The IRS has many enforcement priorities, in part due to the funding windfall that was promised in 2022. The Inflation Reduction Act granted the IRS $80 billion over 10 years to be used for enforcement, collection and improving taxpayer service. This extra money was in addition to the IRS's annual funding. However, Congress has clawed back 25% of the windfall and is looking to cut IRS funding even further.
Improving partnership tax compliance is on the list of the IRS's enforcement priorities. Over the past several years, partnership audits by IRS revenue agents have been dismal. The agency's audit rate for partnership returns has hovered around 0.1% or less, with about half of these examinations resulting in no change to taxes at the partnership level. The IRS audit statistics for very large partnerships with $100 million or more in total assets and 100 or more partners are even more abysmal. According to a report by the nonpartisan Government Accountability Office, there were 20,052 of these large partnerships in 2019, and the IRS audited only 54. From 2010 to 2018, 80% of the IRS's audits of large partnerships were no-change exams.
The IRS wants to improve these figures and bring in additional revenue. Earlier this year, the agency updated its operating plan, explaining what it would do with its funding windfall. On enforcement, the IRS said it would do more audits of big C corporations and partnerships, individuals with high income or high wealth, cross-border activities, digital currency and more.
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Under the updated plan, audit coverage of large partnerships would increase to 1%. The IRS projected that audit rates of pass-through entities, such as S corporations and partnerships, with $10 million or more in assets would rise until they reach 1% for 2026 tax returns.
The IRS began audits on 76 of the biggest partnerships in the U.S. in addition to starting exams on hundreds of other pass-through entities with over $10 million in assets. The IRS is relying on the use of artificial intelligence tools to help identify partnerships that are at the highest risk of tax noncompliance.
The IRS has a new pass-through working group to focus on these partnership audits. The group is situated within the IRS's Large Business and International Division. There is also an office in the IRS's Office of Chief Counsel that focuses on partnerships, S corporations and other pass-through entities.
But the IRS is off to a bit of a slower start on partnership audits than it had originally anticipated. In 2024, it began 2,285 partnership exams, down from its goal of 4,074 audits and way below 2023's figure of 6,079 exams. In 2025, the IRS plans to open up 3,600 partnership audits. The IRS says it is taking a long time to train new hires, and the audits of large partnerships are very complex.
In addition to auditing large partnerships, the IRS is scrutinizing some more specific partnership tax issues. The IRS's Large Business and International Division has targeted campaigns that focus on risk areas in which the IRS has found taxpayer compliance to be lacking. Among the partnership projects on the list:
- Excess losses claimed by partners: Partners can take flow-through losses from partnerships on their individual returns only to the extent of their adjusted tax basis in their partnership interests. Excess losses aren't lost forever. They are carried forward to a year in which the partner has basis.
- Cash or property distributions that exceed a partner's tax basis in the partnership. A partner who receives a distribution of property (not cash) from the partnership in 2024 or later must report the distribution on new IRS Form 7217 (currently in draft form) and file it with his or her Form 1040 federal tax return.
- Sale or transfer of a partnership interest. Generally, a partner has capital gain or loss on the sale of a partnership interest. But if the partnership has inventory items or unrealized receivables, then part of the gain is treated as ordinary income or loss.
- Partnerships that own sports teams and report large losses on Form 1065.
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