United States

GAO testimony highlights IRS’s struggle to examine large partnerships


In July 2014, the U.S. Government Accountability Office (GAO) presented testimony to the U.S. Senate’s Permanent Subcommittee on Investigations that highlighted the IRS’s struggles with examining large partnership tax returns. Though the GAO did not issue any recommendations during the testimony, a report will be released later in the year that assesses the IRS’s challenges in this area. The GAO’s testimony resulted from a comprehensive review of IRS documentation, interviews with IRS officials, and six focus groups within the IRS’s large partnership examination division.

Large partnerships

Large partnerships are defined in the GAO’s testimony as partnerships with 100 or more direct or indirect partners and $100 million or more in total assets. Direct partners hold an interest in an operating partnership that conducts business operations. Indirect partners hold an interest in an operating partnership through other pass-through entities, such as partnerships, S corporations, limited liability companies and certain trusts, thus creating a tiered partnership structure and numerous levels of indirect ownership. While the number of newly formed corporate taxpayers has decreased nearly 14 percent over the past decade, the number of newly formed partnerships has risen 45 percent.1 This is due to businesses adopting more complex U.S. ownership structures, which then affect the tax reporting.

The IRS audit rates and results for large partnerships illustrate the difficulties these complex business structures pose for tax administration and may shed light on the impetus behind recent legislative proposals to impose tax at the operating partnership level. IRS audit rates for large partnerships between 2007 and 2012 reflect insignificant audit activity of less than 1 percent. In contrast, audit rates for corporations of a similar asset size have risen from 20.6 percent in 2007 to 27.1 percent in 2012. A stark contrast also exists between audit results produced by the IRS for comparably sized partnerships and corporations. For audits closed between 2007 and 2013, nearly 65 percent of large partnership audits resulted in a “no-change,” meaning that no items of income or loss were adjusted. Comparatively, corporations of a similar size had only 21 percent of audits result in a no-change. Even more discouraging for the IRS was the fact that the net audit adjustments across all large partnerships (aside from the no-change) in 2013 were negative, likely producing refunds for the partners, whereas the corresponding audits or large corporations resulted in additional tax due. The GAO noted that the average number of days and IRS field hours charged for large partnership audits has steadily increased over the last four years, while corporate audits have remained more consistent. Based on the facts presented, it appears the IRS is spending increasingly more time and resources on large partnership audits, but attaining less return on its audit investment. It was unclear from the GAO’s testimony whether the IRS was selecting taxpayers that were in good compliance, or if the IRS had failed to discover existing noncompliance with tax laws.

TEFRA audit procedures

Generally, when a partnership has 11 or more partners (or any partners that are pass-through entities) at any point throughout the year, the partnership is considered a TEFRA partnership (under the Tax Equity and Fiscal Responsibility Act of 1982) for IRS audit purposes. TEFRA status allows the IRS to audit at the partnership-item level, rather than at the individual partner level. The resulting partnership audit adjustments are agreed to by the partnership’s tax matters partner (TMP) and are directly billed to the underlying partners for the tax year in question, without the IRS auditing the individual partners’ tax returns. As noted in the GAO testimony, TEFRA audits of large partnerships present numerous issues for the IRS exam team, due, in part, to the complexity of passing the tax consequences of the audit adjustments through the tiered structure to the ultimate partners responsible for paying tax.2

First, the IRS may take up to 18 months to process a large partnership return, leaving only an additional 18 months on the statute of limitations to complete an exam. This window vastly shrinks as the IRS attempts to identify the TMP of the large partnership, who is responsible for coordinating the exam with the IRS. Because in many tiered partnership structures the TMP is an entity, the IRS must track down a responsible party of the entity to act as the TMP’s representative. It was documented in the GAO report that this process can take months. A further issue identified in tiered structures is that the IRS has difficulty determining the business purpose for large partnerships and the true sources of income or loss. This results in the inability of the IRS to properly determine the characterization of income and whether the partnership has engaged in a tax shelter or an abusive tax transaction.

Another significant difficulty is the actual administration of any potential changes or assessments. Since TEFRA audit changes are directly assessed to the underlying partners, the IRS must first identify each partner. When a large partnership has hundreds or thousands of partners across multiple tiers, the cost of identifying and adjusting each individual partner’s tax liability can easily outweigh the benefit to the IRS. Furthermore, the GAO’s IRS focus groups revealed that there is not a necessary level of timely support from other IRS specialists, chief counsel and TEFRA audit coordinators to assist the examination teams with the complexities of examining large partnerships.


The GAO’s testimony on large partnership audits will likely result in changes in the way the IRS approaches the audit process for these entities. However, with current-year budget cuts looming and an already overloaded exam division, the IRS will likely still struggle to efficiently complete audits of large partnerships. While this may be of benefit to taxpayers, large partnerships should expect the IRS to design new approaches for examining large partnerships. More Congressional discussion and debate on the taxation of large partnerships is anticipated

  1. The statistics referenced in this article were reported by the GAO in its testimony on July 22, 2014.
  2. See sections 6221 through 6234




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