Large Partnerships:

With Growing Number of Partnerships, IRS Needs to Improve Audit Efficiency

GAO-14-732: Published: Sep 18, 2014. Publicly Released: Sep 18, 2014.

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What GAO Found

The number of large partnerships has more than tripled to 10,099 from tax year 2002 to 2011. Almost two-thirds of large partnerships had more than 1,000 direct and indirect partners, had six or more tiers and/or self reported being in the finance and insurance sector, with many being investment funds.

The Internal Revenue Service (IRS) audits few large partnerships. Most audits resulted in no change to the partnership's return and the aggregate change was small. Although internal control standards call for information about effective resource use, IRS has not defined what constitutes a large partnership and does not have codes to track these audits. According to IRS auditors, the audit results may be due to challenges such as finding the sources of income within multiple tiers while meeting the administrative tasks required by the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) within specified time frames. For example, IRS auditors said that it can sometimes take months to identify the partner that represents the partnership in the audit, reducing time available to conduct the audit. TEFRA does not require large partnerships to identify this partner on tax returns. Also under TEFRA, unless the partnership elects to be taxed at the entity level (which few do), IRS must pass audit adjustments through to the ultimate partners. IRS officials stated that the process of determining each partner's share of the adjustment is paper and labor intensive. When hundreds of partners' returns have to be adjusted, the costs involved limit the number of audits IRS can conduct. Adjusting the partnership return instead of the partners' returns would reduce these costs but, without legislative action, IRS's ability to do so is limited.

Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) Audit Timeline

Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) Audit Timeline

Note: A 3-year statute of limitations governs the time IRS has to conduct partnership audits, which is about equally split between the time from when a return is received until the audit begins and the time to do the audit. IRS then has a year to assess the partners their portion of the audit adjustment.

IRS has initiated three projects—one of which is under development—to make large partnership audit procedures more efficient, such as identifying higher risk returns to audit. However, the two projects implemented were not developed in line with project planning principles. For example, they do not have clear and measurable goals or a method for determining results. As a consequence, IRS may not be able to tell whether the projects succeed in increasing audit efficiency.

Why GAO Did This Study

More businesses are organizing as partnerships while fewer are C corporations. Unlike C corporations, partnerships do not pay income taxes but pass on income and losses to their partners. Large partnerships (those GAO defined as having $100 million or more in assets and 100 or more direct and indirect partners) are growing in number and have complex structures. Some partnerships create tiers of partnerships with hundreds of thousands of partners. Tiered large partnerships are challenging for IRS to audit because tracing income through the tiers to the ultimate partners is complex.

GAO was asked to assess IRS's ability to audit large partnerships. GAO's objectives include: 1) determine what IRS knows about the number and characteristics of large partnerships, 2) assess IRS's ability to audit them, and 3) assess IRS's efforts to address the audit challenges. GAO analyzed IRS data from 2002 to 2011 and IRS audit documentation, interviewed IRS officials, met with IRS auditors in six focus groups, and interviewed private sector tax lawyers knowledgeable about partnerships.

What GAO Recommends

Congress should consider requiring large partnerships to identify a partner to represent them during audits and to pay taxes on audit adjustments at the partnership level. IRS should take multiple actions, including: define large partnerships, track audit results using revised audit codes, and implement project planning principles for the audit procedure projects. IRS agreed with all the recommendations, but noted that revision of the audit codes is dependent upon future funding.

 

Matters for Congressional Consideration

  1. Status: Closed - Implemented

    Comments: Legislation has been enacted that would alter TEFRA audit procedures as GAO suggested in September 2014. In October 2015, H.R. 1314 was amended to include the Bipartisan Budget Act of 2015 which included provisions that would repeal TEFRA audit procedures and put in place audit procedures that would require partnerships with more than 100 partners to pay audit adjustments at the partnership level, among other changes. In November 2015, the President signed this legislation into law.

    Matter: Congress should consider altering the TEFRA audit procedures to require partnerships that have more than a certain number of direct and indirect partners to pay any tax owed as determined by audit adjustments at the partnership level.

