Businesses Structured as Partnerships Could Have Increased Tax Audit Risk in 2023
The Biden Adminstration, passed a bill last year called the Inflation Reduction Act, which allocated billions in funding and beefing up the IRS over the next decade to go after high net worth individuals to pay their “fair share”. Today, the IRS is steadily cracking down on tax evasion and fraud focusing on high-net-worth filers and now non-filers with complex income structures. The Global High Wealth Industry Group (GHW), a division of the IRS, was created in 2009 and its purpose is to audit, investigate, and collect taxes from high-net-worth individuals and their related entities. As noted by the IRS during their research on high-wealth noncompliance, economists and researchers have found the top 1% of the U.S. tax population have failed to report over 20% of income resulting in nearly $175 billion in unaccounted tax revenue each year. Accounting firm Forvis recently wrote an article stating within the IRS’ Global High Wealth Program Processes and Procedures, divisions are collaborating to examine red flags that may be correlated with abusive tax structures and transactions including, but not limited to, the following:
- Complex organizational structures
- Strategies and structures commonly used by individuals in the highest tax brackets to shelter income, claim deductions they are not entitled to, and commit other misreporting transgressions
- Financial enterprises and businesses with assets or earnings over $10 million
- Foreign and offshore financial assets and bank accounts
- Interests in complex partnerships, trusts, S-corporations, other pass-throughs, and foreign entities
- Relationships with private foundations
- Large gifts
Recently the accounting industry site CPA Practice Advisor, recently published an article about this topic, stating “many partnerships will find themselves subject to their first IRS audits under the new procedurally complex partnership audit rules. Under these rules, the default is that the partnership pays an entity-level tax called an “imputed underpayment” (IU) on any adjustments.
- The IRS is focusing on partnerships as part of its enforcement efforts.
- The new partnership audit rules make it easier for the IRS to audit partnerships and collect taxes.
- The economy is improving, which means that there is more money to be audited. If you are a partner in a partnership, it is important to be aware of the increased audit risk and to take steps to protect yourself.
So if you are a business owner involved in a partnership, it’s important to be aware of these matters, and beagle to navigate these often complex tax rules and ensure that the correct amount of taxes are paid by the right partners, partnership and or representatives. The CPA Practice Advisor article also mentions that if a partnership receives a notice of selection for examination (NOSE) also called Bipartisan Budget Act (BBA) audit.
They give 5 important steps to take within 30 days of receiving one of these audit notices:
- Identify the Partnership Representative and Determine Whether a Change Is Necessary. The partnership representative (PR) has wide-ranging powers in a partnership audit. The PR can extend the statute of limitations, protest the adjustments or settle with the IRS. The PR’s actions bind the partnership and the partners regardless of any restrictions in the partnership agreement. Upon receipt of the NOSE, the partnership should identify the PR and consider whether a change is necessary. As an example, it not unusual to change the partner representative if the PR is no longer a partner because the current partners typically want a PR who will have an incentive to ensure that the tax is paid by the audit-year partners, not the current partners.
- Review the Tax Return Under Audit and Consider Filing an Administrative Adjustment Request. The partnership has relatively short timeframe after the NOSE to file an administrative adjustment request (AAR) correcting an item on the original return. The partnership may want to file an AAR to correct a mistake because it can push out the adjustments to the audit-year partners without the partners paying “hot” interest (i.e., interest at an increased rate) and reduce the imputed underpayment by taking into account the partners’ tax positions without IRS approval.
- Consult the Partnership Agreement. Partnership agreements often contain requirements that the partners be notified of an audit. The PR will want to consult the partnership agreement for notice requirements and other audit-related obligations or restrictions.
- Evaluate Whether to Revoke an “Election Out.” Some types of partnerships may elect out of the partnership audit rules, so that the partners are audited directly rather than in a partnership-level audit. The partnership can (with the consent of the IRS) revoke the election after it receives the NOSE. The partnership may want to revoke the election if the partners do not want to be audited directly, the partnership wants to retain control of the audit or the partnership does not want to give the partners full access to its books and records.
- Contact Outside Tax Counsel. The partnership audit rules are complex and new to both taxpayers and IRS agents. Partnerships and their representatives should contact outside counsel to help them navigate the many traps for the unwary in these rules, as well as protect any privileges that may exist and avoid any potential conflicts of interest.
By taking these steps, you can help to reduce your risk of being audited and protect yourself from potential tax problems.
Here are some additional things that partnerships can do to reduce their audit risk:
- Adopt a written partnership agreement that clearly defines the rights and responsibilities of the partners
- Have the partnership agreement reviewed by an attorney who specializes in partnership law.
- Keep accurate and up-to-date books and records, which is especially important for partnerships that are at risk of being audited
- File all required tax returns and reports on time
- Pay all taxes and assessments promptly
- Cooperate with the IRS during an audit
By taking these steps, partnerships can help to reduce their audit risk and protect themselves from potential tax problems. If you find yourself questioning the treatment of previous filings or are already under audit, contact Huckabee CPA for a free consultation and and we can take a look at your specific situation.