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April 28, 2014
IRS Failing to Audit High-Value Electing Large Partnerships
by Amy S. Elliott

Full Text Published by Tax Analysts®

Over the seven-year period spanning fiscal 2007 to fiscal 2013, the IRS didn't complete a single audit of a large partnership that elected into the simplified electing large partnership (ELP) audit rules that Congress put in place in 1997, according to a Government Accountability Office preliminary report (GAO-14-379R) released April 17.

That revelation is one of many buried in the footnotes to the preliminary GAO report. Another is that the average number of direct partners reported on partnership returns filed between tax years 2002 and 2011 with between 1,001 and 100,000 total investors (direct and indirect partners) was 130. If the median, which was not disclosed, is less than or closer to 100, that calls into question the usefulness of the GAO's definition of a large partnership, which is a partnership that reported 100 or more direct partners and $100 million or more in assets. (Prior coverage: Tax Notes, Apr. 21, 2014, p. 311; prior analysis: Tax Notes, Apr. 7, 2014, p. 7.)

James R. White, director of tax issues at the GAO, told Tax Analysts that the organization is "exploring the possibility of using a broader definition of large partnerships" that accounts for indirect partners because the current definition "might not tell the full story." The GAO plans to issue its full report to the Senate Finance Committee and the Senate Homeland Security and Governmental Affairs Permanent Subcommittee on Investigations this fall.

Simpler ELP Audits

President Obama in his past three budget plans proposed mandating the streamlined ELP audit and adjustment procedures for a much larger population of partnerships to make IRS audits easier. But if the IRS isn't taking advantage of the simplified rules to audit even one of the largest of those businesses, why should Congress bother changing the law? (Treasury's green book explanation of the fiscal 2015 budget's revenue provisions.)

White pointed out, however, that only 15 of the 2,226 large partnerships in tax year 2011 were ELPs. "If the IRS audited only one, the audit rate for ELPs would be much higher than for non-ELP large partnerships," he said.

IRS spokesman Bruce Friedland stressed the historically small number of ELPs, adding that the "IRS does not discuss the specifics of how it determines compliance risk or selects returns for examination."

"The administration's required large partnership proposal would fundamentally change the current treatment of the entire population," Friedland told Tax Analysts. "We strongly believe it would be misleading to extrapolate future compliance activity in the large partnership population if the required large partnership proposal was enacted based on results experienced under the current electing large partnership framework."

                    Business Audit Statistics, Fiscal 2011

                             Large Partnerships              Large Corporations
                             (100 or more                    (generally Form
                             direct partners)                1120 series)

 $1 billion+ Audit                 2.6%                            40.5%
 Coverage Rate
 $1 billion or more asset
 size, all audits closed
 fiscal 2011/returns filed
 calendar year 2010

 $100 million+ Audit               0.9%                            23.1%
 Coverage Rate
 $100 million or more asset
 size, field only audits
 closed fiscal 2011/returns
 filed calendar year 2010

 No-Change Rate                     90%                              20%
 $100 million or more asset
 size, field only

 Total Recommended                   $0                       $24,094,867,000
 Additional Tax
 $100 million or more asset
 size, field only. The
 large partnerships amount
 is the total audit
 adjustment and would have
 to be multiplied by a tax
 rate to get the additional
 tax amount, but it's $0 so
 that's not needed.

 Average IRS Audit Hours         268 hours                        581 hours
 Charged                     (the total wasn't                 (the total was
 $100 million or more asset      disclosed)                       2,818,368)
 size, field only. The
 large corporations amount
 is based on IRS audit
 information management
 system data prepared by
 the Transactional Records
 Access Clearinghouse
 (TRAC), Syracuse
 University, available at

 Average Additional Tax            $0/hour                       $8,549/hour
 Dollars Netted Per
 Audit Hour
 IRS audit information
 management system data
 prepared by TRAC, Syracuse
 University, available at

Apples to Apples

To get a sense of how poor the audit statistics for large partnerships as defined by the GAO are, compare them with the audit statistics of comparably sized corporations in the table. Keep in mind, however, that in some cases, the GAO's audit numbers likely overstate IRS examination activity.

White said that whenever possible, the GAO's audit statistics distinguish between traditional field audits (which examine the business's books and records) and what are called campus function audits (which merely involve the passing of the audit adjustments through to the partners' returns). However, in some instances (see the audit rate above for large partnerships with $1 billion or more in assets) that distinction isn't made, and field and campus audits are lumped together and treated as equals because to do otherwise would result in field audit numbers of 10 or fewer, triggering concerns about disclosure of specific taxpayer information, White said.

White agreed that the IRS's definition of what constitutes an audit is a problem. According to the Service, when it audits the books and records of a partnership and passes the adjustments through two lower-tier levels of partnerships, it counts that as three audits, not one. Friedland was unable to answer by press time why the IRS counts campus function passthroughs as audits.

IRS Isn't Doing Nothing

The zero dollars in total adjustments for all large partnership audits in fiscal 2011 sounds bad, but the fiscal 2013 numbers were worse. The 174 large partnership audits closed that year actually resulted in $215 million of adjustments in favor of the partnerships. White said those adjustments were passed through to partners, resulting in tax refunds unless the partnership entered into a closing agreement with the IRS. He said the GAO's follow-up report will contain data on the actual revenue collected from large partnership audits.

Beyond the IRS's poor partnership audit numbers, the GAO report revealed steps that the Service is taking to improve its audit coverage of large partnerships, including an initiative to identify large partnerships. White said that initiative will be discussed in more detail in the GAO's follow-up report.

Friedland said the initiative is a set of "database tools" that the IRS is using "to unravel large partnerships and their tiers." One of the tools is likely the YK1 readiness/link analysis tool.

According to the GAO report, the IRS plans to implement a new activity code structure in fiscal 2015 that will allow for a more granulated breakout of partnership audits. It's unclear whether the breakout will mirror what's now available for audits of large corporations (broken down by size of total assets, with break points at $10 million, $50 million, $100 million, $250 million, $500 million, $1 billion, $5 billion, and $20 billion) or will include a breakdown by number of direct or ultimate partners.

Friedland said the implementation deadline for the new activity code structure has been delayed because of resource limitations and won't be in fiscal 2015.

Correction, April 28, 2014: Because of an editing error, the headline originally stated that the IRS was failing to audit ELPs in general.

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