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US Budget Deal Would Alter IRS Partnership Auditing

by Mike Godfrey, Tax-News.com, Washington

29 October 2015


Current difficulties experienced by the Internal Revenue Service (IRS) in auditing large partnerships, including private equity and hedge funds, could be reduced by the bipartisan US Budget proposals revealed on October 27, providing they are approved.

Some USD9bn of additional tax revenue over the next 10 years is expected to be provided from increased tax compliance by such firms, to fund part of the increased spending plans within the two-year Bipartisan Budget Bill of 2015.

A Government Accountability Office (GAO) report in September last year noted that the number of large partnerships – those with 100 or more partners and assets exceeding USD100m – tripled to 10,099 in the period from 2002 to 2011. They then had total assets of over USD7.5 trillion. Taxed on a pass-through basis, with income reported on partners' income tax returns, nearly two-thirds also had more than 1,000 direct or indirect partners and six or more tiers. Almost three-quarters of large partnerships were active in the finance and insurance sector.

However, the GAO also found that the IRS experienced serious difficulties in auditing large partnership, due to their complexity. In fiscal year 2012, IRS audited only 0.8 percent of large partnerships, compared to a 27.1 percent audit rate for C corporations with USD100m or more in assets.

According to a summary of the Bipartisan Budget Bill of 2015 by the House of Representative Rules Committee, the three different methods that currently exist for auditing partnerships would be reduced to one in most cases. The new framework would be delayed for two years, and apply to returns filed for partnership tax years beginning after 2017.

The Rules Committee explained that, at present, for partnerships with 10 or fewer partners, the IRS generally applies the audit procedures for individual taxpayers, auditing the partnership and each partner separately.

For most partnerships with more than 10 partners, the IRS conducts a single administrative proceeding (under the so-called TEFRA rules) to resolve audit issues regarding partnership items that are more appropriately determined at the partnership level. The IRS then recalculates the tax liability of each partner in the partnership for the particular audit year.

However, the Committee confirmed that a third, more complicated, audit regime also applies to partnerships with 100 or more partners that choose to be treated as Electing Large Partnerships (ELPs) for reporting and audit purposes.

Under the new bill, the current TEFRA and ELP rules would be repealed, and the partnership audit rules would be streamlined into a single set of rules for auditing partnerships and their partners at the partnership level. Under this streamlined audit approach, the IRS would examine the partnership's items of income, gain, loss, deduction, credit and partners' distributive shares for a particular year of the partnership. Any adjustments would be taken into account by the partnership (not the individual partners).

It was added that partners would not be subject to joint and several liability for any liability determined at the partnership level. Partnerships would also have the option of demonstrating that the adjustment would be lower if it were based on certain partner-level information from the reviewed year rather than imputed amounts determined solely on the partnership's information in such year.

A partnership would have the option of initiating an adjustment for a reviewed year, such as when it believes additional payment is due or an overpayment was made.

TAGS: compliance | tax | investment | business | private equity | tax compliance | law | hedge funds | budget | Internal Revenue Service (IRS) | tax authority | legislation | United States | individual income tax | business investment | Tax

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