Levin, Wyden, McCain release GAO report showing large partnerships avoid IRS audits

WASHINGTON – The IRS audits less than one percent of large partnerships, even as the number and assets of such partnerships has more than tripled, according to a Government Accountability Office report [PDF] released today by Sen. Carl Levin, D-Mich.; Sen. Ron Wyden, D-Ore.; and Sen. John McCain, R-Ariz.

The report raises significant questions about whether the IRS is capable of detecting noncompliance and abusive tax schemes within large partnerships, which GAO defines as having $100 million or more in assets and 100 or more direct and indirect partners. GAO found that just 0.8 percent of large partnerships undergo an IRS audit; by comparison, GAO found 27 percent of traditional C corporations were audited in 2012. The number of large partnerships tripled from 2002 to 2011, while the number of C corporations fell by 22 percent.

The report was prepared at the request of Levin as chairman and McCain as ranking member, of the Senate Permanent Subcommittee on Investigations, and former Sen. Max Baucus, then-chairman of the Senate Finance Committee, which Wyden now chairs.

“Fairness is essential in our tax system. If the system isn’t fair, that undermines trust and weakens the system,” Levin said. “It doesn’t make sense for large corporations to face a nearly 30 times greater chance of an IRS audit than highly profitable large partnerships.”

“All points lead to the need for comprehensive, bipartisan tax reform and this is yet another example,” Wyden said. “With a boom in the creation of large partnerships – increasing 47 percent from 2002 to 2011 – and the decline in traditional C corporations, GAO makes a good case for revisiting how the tax code shields large partnerships from IRS audits. We need a 21st century tax code that is equitable to all taxpayers and the current system for partnerships makes it almost impossible to determine if they are paying their fair share.”

Partnerships function as “pass-through” entities – that is, the partnership does not pay income taxes itself, but is required to file information with the IRS so tax authorities can ensure that individual partners pay taxes on income they earn through the partnership. Auditing those filings is essential to ensuring that IRS collects taxes on partner income.

Large partnerships mostly escaping IRS scrutiny include hedge funds, private equity funds, and publicly traded partnerships. Many are active in the energy and investment fields. Some have revenues totaling tens of billions of dollars per year.

The GAO study found that:

  • Large partnerships are growing, not just in number and size, but in complexity. In 2012, they held more than $7.5 trillion in assets. One IRS official told GAO that there were more than 1,000 partnerships with more than a million partners in 2012.
  • IRS audited just 0.8 percent of large partnerships in 2012, compared to 27 percent of C corporations that met the same $100 million asset level GAO used to distinguish large partnerships.
  • IRS lacks data to adequately analyze possible tax compliance issues with such partnerships.
  • Administrative requirements of the Tax Equity and Fiscal Responsibility Act (TEFRA), now 32 years old, complicate large partnership audits and delay tax assessments which, by law, must be made within three years of the filing of a tax return. TEFRA also requires IRS to identify a “tax matters partner” to represent the partnership on tax issues, but many partnerships do not designate such a partner, and the effort to identify the tax matters partner in a complex partnership can take months.
  • IRS auditors say they lack the time and support to effectively audit large partnerships, in part because law and IRS regulations add significant time constraints.
  • Three projects IRS has launched to improve its audit procedures do not always follow planning principles that GAO has identified as likely to produce quality results.

GAO recommends that Congress consider changing provisions of TEFRA to reduce time constraints on the IRS, require partnerships to identify a tax matters partner on their tax returns, and enable the IRS to impose and collect audit adjustments at the partnership level, rather than requiring the IRS to collect taxes from each of what could be thousands of partners. Levin intends to introduce legislation that would make such changes.