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
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.
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.
Matter for Congressional Consideration
|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.||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.|
|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.||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. 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. The legislation specifies that the new partnership audit procedures apply to partnership returns filed for tax years beginning after December 31, 2017. In August 2018, IRS released the final regulations on the partnership audit regime (section 6223-- notice to partners of proceeding T.D.9839), including section 301.6223-1 which has provisions on designating a qualified representative who is an individual and keeping the designation up to date (e.g., section 301.6223-1(b)(3)), as indicated in GAO's report.|
Recommendations for Executive Action
|Internal Revenue Service||
Priority Rec.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.
|Internal Revenue Service||
Priority Rec.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.
|Internal Revenue Service||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.|
|Internal Revenue Service||The Commissioner of Internal Revenue should use existing authority to promptly designate the TMP under the largest profits interest rule or some other criterion.|
|Internal Revenue Service||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.|
|Internal Revenue Service||The Commissioner of Internal Revenue should clarify how and when field auditors can access refresher training on TEFRA audit procedures and partnership tax law.|
|Internal Revenue Service||
Priority Rec.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.
|Internal Revenue Service||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.|