorsed this week by the American Institute of CPAs, and passed two others as well.
H.R. 1152, the Electronic Filing and Payment Fairness Act, sponsored by Rep. Darin LaHood, R-Illinois, Suzan Delbene, D-Washington, Randy Feenstra, R-Iowa, Brad Schneider, D-Illinois, Brian Fitzpatrick, R-Pennsylvania and Jimmy Panetta, D-California. The bill would apply the “mailbox rule” to electronically submitted tax returns and payments to allow the IRS to record payments and documents submitted to the IRS electronically on the day the payments or documents are submitted instead of when they are received or reviewed at a later date. The AICPA believes this would offer clarity and simplification to the payment and document submission process while protecting taxpayers from undue penalties.
H.R. 998, the Internal Revenue Service Math and Taxpayer Help Act, sponsored by Rep. Randy Feenstra, R-Iowa, and Brad Schneider, D-Illinois, which would require notices describing a mathematical or clerical error to be made in plain language, and require the Treasury to provide additional procedures for requesting an abatement of a math or clerical error adjustment, including by telephone or in person, among other provisions.
H.R. 517, the Filing Relief for Natural Disasters Act, sponsored by Rep. David Kustoff, R-Tennessee, and Judy Chu, D-California. The process of receiving tax relief from the IRS following a natural disaster typically must follow a federal disaster declaration, which can often come weeks after a state disaster declaration. The bill would provide the IRS with authority to grant tax relief once the governor of a state declares either a disaster or a state of emergency and expand the mandatory federal filing extension under Section 7508(d) of the Tax Code from 60 days to 120 days, providing taxpayers with more time to file tax returns after a disaster.
H.R. 1491, the Disaster related Extension of Deadlines Act, sponsored by Rep. Gregory Murphy, R-North Carolina, and Jimmy Panetta, D-California, would extend the amount of time disaster victims would have to file for a tax refund or credit (i.e., the lookback period) by the amount of time afforded pursuant to a disaster relief postponement period for taxpayers affected by major disasters. This legislative solution would place taxpayers on equal footing as taxpayers not impacted by major disasters and would afford greater clarity and certainty to taxpayers and tax practitioners regarding this lookback period.
“The AICPA has long supported these proposals and will continue to work to advance comprehensive legislation that enhances IRS operations and improves the taxpayer experience,” said Melanie Lauridsen, vice president of tax policy and advocacy for the AICPA, in a statement Tuesday. “We are pleased to work closely with each of these Representatives on common-sense reforms that will benefit taxpayers, tax practitioners and tax administration and we’re encouraged by their passage in the House. We look forward to continuing to work with Congress to improve the taxpayer experience.”
The House also passed two other tax-related bills Tuesday that weren’t endorsed in the recent AICPA letter.
H.R. 1155, Recovery of Stolen Checks Act, sponsored by Rep. Nicole Malliotakis, R-New York, would require the IRS to create a process for taxpayers to request a replacement via direct deposit for a stolen paper check. If a check is determined to be stolen or lost, and not cashed, a taxpayer will receive a replacement check once the original check is cancelled, but many taxpayers are having their replacement checks stolen as well. Taxpayers who have a check stolen are then unable to request that the replacement check be sent via direct deposit. The bill would require the Treasury to establish processes and procedures under which taxpayers, who are otherwise eligible to receive an amount by paper check in replacement of a lost or stolen paper check, may elect to receive such amount by direct deposit.
H.R. 997, National Taxpayer Advocate Enhancement Act, sponsored by Rep. Randy Feenstra, R-Iowa, would prevent IRS interference with National Taxpayer Advocate personnel by granting the NTA responsibility for its attorneys. In advocating for taxpayer rights, the National Taxpayer Advocate often requires independent legal advice. But currently, the staff members hired by the National Taxpayer Advocate are accountable to internal IRS counsel, not the Taxpayer Advocate, creating a potential conflict of interest to the detriment of taxpayers. The bill would authorize the National Taxpayer Advocate to hire attorneys who report directly to her, helping establish independence from the IRS.
House Ways and Means Committee Chairman Jason Smith, R-Missouri, applauded the bipartisan House passage of the various bills, which had been unanimously passed by the committee.
“President Trump was elected on the promise of finally making the government work better for working people,” Smith said in a statement Tuesday. “This bipartisan legislation helps fulfill that mandate and makes improvements to tax administration that will make it easier for the American people to file their taxes. Those who are rebuilding after a natural disaster particularly need help filing taxes, which is why this set of bills lightens the load for taxpayers in communities struck by a hurricane, tornado or some other disaster. With Tax Day just a few days away, we must look for common-sense, bipartisan ways to make filing taxes less of a hassle.”
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