  2. Status: Open

    Comments: In October 2015, H.R. 1314 was amended to include the Bipartisan Budget Act of 2015, which included provisions that would repeal the TEFRA audit procedures and put in place new audit procedures for partnerships with more than 100 partners. This legislation was signed into law in November 2015. According to the legislation, the new audit procedures would require partnerships to designate a qualified representative for the partnership audit. However, the legislation did not require audited partnerships to identify a representative who is an individual nor do they require that audited partnerships keep the designation up to date as suggested in GAO's report. The legislation does give IRS the authority to develop regulations about how the partnership representative should be designated by the partnership and such regulations may address the items in GAO's report. Currently regulations are under development at IRS. The legislation specifies that the new partnership audit procedures apply to partnership returns filed for tax years beginning after December 31, 2017.

    Matter: Congress should consider altering the TEFRA audit procedures to require partnerships to designate a qualified Tax Matters Partner (TMP) and, if that TMP is an entity, to also identify a representative who is an individual and for partnerships to keep the designation up to date.

Recommendations for Executive Action

  1. Status: Open

    Priority recommendation

    Comments: No executive action taken. IRS said that it plans to address parts of GAO's September 2014 recommendation about tracking the audit results on large partnerships but has not yet done so. In November 2014, IRS said that it plans to define large partnerships using asset size and the number of partners and to find an alternative method to account for field and campus large partnership cases using existing capabilities, but that revising IRS's activity codes to enable it to track large partnership audits would be dependent on future funding. In December 2016 , IRS told GAO that it would need until September 2017 to address this recommendation. Section 1101 of the Bipartisan Budget Act of 2015 (Public law 114-74), which was enacted in November 2015, includes provisions that repeal TEFRA audit procedures and put in place audit procedures that would require partnerships with more than 100 partners to pay audit adjustments at the partnership level, among other changes. IRS explained that these changes significantly alter the procedural and administrative components of partnerships. IRS said it would need this additional time to analyze options and determine the most appropriate steps for effectively tracking the results of large partnership audits. Without these changes, IRS cannot conduct analysis to identify ways to better plan and use IRS resources in auditing large partnerships as well as analyze whether large partnerships present a high noncompliance risk.

    Recommendation: The Commissioner of Internal Revenue should track the results of large partnerships audits: (a) define a large partnership based on asset size and number of partners; (b) revise the activity codes to align with the large partnership definition; and (c) separately account for field audits and campus audits.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  2. Status: Open

    Priority recommendation

    Comments: As of October 2016, the Internal Revenue Service (IRS) said that based on completion of GAO's recommendations on tracking results and after sufficient large partnership audit results have been obtained, it still plans to conduct a study to analyze these results and recommend any ways in which resource use can be improved. IRS is expected to complete this analysis by September 2018.

    Recommendation: The Commissioner of Internal Revenue should analyze the audit results by these activity codes and types of audits to identify opportunities to better plan and use IRS resources in auditing large partnerships.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  3. Status: Closed - Not Implemented

    Comments: In December 2015, the Internal Revenue Service (IRS) provided documentation, which was shared with IRS staff to ensure they submit the documentation needed in a timely manner to establish the TEFRA audit on the Partnership Control System. In following up with IRS on the documentation in March 2016, IRS officials said the 45-day rule has not been extended but rather they attempted to improve IRS staff's understanding of the 45-day rule. In addition, IRS determined that extending the 45-day rule would not accomplish or improve the examination process.

    Recommendation: The Commissioner of Internal Revenue should extend the 45-day rule to give field audit teams more flexibility on when to withdraw an audit notice.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  4. Status: Open

