GAO Issues Final Report with Recommendations to Improve Large Partnership Audits

Posted by Mary McNulty and Lee Meyercord           The Government Accountability Office (“GAO”) recently issued its final report with recommendations to improve the efficiency and effectiveness of large partnership audits, a copy of which is available here.  The GAO issued two interim reports earlier this year that addressed the number and characteristics of large partnerships (discussed here) and the challenges in auditing large partnerships (discussed here).The GAO defines “large partnership” as a partnership that reported having 100 or more direct and indirect partners and $100 million or more in assets on their partnership income tax return.  Large partnerships are often structurally complex and involve more than 1,000 direct and indirect partners and hundreds have more than 100,000 partners and multiple tiers.  The IRS audits very few large partnership returns, and the audits result in minimal adjustments. As explained in an earlier interim report, the IRS faces unique challenges in auditing large partnership returns that may explain the minimal adjustments to partnership net income.  These challenges stem from the administrative complexities in applying the TEFRA audit procedures to large partnerships and the complexity of identifying tax noncompliance in large partnerships.  These challenges are exacerbated by the IRS’s limited resources.  From 2010 to 2014, due to a decline in appropriations, IRS staffing declined by more than 10,000 full-time employees (or 11%), and most of this decline was in enforcement.To address the challenges faced in large partnership audits, the report recommends that the IRS: Establish a definition of “large partnerships” based on asset size and partners, so the IRS can track the results of large partnership audits and use this information to better allocate IRS resources. Extend the period during which the IRS may withdraw a notice of the beginning of the audit and close the audit as no change without having to notify the partners. (The current period is 45-days, which is too short for the IRS to determine whether a large partnership audit should be closed with no change). Reduce the time spent determining the tax matters partner (TMP) of a partnership by promptly using its authority to designate a TMP under the largest profits interest rule.Improve the support auditors receive from IRS counsel, TEFRA coordinators and IRS specialists and track the support requests and response times to better allocate resources in large partnership audits. Provide auditors information regarding the availability of training on TEFRA audit procedures and partnership tax law.In addition, the final report recommends that Congress consider adopting legislation that would:Require partnerships that have more than a certain number of direct and indirect partners to pay any tax resulting from an audit adjustment at the partnership level.Require partnerships to designate a qualified TMP on the partnership return and, if the TMP is an entity, identify an individual that will serve as the representative of the TMP.The report acknowledged that the IRS is developing three audit procedure projects to improve large partnership audits.  However, the report found that these projects were lacking because the projects did not (i) have a project plan with clear and measurable goals, schedules and resources; (ii) evaluate mitigation options or contingency plans; or (iii) address how data would be collected to monitor the effectiveness of the project.The GAO’s recommendations and IRS’s audit procedure projects may have implications for large partnerships and their partners and may foreshadow future legislation and an increase in the resources dedicated to auditing large partnerships.  If you have any questions about large partnership audits, please contact one of us or any of the other Tax lawyers at Thompson & Knight.