IRS aims to close tax loopholes for wealthy

As part of ongoing efforts to focus more attention on high-income compliance issues, the IRS recently announced a new series of steps to combat abusive partnership transactions that allow wealthy taxpayers to avoid paying what they owe.

IRS compliance work continues to accelerate in the complex area of law following Inflation Reduction Act funding. As part of this, the IRS is announcing a new dedicated group in the Office of Chief Counsel focused on developing guidance on partnerships, including closing loopholes. The office will work closely with a new passthrough work group being established in the IRS Large and Business International division that will be formally established fall 2024.

The IRS and the U.S. Department of the Treasury also issued three pieces of guidance focused on partnerships following discoveries by IRS audit teams. Currently, the IRS has tens of billions of dollars of deductions claimed in these transactions under audit.

The new guidance is designed to stop the use of “basis shifting” transactions that use related-party partnerships to avoid taxes. In these complex moves, high-income taxpayers and corporations strip basis from assets they own where the basis is not generating tax benefits, and then move the basis to assets they own where it will generate tax benefits without causing any meaningful change to the economics of their businesses. These basis shifting transactions allow closely related parties to avoid taxes.

Treasury estimates these abusive transactions, which cut across a wide variety of industries and individuals, could potentially cost taxpayers more than $50 billion over a 10-year period.

The IRS is looking at these issues in current audits and will equip examiners to identify these issues on other partnership returns identified for examination as part of either the Large Partnership Compliance (LPC) program, partnership audit campaigns or other selection methods.

In addition, the new guidance provides greater clarity to taxpayers and examiners. And when final regulations are issued, the increased reporting requirements under the Transactions of Interest (TOI) would give the IRS greater awareness of these arrangements, which are difficult to identify from the face of the tax return.

Partnerships are part of a category of pass-through organizations under the federal tax code. Pass-throughs include entities such as partnerships and S-corporations. These groups are not subject to the corporate income tax; instead, income is “passed through” onto the income tax returns of the individual or corporate owners and taxed at their income tax rates. Partnerships and other pass-throughs are frequently used by higher-income groups and can be complex tax arrangements.

During the past decade, IRS budget cuts have made it harder for the agency to focus compliance resources on partnerships. Tax filings from passthrough businesses with more than $10 million in assets jumped to nearly 300,000 filings in 2019, 70% more than 2010. At the same time, audit rates fell from 3.8% in 2010 to 0.1% in 2019.

To counter these continuing compliance concerns, the IRS is using funding from the Inflation Reduction Act to strengthen enforcement among high-income taxpayers and corporations, with a special focus on partnerships. The IRS continues to work to add more top talent to help improve compliance work in this area.

The IRS has already announced a series of steps to improve compliance involving high-income individuals and partnerships, including launching audits on 76 of the largest partnerships with average assets over $10 billion that includes hedge funds, real estate investment partnerships, publicly traded partnerships, large law firms and many other industries. The IRS announced today that these complex audits are proceeding and in various stages of the process. These audits can take years depending on the size and complexity of the partnerships.