While few details are available as yet, this announcement may be best understood by reference to recent statements by IRS Commissioner Danny Werfel and Charles Rettig, who served as IRS Commissioner in the Trump and Biden administrations until November 2022.
This new audit group is not expected to be fully in place until late in 2024, which is in the time frame when the IRS would normally be auditing partnerships’ and individuals’ 2022 tax returns. According to Commissioner Werfel, the aim of this initiative is to “disrupt efforts by certain large partnerships to use pass-throughs to intentionally shield income to avoid paying the taxes they owe.” Former Commissioner Rettig has suggested that it is the intention of the IRS to use artificial intelligence to select tax returns for audit and quickly identify trends which the government views as problematic, and that while a unit using digital technology to identify targets was established in 2020, the Service did not then have sufficient resources for adequate follow up. As examples of problematic transactions targeted during his tenure, former Commissioner Rettig has listed cryptocurrency transactions, off-shore tax evasion, monetized installment sales, inflated conservation easement deductions, micro-captive insurance companies and tax shelter promoters.
Even before the new group is in place, the IRS in September 2023 commenced audits of 75 very large partnerships, having on average $10 billion in assets, which audits they undoubtedly will use to identify new targets.
We will continue to monitor this IRS initiative and issue further client alerts as it unfolds and more details become available, such as the size above which investment funds and other partnerships and LLCs will be likely targets of the new audit group. At the very least, we recommend checking with us before adopting tax strategies that may seem too good to be true. In the meantime, it is advisable for the general partners and managers of investment funds who have not already done so to review the provisions of their partnership and operating agreements that address tax audits and consider the optimal course of action to be taken in the case of a tax audit in terms of (1) minimizing the tax adjustments that are payable by the partnership or LLC itself, including by “pushing out” any adjustments to those who were investors in the year(s) being audited, and (2) allocating the economic burden of any amounts that are paid by the partnership among the current and former investors.
Co-authors Mark Berg, chair and Larry Arem, partner are members of the tax practice group at Klehr Harrison.