	Large Partnerships Have Grown in Number, Size, and Complexity Since 2002 with Hundreds Now Having More Than 100,000 Partners

According to IRS data, between tax years 2002 to 2011, the number of  large partnerships more than tripled from 2,832 to 10,099. For comparison, our interim report on large  partnerships, which defined large partnerships as those with 100 or more  direct partners and $100 million or more in assets, found that over the  same time period the number of large partnerships more than tripled,  from 720 in tax year 2002 to 2,226 in tax year 2011. According to IRS officials and data, many of these entities are investment  funds, such as hedge funds and private equity funds, which are pools of  assets shared by investors that are counted legally as partners of the  large partnership. Almost two-thirds of large partnerships in 2011 had more  than 1,000 direct and indirect partners, although hundreds of large  partnerships had more than 100,000. IRS Audits Few Large Partnerships Due to Challenges Presented by the Complexity of Both the Audit Procedures and the Large Partnership Structures

		IRS Audits Large Partnerships at a Much Lower Rate than Large Corporations and the Audits Produce Minimal Results for Audit Time Spent

IRS audits few large, complex partnerships. The audit rate for  large partnerships remains well below that of C corporations with $100  million or more in assets, which was 27.1 percent in fiscal year 2012. In 2013,  for example, 64.2 percent of the large partnership audits resulted in no  change to the reported income or losses. Several Challenges Related to Complexity Hinder IRS’s Audits of Large Partnerships

The high no change rates and minimal adjustment amounts for IRS audits  of large partnerships may be due to a number of challenges that can  cause IRS to spend audit time on administrative tasks, or waiting on  action by a large partnership or IRS stakeholder rather than doing actual  audit work. Congress enacted the TEFRA audit procedures  in response to concerns about IRS’s ability to audit partnership returns. According to the congressional Joint Committee on Taxation (JCT), the  complexity and fragmentation of partnership audits prior to TEFRA,  especially for large partnerships with partners in many audit jurisdictions,  resulted in the statute of limitations expiring for some partners while other  partners were required to pay additional taxes as a result of the audits. To pass through the audit adjustments to the taxable  partners, IRS has to first link, or connect, the partners’ returns to the  partnership return being audited. For example,  IRS officials reported having difficulty in identifying the business purpose  for the large partnerships or in determining the source of income or losses  within their structures (i.e. They cited a  number of reasons for the inefficient use of resources, such as having to  collect and review information on a large number of partners and the  difficulty of passing through audit adjustments to those partners. IRS Has Limited Ability to Fully Address Challenges

IRS by itself cannot fully address the tax law and resource challenges in  auditing large partnership returns. Aside from closing agreements, the IRS efforts affect steps IRS takes at  the beginning of an audit—such as understanding the complexity of large  partnerships and selecting returns for audits. IRS provided  technical comments, which were incorporated, as appropriate.
Why GAO Did This Study

Businesses organized as partnerships have increased in number in recent years while the number of C corporations (i.e. those subject to the corporate income tax) has decreased. The partnership population includes large partnerships (those GAO defined as having $100 million or more in assets and 100 or more direct and indirect partners). Their structure varies. Some large partnerships have direct partners that are partnerships and may bring many of their own partners into the structure. By tiering partnerships in this manner, very complex structures can be created with hundreds of thousands of direct and indirect partners. Tiered large partnerships are challenging for the Internal Revenue Service (IRS) to audit because of the difficulty of tracing income from its source through the tiers to the ultimate partners.
GAO was asked to study the challenges large partnerships pose for IRS. GAO describes the number of large partnerships and their assets, IRS's large partnership audit results and the challenges IRS faces in auditing these entities, and options for addressing these challenges. GAO analyzed IRS data on partnerships, reviewed IRS documentation, interviewed IRS officials, met with IRS auditors in six focus groups, and interviewed private sector lawyers knowledgeable about partnerships.

What GAO Found

Internal Revenue Service (IRS) data show, from tax years 2002 to 2011, the number of large partnerships more than tripled. According to IRS officials, many large partnerships are hedge funds or other investment funds where the investors are legally considered partners. Many others are large because they are tiered and include investment funds as indirect partners somewhere in a tiered structure. According to IRS data, there were more than 10,000 large partnerships in 2011. A majority had more than 1,000 direct and indirect partners although hundreds had more than 100,000. A majority also had six or more tiers.
IRS audits few large partnerships—0.8 percent in fiscal year 2012 compared to 27.1 percent for large corporations. Of the audits that were done, about two-thirds resulted in no change to the partnership's reported net income. The remaining one-third resulted in an average audit adjustment to net income of $1.9 million. These minimal audit results may be due to challenges hindering IRS's ability to effectively audit large partnerships. Challenges included administrative tasks required by the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) and the complexity of large partnership structures due to tiering and the large number of partners. For example, IRS auditors said that it can sometimes take months to identify the person who represents the partnership in the audit, as required by TEFRA, reducing the time available to conduct the audit. Complex large partnerships also make it difficult to pass through audit adjustments across tiers to the taxable partners.
IRS cannot resolve some of the challenges because they are rooted in tax law, such as those required by TEFRA. Congress and the Administration have proposed statutory changes to the audit procedures for partnerships, such as requiring partnerships to pay taxes on net audit adjustments rather than passing them through to the taxable partners. In addition, IRS has implemented some changes to its large partnership audit process, such as understanding the complexity of large partnerships and selecting returns for audits.

What GAO Recommends

GAO makes no recommendations but will issue a report later in 2014 assessing IRS's large partnership audit challenges. IRS provided technical comments, which were incorporated.