IRS Announces Next Steps In Plans To Focus On Pass-Throughs, Including Complex Partnerships


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For weeks, the IRS has been teasing new compliance initiatives—including increased hiring—to focus on expanded enforcement work on complex partnerships, large corporations, and high-income and high-wealth individuals. Today, the IRS announced plans to establish a special pass-through organization to focus on large or complex pass-through entities.

According to the IRS, the new group will be housed in the IRS Large Business and International (LB&I) division. LB&I is one of four primary operating divisions in the IRS. The remaining three divisions are the Wage and Investment Division, the Small Business Self-Employed Division, and the Tax Exempt and Government Entities Division.

Typically, LB&I typically focuses on corporations, subchapter S corporations, and partnerships with assets of $10 million or more, while SB/SE serves small businesses, approximately 3.8 million partnership filers, and self-employed taxpayers. The new group will eventually include employees currently in LB&I as well as the Small Business/Self Employed division.

“This is another part of our effort to ensure the IRS holds the nation’s wealthiest filers accountable to pay the full amount of what they owe,” said IRS Commissioner Danny Werfel. “We are honing-in on areas where we believe non-compliance among our wealthiest filers has proliferated over the last decade of IRS budget cuts, and pass-throughs are high on our list of concerns. This new unit will leverage Inflation Reduction Act funding to disrupt efforts by certain large partnerships to use pass-throughs to intentionally shield income to avoid paying the taxes they owe. These efforts are consistent with our broader commitment to use Inflation Reduction Act dollars to end the era of historically low error rates for wealthy and large entities, while making sure middle- and low-income filers continue to see no change in audit rates for years to come.”

The new unit will focus on pass-through organizations, which include entities like partnerships and S-corporations. Limited liability companies, or LLCs, can also be taxed as pass-throughs. Pass-throughs get their name for the unique way that they are taxed. They are not taxed at the entity level, like a C-corporation, but rather, income is “passed through” to the individual or corporate owners. That income, along with other tax characteristics like some gains and losses, shows up on tax forms from the entities—typically a Form K-1—and that information is reported on the owners’ tax returns.

Because pass-throughs can allow for simplicity, they are very popular with business owners. However, they are also frequently used by higher-income groups and can be involved in more complex tax arrangements, often through many different tiers of businesses (for example, one organization may own another).

Partnership Initiatives

There is nothing illegal or improper about using pass-through companies, even if you use many different pass-through companies to hold business interests. However, using them to hide income or avoid reporting for tax purposes is illegal and has become a concern of the IRS in recent years.

LB&I Commissioner Holly Paz announced the start of work on pass-through entities today. “This is an important change we will be making, and we will be working in the months ahead to efficiently and effectively transition to this new group,” Paz said. “This effort will include working inside the IRS as well as working with external partners to ensure this is a smooth transition period for everyone involved.”

Earlier this year, the IRS announced that it was opening examinations of 75 of the largest partnerships in the U.S. At the same time, Werfel announced that the IRS has flagged ongoing discrepancies on balance sheets involving partnerships with over $10 million in assets. Those discrepancies can be an indicator of potential non-compliance, and IRS says that taxpayers filing partnership returns are showing differences in the millions of dollars between end-of-year balances compared to the beginning balances the following year, without explanation. As part of efforts to force compliance for high-risk large partnerships, the IRS will send notices to around 500 partnerships about those discrepancies. Depending on the responses, the IRS will add them to the audit stream for follow-up.

TIGTA Report

Goals include helping compliance teams better detect tax cheating, identify emerging compliance threats, and improve case selection tools to avoid burdening taxpayers with those needless “no-change” audits. Last year, a report from the Treasury Inspector General for Tax Administration (TIGTA) revealed that IRS examinations of partnerships tended to result in no additional tax liability.

TIGTA’s review found that at the end of fiscal year 2021, the IRS had completed 480 Bipartisan Budget Act (BBA) partnership audits, including returns filed for tax years 2016 through 2019.

The IRS closed 376 (approximately 78%) of these partnership returns as a no-change.

TIGTA found that this rate was high compared to the average no-change rate of 50% for all partnership returns for the same tax years.

This was the first real look at audit numbers since the Bipartisan Budget Act of 2015 repealed the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) partnership procedures and replaced them with a new centralized partnership audit regime, or CPAR. According to the U.S. Department of Treasury and the IRS, applying the old TEFRA rules to audits of large partnerships was inefficient, and the law was overly complex. Part of the change was geared towards alleviating some of the complexity and inefficiency of auditing partnerships. It is worth noting, however, that the changes under the BBA didn’t require the CPAR structure until the 2018 tax year. However, some partnerships could opt into the scheme early.

The concern isn’t just that compliant taxpayers are being overburdened but that non-compliant taxpayers are being overlooked. The IRS hopes to change those results. Werfel previously referred to these initiatives as part of what is being called “a sweeping, historic effort to restore fairness in tax compliance.”

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