Authored by RSM US LLP
Executive summary: IRS to target large partnerships and wealthy individuals
Large partnerships and high net worth individuals are the target of a sweeping enforcement effort that artificial intelligence will support, the IRS announced Sept. 8, 2023. The agency will prioritize enforcement against the largest and most complex partnerships, as well as individuals with annual income over $1 million and more than $250,000 in tax debt.
The IRS has worked in conjunction with experts in data science and tax enforcement to create machine learning technology to identify compliance issues in the areas of partnership tax, general income tax and accounting, and international tax.
IRS shifts its focus to large partnerships and wealthy individuals
On the heels of the Inflation Reduction Act, which increased the agency’s funding, the IRS has initiated a broad effort to crack down on partnerships and wealthy individuals at risk for noncompliance, specifically targeting the largest partnerships as well as individual taxpayers with income exceeding $1 million and tax debt exceeding $250,000.
Large partnerships
The Government Accountability Office in July 2023 released data that detailed a significant increase in the formation of large partnerships between 2002 and 2019. The report revealed a 600% increase in large partnerships, which it defined as partnerships with at least $100 million in assets and 100 or more partners.
The report further determined the audit rate for these large partnerships had dropped to less than 0.5% since 2007. The report revealed 80% of the audits conducted resulted in no changes to the partnership return, perhaps as a result of the IRS’ inability to properly target noncompliant partnerships.
In October 2021, the IRS initiated the Large Partnership Compliance (LPC) pilot program via its Large Business and International Division in response to the need for a coordinated approach to audits of partnerships under the centralized audit regime enacted as part of the Bipartisan Budget Act of 2018. The LPC successfully engaged in examinations of some of the largest and most complex partnerships in the U.S.
Building on the success of the LPC program, the IRS in September 2023 announced its intent to target 75 of the largest partnerships—those with at least $10 billion in assets—in fiscal year 2024.
Introducing AI to enforcement efforts
To accurately select partnerships for examination, the IRS will use an AI solution, which was developed through a collaboration of experts in data science and tax enforcement who have been working together to develop machine learning technology. The AI will “identify potential compliance risk in the areas of partnership tax, general income tax and accounting, and international tax in a taxpayer segment that historically has been subject to limited examination coverage,” according to the IRS’ news release.
The news release stated that the IRS has also identified balance sheet discrepancies involving partnerships with over $10 million in assets. Specifically, the IRS will target partnerships whose returns show discrepancies exceeding $1 million between end-of-year balances and the beginning balances for the following year.
The agency will mail compliance letters requesting explanations of the discrepancies to around 500 partnerships, and, depending on the responses, may add these partnerships to the audit stream for additional review.
Individuals
The IRS is also targeting high net worth taxpayers with annual income above $1 million who have more than $250,000 in recognized tax debt.
The agency will engage dozens of revenue officers to focus on these high-end collection cases in fiscal year 2024. Through the first half of November 2023, the agency contacted 1,600 high net worth taxpayers that owe hundreds of millions of dollars. Through this effort, IRS collected $122 million in the first 100 cases.
Actions taxpayers should take
Partnerships and high net worth taxpayers should be prepared for an increase in IRS audit activity in the coming months and years. Maintenance and retention of financial records, as well as documentation supporting tax positions likely to be challenged, will be critical. Working with your tax advisor to ensure accurate reporting and prepare for an examination in advance would benefit taxpayers who may be affected by the IRS’ increased enforcement efforts.
Partnerships should regularly update basis schedules for partners. Attempting to re-create them years after the relevant transactions can be difficult due to a lack of adequate records.
All taxpayers should take care to document certain deductions or positions taken on a tax return, including but not limited to:
- Any position that has been identified as a campaign issue by the IRS’ Large Business and International Division
- Any position identified as a listed transaction
- Any position for which a Schedule UTP (uncertain tax position) is required
- Any position with respect to which a Form 8275 (Disclosure Statement) is included with the relevant return
- Any positions claiming a research credit
- Any position on a sale of partnership interest or sale of other assets
- Any positions where the IRS can question capital vs. ordinary gain treatment of an item
With respect to any of these deductions, credits or positions, taxpayers should make sure they can readily substantiate them to the IRS during an audit. Written memoranda with legal citations supporting positions taken should be drafted as the relevant tax return is prepared. A research credit should not be claimed unless there is a completed research credit study justifying the credit.
Prudent taxpayers should ask their advsors to perform an audit readiness assessment that identifies tax return items that the IRS is likely to examine. This will enable taxpayers to further support those items.
