Report: IRS can't effectively audit large firms

Current law is hurting the IRS’s ability to effectively audit large financial services companies and other firms, according to a new federal report.

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The Government Accountability Office said Thursday that the current law, now more than three decades old, gives the IRS three years to complete audits of large partnerships.

That’s not enough time in some cases, the audit found, because many large partnerships have such complex se-ups that it can be difficult for the IRS to know where to get started. The GAO said it takes the IRS, on average, about 18 months after receiving a large partnership’s return to actually start the audit.

Senate Finance Committee Chairman Ron WydenRonald (Ron) Lee WydenHillicon Valley: Facebook won't remove doctored Pelosi video | Trump denies knowledge of fake Pelosi videos | Controversy over new Assange charges | House Democrats seek bipartisan group on net neutrality Manning: Additional Assange charges are feds using the law 'as a sword' Overnight Health Care — Presented by PCMA — Senators unveil sweeping bipartisan health care package | House lawmakers float Medicare pricing reforms | Dems offer bill to guarantee abortion access MORE (D-Ore.) said the new report, which updates one from earlier this year, underscored how badly the tax code needs to be overhauled.

“GAO makes a good case for revisiting how the tax code shields large partnerships from IRS audits,” Wyden said.

“We need a 21st century tax code that is equitable to all taxpayers and the current system for partnerships makes it almost impossible to determine if they are paying their fair share”

The GAO’s previous report found that the IRS only audited 0.8 percent of partnerships with more than 100 partners and $100 million or more in assets in 2012. Roughly 27 percent of corporations faced an audit that year.

Sen. Carl LevinCarl Milton LevinListen, learn and lead: Congressional newcomers should leave the extremist tactics at home House Democrats poised to set a dangerous precedent with president’s tax returns The Hill's 12:30 Report — Sponsored by Delta Air Lines — White House to 'temporarily reinstate' Acosta's press pass after judge issues order | Graham to take over Judiciary panel | Hand recount for Florida Senate race MORE (D-Mich.), the chairman of the Permanent Subcommittee on Investigations, postponed a hearing on the audit issue scheduled for Thursday.

“It doesn’t make sense for large corporations to face a nearly 30 times greater chance of an IRS audit than highly profitable large partnerships,” Levin said Thursday. 

Part of the problem, the GAO found, is that large partnerships often have complex business structures, with multiple tiers of partners. In some cases, the new report said, the IRS can’t figure out with which partner or tier of partners to start the audit.

That complexity can be especially pronounced in hedge funds, the GAO report said, and stands in stark contrast to the more straightforward set-up of corporations.

In a statement, the IRS said it was doing everything it could to beef up its enforcement efforts for large partnerships, but said it was hamstrung by recent budget cuts. Congress has slashed the agency's budget by hundreds of millions of dollars in recent years, something the IRS says has hurt its ability to bring on new staff. 

"The IRS is mindful of the need to do everything possible, within our limited resources, to improve the efficiency and effectiveness of our enforcement efforts in regard to large partnerships, and has been working on a number of approaches to this problem," the agency said.

"It is important to note the extent to which the IRS’ resource limitations constrain our ability to make improvements in the partnership audit area." 

Large partnerships in particular have become more prevalent in recent years, now controlling around $7.5 trillion in assets. More than 10,000 firms had at least 100 partners and at least $100 million in assets in 2011, triple the number in 2002. Around three-quarters of those large partnerships are in the finance and insurance fields, GAO said.

In general, pass-through entities — in which a firm’s owners pay taxes through the individual system — have become more popular over the last decade or so. The GAO found that the number of corporations fell 22 percent from 2002 to 2011.

The agency's study also reported that IRS audits of large partnerships rarely found that the companies were noncompliant with their taxes. In 2013, almost 65 percent of the audits of large partnerships resulted in no change in the company’s taxes. Corporations that were audited were far more likely to owe more after an audit.

But the watchdog said that doesn’t mean that partnerships are less at risk for trying to skirt their taxes, and IRS officials say they don’t know yet why their audits often turn up so little.

“Large partnership returns have the potential for a high tax noncompliance risk,” the GAO audit said. “It is not clear whether the high no change rate for large partnership audits is due to IRS selecting large partnerships that were tax compliant or is due to an inability of IRS audits to identify noncompliance.”

This post was last updated at 12:08 p.m. on Sept. 19