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
“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
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 types of taxpayers 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 auditing and training those personnel.
“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
“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 bite 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.”
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