IRS Unveils Comprehensive Strategy to Target Pass-Through Entities

IRS Unveils Comprehensive Strategy to Target Pass-Through Entities. In a recent announcement, the Internal Revenue Service (IRS) has unveiled its comprehensive plan to intensify its enforcement efforts targeting pass-through entities, with a particular focus on large or complex pass-through organizations. This initiative is part of a broader strategy to enhance compliance among high-income individuals, high-wealth entities, and large corporations. Here are the key highlights of the IRS’s plan:

Creation of a Special Pass-Through Unit

The IRS is establishing a dedicated pass-through organization within its Large Business and International (LB&I) division, one of the agency’s four primary operating divisions. This new unit will specifically concentrate on addressing non-compliance within the realm of pass-through entities.

Shift of Focus Within LB&I Division

Traditionally, the LB&I division has primarily concentrated its efforts on corporations, subchapter S corporations, and partnerships with assets exceeding $10 million. The new pass-through unit will absorb personnel from both the LB&I and Small Business/Self Employed divisions to better address non-compliance among pass-through entities.

IRS Commissioner Statement

IRS Commissioner Danny Werfel emphasized the agency’s commitment to ensuring that the nation’s wealthiest taxpayers fulfill their tax obligations fully. He stated that this initiative aims to counteract non-compliance trends that have emerged due to budget cuts in recent years. The IRS intends to use funding from the Inflation Reduction Act to disrupt strategies employed by large partnerships to shield income through pass-through structures.

Understanding Pass-Through Entities

Pass-through entities, including partnerships, S-corporations, and certain limited liability companies (LLCs), derive their name from the unique tax treatment they receive. Unlike C-corporations, they are not taxed at the entity level. Instead, the income “passes through” to individual or corporate owners, who report it on their tax returns.

Pass-through structures are favored by many business owners for their simplicity but are also utilized by higher-income groups for more intricate tax arrangements, often involving multiple tiers of businesses.

Concerns About Non-Compliance

While using pass-through entities for legitimate purposes is entirely legal, the IRS has expressed concerns about their misuse to conceal income or evade tax reporting. This misuse has prompted increased scrutiny and enforcement efforts.

LB&I Commissioner Statement

LB&I Commissioner Holly Paz highlighted the significance of this transition and expressed the IRS’s commitment to ensure a smooth changeover, both internally and in collaboration with external partners.

Targeting High-Risk Partnerships

The IRS has already initiated examinations of the 75 largest partnerships in the United States and identified discrepancies in balance sheets for partnerships with assets exceeding $10 million. These discrepancies can indicate potential non-compliance, and the IRS plans to send notices to around 500 partnerships regarding these discrepancies, potentially leading to audits.

Enhancing Compliance and Reducing Burden

The IRS’s overarching goals include improving its ability to detect tax evasion, identify emerging compliance threats, and enhance its case selection tools. The aim is to avoid subjecting compliant taxpayers to unnecessary “no-change” audits, as revealed in a report by the Treasury Inspector General for Tax Administration (TIGTA).

Impact of the Bipartisan Budget Act

The Bipartisan Budget Act of 2015 brought significant changes to partnership audit procedures, replacing the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) with a new centralized partnership audit regime (CPAR). While these changes were intended to streamline partnership audits, the shift didn’t fully take effect until the 2018 tax year.

Restoring Fairness in Tax Compliance

The IRS views these initiatives as part of a broader effort to restore fairness in tax compliance. The focus is not only on reducing the burden on compliant taxpayers but also on addressing non-compliance effectively.