    Comments: In December 2015, the Internal Revenue Service (IRS) provided documentation of initiatives which were implemented that IRS said would assist in the early identification of the Tax Matters Partner (TMP). Theses included (1) revisions to an IRS publication to include examples illustrating how a person designated as TMP should sign IRS documents on behalf of the partnership, (2) developing a TMP information document request form to help IRS identify and validate the proper TMP early in the process, (3) adding lines to form 1065 to request TMP contact information, and (4) developing a new initial contact letter to the verify contact information of the TMP from the partnership. Additionally, IRS Chief Counsel issued guidance advising how audit teams can proceed with an exam even when the TMP cannot be identified or determined under regulations. While all of these changes should help IRS identify the TMP earlier in the audit or move forward on the audit without a TMP initially, none of these changes directed IRS staff to use its existing authority to designate the TMP under the largest profits rule or some other criterion. In March 2016, IRS officials confirmed this by saying that IRS decided to improve guidance for IRS staff attempting to identify the TMP rather than change, alter, or promote the use of the largest profits interest rule or IRS's own authority more broadly to identify the TMP.

    Recommendation: The Commissioner of Internal Revenue should use existing authority to promptly designate the TMP under the largest profits interest rule or some other criterion.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  5. Status: Open

    Comments: In December 2016, the Internal Revenue Service (IRS) provided documentation on how it plans to track requests from large partnership audits for specialists, TEFRA coordinators, and Chief Counsel help within the Large Business & International (LB&I) division. For example, Chief Counsel added a code to their existing reporting systems to track large partnership audits, the Small Business/Self Employed (SB/SE) division began manually tracking requests for TEFRA coordinators associated with large partnerships audits, and LB&I specialist system added a sub-issue category for large partnerships audits. These changes were made in August and September 2016. In addition, IRS also shared guidance clarifying the expected response times for large partnerships audits when requesting chief counsel, TEFRA coordinator and partnership specialist help. This guidance was published in LB&I Frontline News on October 24, 2016 and posted on the SB/SE's website as technical news on November 9, 2016. However, IRS did not share documentation for how it plans to use this new tracking information when planning the number and scope of large partnership audits.

    Recommendation: The Commissioner of Internal Revenue should help field auditors for large partnership audits receive the support they request from counsel staff, TEFRA coordinators, and IRS specialists: (a) track the number of requests and time taken to respond; (b) clarify when responses to their requests should be expected; and (c) use the tracked and clarified information when planning the number and scope of large partnership audits.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  6. Status: Closed - Implemented

    Comments: In December 2015, the Internal Revenue Service (IRS) provided documentation showing that it has (1) emphasized the availability of TEFRA training and resources to support staff by reformatting its website, (2) issued multiple notices for managers reminding them of the availability of TEFRA resources and training for staff, and (3) sent direct emails to IRS staff that have been assigned to TEFRA partnership audits and their managers reminding them of the training.

    Recommendation: The Commissioner of Internal Revenue should clarify how and when field auditors can access refresher training on TEFRA audit procedures and partnership tax law.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  7. Status: Open

    Comments: In September 2016, the Internal Revenue Service (IRS) provided documentation of its Campaign Development Form, which is a risk-based methodology for improving taxpayer compliance (i.e., "campaigns"). The new campaign process aligns with the five project planning principles. However, IRS did not provide documentation of how this process has been applied to any large partnership efforts. IRS said that the application of this process to large partnership efforts is still underway and it should have documentation at some point in early 2017.

    Recommendation: The Commissioner of Internal Revenue should develop and implement large partnership efforts in line with the five leading principles for project planning and track the results to identify whether the efforts worked as intended.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  8. Status: Closed - Implemented

    Comments: In December 2015, the Internal Revenue Service (IRS) provided documentation that showed how it incorporated the Enterprise Risk Management (ERM) structure into the Large Business and International (LB&I) division. IRS officials said that LB&I encourages its employees to play an active role in identifying and assessing risks that may affect LB&I. In August 2016, IRS provided documentation that showed how the LB&I ERM process identified large partnerships as a risk in the context of the new partnership audit procedures from the Bipartisan Budget Act of 2015. It was identified as a risk as part of the May 2016 LB&I Risk Government Board, added to LB&I's risk register, and IRS is developing on a mitigation strategy.

    Recommendation: The Commissioner of Internal Revenue should make and document a determination about how large partnerships are to be incorporated into the Enterprise Risk Management process.

    Agency Affected: Department of the Treasury: Internal Revenue Service

 

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