On September 8, 2023, the Internal Revenue Service (IRS) issued a press release (“September 8, 2023 Press Release”) that starting in October 2023, the agency will begin mailing compliance letters to partnerships as part of its increasing focus on large partnerships and complex partnership returns. These compliance letters will likely impact partnerships with over $10 million in assets; however, the IRS maintains a broader goal of increasing audit activity and examinations of large partnerships and high-income taxpayers.
In more detail
September 8, 2023 Press Release
The broader implications of the September 8, 2023 Press Release are that the IRS intends to increase audit rates for high income earners and large partnerships. The IRS expects to use a new arsenal of improved technology and Artificial Intelligence (AI) tools to detect tax “cheating,” identify compliance threats, and improve case selection tools. The IRS’s new Commissioner, Danny Werfel, stated that “[t]he years of underfunding that predated the Inflation Reduction Act led to the lowest audit rate of wealthy filers in [IRS] history . . . .”
The key elements of Commissioner Werfel’s new compliance plan include prioritizing high-income cases. High-income cases are defined as taxpayers “with a total positive income above USD 1 million that have more than USD 250,000 in recognized tax debt.” In the past the IRS has collected USD 38 million from more than 175 high-income earners. Furthering this trend, the IRS plans to contact 1,600 additional taxpayers that fall within this category.
The IRS also plans to expand the Large Partnership Compliance Program (LPC), which launched in 2021. The LPC focuses on examining the “largest and most complex partnership returns” in the IRS’s “filing population.” The IRS will now use its new AI tools and ongoing collaboration between data scientists and tax enforcement experts to identify potential issues related to the following areas: (1) partnership tax, (2) general income tax and accounting, and (3) international tax. Moreover, by the end of September 2023, the IRS will open 75 examinations on the largest United States partnerships. These examinations will span across various industries including hedge funds, real estate investors, publically traded partnerships, and large law firms.
Beginning in October, the IRS will issue compliance letters to partnerships with over USD 10 million in assets and discrepancies on their balance sheets. The compliance letters are a result of millions of dollars of discrepancies between taxpayers’ end-of-year balances compared to the beginning balances of the subsequent year. The IRS will issue compliance letters to around 500 partnerships during the month ahead.
Inflation Reduction Act Strategic Operating Plan
The September 8, 2023 Press Release will come as no surprise to taxpayers and advisors that have monitored Commissioner Werfel’s priorities. During Commissioner Werfel’s nomination hearing before the US Senate Committee on Finance, the then-nominee received numerous questions on how he would oversee the IRS’s use of USD 80 billion in funding that the agency received as part of the Inflation Reduction Act (this amount was slightly reduced as part of the Fiscal Responsibility Act of 2023). Commissioner Werfel responded that he would like to see the agency use a portion of the funding to modernize its technology and increase audit rates for taxpayers with an annual income in excess of USD 400,000.
On April 5, 2023, following Commissioner Werfel’s confirmation, the IRS released its Inflation Reduction Act Strategic Operating Plan, which provides a comprehensive explanation of how the IRS intends to use the additional funding. The plan hinges on the following five objectives, which were identified by Commissioner Werfel:
- Dramatically improve services to help taxpayers meet their obligations and receive the tax incentives for which they are eligible
- Quickly resolve taxpayer issues when they arise
- Focus expanded enforcement on taxpayers with complex tax filings and high-dollar noncompliance to address the tax gap
- Deliver cutting-edge technology, data, and analytics to operate more effectively
- Attract, retain, and empower a highly skilled, diverse workforce and develop a culture that is better equipped to deliver results for taxpayers
The September 8, 2023 Press Release likely aligns with the third objective. To the extent that there is any surprise associated with the September 8, 2023 Press Release, it is the rapid pace at which the IRS is acting on these objectives by issuing compliance letters to taxpayers within six months of finalizing the Strategic Operating Plan.