Hiring More Agents: A Good Start but Not the Sole Solution

Excerpted from Tax Notes.

I read with interest the news story on an IRS announcement declaring the agency’s intention to audit many more “complex partnerships” in the near future.1 The headline for the IRS announcement discloses the agency’s intent: “IRS Looks to Hire 3,700 Employees Nationwide to Help Expand Compliance for Large Corporations and Complex Partnerships; Experienced Accountants Encouraged to Apply for Revenue Agent Positions.”

The announcement continues by stating:

“This next wave of hiring will help the IRS add key talent like tax accountants to help reverse a decade-long decline of audits for the wealthy as well as complex partnerships and corporations. These new employees will be focused on higher-income and complex tax areas like partnerships.”

A significant omission in the announcement is its failure to define what a “complex partnership” is. After many years of experience and practice in this tax specialty area, I can say that partnerships can be complex because, for example, (1) they are large in terms of the assets they hold, (2) the number of partners in the partnership, and/or (3) the number of tiers in the partnership structure.

A partnership may also be complex if it has few partners in terms of number of members, but those members are themselves large. An example of this could be a two-person partnership between General Electric and General Motors. This type of partnership can be complex because each member will typically have great tax advisers and the issues involved often fall into gray areas and are difficult to clearly resolve. For example, when top tax advisers at different law or accounting firms have differences of opinion on an issue, either in terms of result or level of assurance, those issues can be particularly difficult for the IRS to audit effectively given the very high level of expertise the agency will be facing.

Large partnerships — in terms of assets, number of partners, number of tiers, etc. — can be complex merely because of the sheer volume of the information necessary to put together the return and, as a result, the audit of the return would be equally challenging. However, the actual issues involved in those cases can be simple.

Of course, partnerships large, small, complex, or simple can also face complex legal issues. The main difference is that the amount of money at stake and the expertise and experience of the taxpayer’s advisers often ratchet up if the partnership is a complex partnership — however you want to define that term.

Partnerships with small assets, made up of a few partners who are all small themselves (for example, in the size of the assets that they each separately hold, directly or indirectly) are not likely to have much to audit, either in terms of the issues at stake or the dollars involved. Resources should be allocated accordingly.

The complexity of the partnership structure often depends on the type of industry that the partnership is active in, such as private equity, real estate, tax credits, and so on. Certain industries often require complex partnership structures, due in large part to the business needs of the organization. A business structure that may seem to an observer like a proliferation of partnership tiers to “hide the ball” in terms of tax liability or issues to audit2 may actually exist based on bona fide business reasons.

Sometimes, though, partnerships that aren’t large or complex can take very aggressive positions because the partners in control are related to each other and/or to the partnership. This frequently occurs because the partnership tax rules are premised on the various partners acting at arm’s length, with varying and adverse economic interests. When the relationship is not adverse economically, the principal IRS weapon is section 482. However, there seems to be reluctance on the part of the government to assert that statute when applying subchapter K (the part of the Internal Revenue Code dealing with partnerships and partners).

Making matters more difficult to examine and audit is the economic reality that not all complexity is abusive and not every complex structure is deliberately opaque to avoid an effective IRS audit. It just depends on the facts and circumstances. That is why, for example, penalizing a partnership for merely undertaking a certain structure, such as using multiple tiers of entities, is not a good idea.

This brings me to the IRS announcement stating that it will be using artificial intelligence to identify which partnerships to audit. I am not an AI expert; far from it. But given the inherently subjective nature of what constitutes a “complex partnership” and the subjectively gray areas of law involved in the process, I frankly don’t understand from what resources the IRS will draw the data for this AI to use.

Even with a perfectly functioning IRS, partnership issues are often difficult to resolve. The difficulty of the legal issues involved and the flexibility and options that the law affords to partnerships and partners make compliance difficult for the IRS to enforce in the best of circumstances.

This area of tax law is ripe for serious consideration of partnership tax reform by Congress.3 Enhanced partnership auditing by the Large Business and International and Small Business/Self-Employed divisions will clearly help tax compliance in this area. Hiring more qualified IRS agents will also help. Better training of IRS agents will be a further plus. Organizational changes within the IRS and Treasury to use available resources more effectively could also help.4

My best guess is that it will take a decade or so of concentrated IRS improvement and development for the agency to effectively take on the outside partnership advisers on an equal footing — or if not equal, at least on a respectably competitive footing.

The IRS announcement is a start. More needs to be done by both the agency and Congress. Now seems a better option than later.

Monte A. Jackel
Jackel Tax Law
Silver Spring, Md.
Sept. 18, 2023

FOOTNOTES

1 See IR-2023–172 (Sept. 15, 2023). See also IR-2023–176 (Sept. 20, 2023) (new work unit to be housed in the Large Business and International Division that will focus on complex and large partnerships to which the new hires in the earlier announcement will be assigned, which will “stand up” — that is, become operational — late next year; no mention of any changes to the IRS Office of Chief Counsel).

2 See Government Accountability Office, “IRS Audit Processes Can Be Strengthened to Address a Growing Number of Large, Complex Partnerships,” GAO-23–106020 (July 27, 2023) (using over $100 million in assets and 100 or more partners as its definition of large partnership). Depending on the government publication at issue, the terms “large partnerships,” and/or “complex partnerships,” and/or “complex, large partnerships,” or merely the term “partnerships” are used to describe the audit target.

3 See Monte A. Jackel, “We Need Subchapter K Reform,” Tax Notes Federal, Aug. 7, 2023, p. 995. See also Jackel, “It’s Time to Reconsider Wyden’s Partnership Tax Reforms,” Tax Notes Federal, Jan. 16, 2023, p. 413; Jackel, “Disallow Uneconomic Partnership Special Basis,” Tax Notes Federal, Nov. 7, 2022, p. 831; Jackel, “Partnership Basis Shifting: A Desperate Need for Immediate Reform,” Tax Notes Federal, Feb. 14, 2022, p. 961; Jackel, “New Wyden Partnership Tax Proposals Deserve Consideration,” Tax Notes Federal, Dec. 20, 2021, p. 1709; Jackel, “Proposals for Limited Subchapter K Reform in Reconciliation Bill,” Tax Notes Federal, Nov. 1, 2021, p. 681; Jackel, “Wyden Partnership Proposals Should Become Law,” Tax Notes Federal, Oct. 25, 2021, p. 527; and Jackel, “Is It (Finally) Time? Reforming Subchapter K,” Tax Notes Federal, Mar. 29, 2021, p. 2031. See also Jackel, “Partnership Tax Reform: Combined Tax Notes Material,” SSRN (Feb. 13, 2023).

4 See, e.g., Jackel, “The IRS Needs a New, Separate Partnership Tax Division,” Tax Notes Federal, Apr. 21, 2023, p. 615. See also IR-2023–176, supra note 1.

END FOOTNOTES