As the number of large partnerships involving 100 or more direct partners continues to grow, the Internal Revenue Service is taking a closer look at them, according to a new government report.

The report, from the Government Accountability Office, acknowledged that there is no statutory, IRS or industry-accepted definition of a “large partnership.” However, the GAO used a combination of criteria for partner size and asset size used by IRS to define large partnerships as those that reported having 100 or more direct partners and $100 million or more in assets. Due to the growth of large partnerships and the limited publicly-available data on them, the GAO was asked to provide information on the number and characteristics of large partnerships and on those large partnership returns that have been subject to an IRS audit.

The GAO report found that the number of large partnerships increased from 720 in tax year 2002 to 2,226 in tax year 2011. Large partnerships also increased in terms of the average number of direct partners and average asset size.

The IRS had data on two categories of large partnership return audits. First, the number of completed field audits of large partnership returns increased from 11 in fiscal year 2007 to 31 in fiscal year 2013. Second, IRS counted audits closed through its campus function, which increased from 42 to 143 over the same period. "Unlike field audits, campus function audits generally do not entail a review of the books and records of the large partnership return but rather were opened to pass through large partnership return audit adjustments to the related partners' returns," the GAO noted.

The percentage of IRS audits that resulted in no change to the taxpayer's return varied from fiscal year 2007 to 2013 but was 52 percent for campus function audits and 45 percent for field audits in fiscal year 2013, according to the GAO.

Senate Finance Committee Chairman Ron Wyden, D-Ore., took note of the findings in the report and said it could play a role in the tax reform efforts. “This is a real problem and serves as yet another example of why Congress needs to get serious about comprehensive, bipartisan tax reform,” he said in a statement.  “This includes looking at the growth of large partnerships and working with the proper parties—including the IRS—to put in place a smart framework for auditing and governance.  By rebuilding our tax fundamentals, rather than jumping from one fire drill to the next, Congress can better ensure that we have a fair code and enforcement system in place.”

However, the IRS may be constrained in its audit efforts by budget constraints. IRS commissioner John Koskinen said recently that the audit rate for individual tax returns last year was at its lowest rate since 2005, due to budget cuts in recent years, and he expects it to decline further this year (see IRS Audit Rate Hits New Low).

Wyden, along with Senators Carl Levin, D-Mich., and John McCain, R-Ariz., pointed out that the GAO's preliminary report shows that the IRS is failing to audit 99 percent of the tax returns filed by large partnerships with assets exceeding $100 million.

“The GAO report shines a needed spotlight on how the IRS is auditing large partnerships, and the news isn’t good,” said Levin, chairman of the Senate Permanent Subcommittee on Investigations.  “The GAO report shows that while the number of these massive partnerships with massive assets has exploded, IRS audits haven’t kept pace.”

According to GAO, “[b]etween tax years 2002 and 2011, the number of businesses organized as partnerships (with 100 or more partners and $100 million or more in assets) increased more than 200 percent, accounting for $2.3 trillion in assets and $68.9 billion in total net income by 2011.”

Yet in 2012, for example, IRS field audits reviewed the books and records of only 0.8 percent of large partnership returns, according to the preliminary report.

“Auditing less than 1 percent of large partnership tax returns means the IRS is failing to audit the big money,” said Levin in a statement. “It means over 99 percent of the hedge funds, private equity funds, master limited partnerships and publicly traded partnerships in this country, some of which earn tens of billions each year, are audit-free. It is obvious something is wrong with the IRS audit program for large partnerships. We literally cannot afford to allow these entities to go unaudited.” 

The final GAO report is expected to provide additional qualitative analysis of why the IRS has performed so few audits of large partnerships.  It is expected to focus in part on the unified partnership audit procedures in the Tax Equity and Fiscal Responsibility Act (TEFRA), which some view as responsible for making large partnership audits time-consuming and expensive.

“If Congressionally-imposed red tape or budget cuts are partly responsible for the poor audit numbers, we need to find that out and change it,” Levin added.

The IRS told the Associated Press that budget cuts in recent years have led to reductions in its enforcement staff.

"Since Fiscal 2010, the IRS budget has been reduced by nearly $900 million," the IRS said in a statement. "The IRS has about 10,000 fewer employees than in 2010, affecting our work across our taxpayer service and enforcement categories. Last year, we had 3,100 fewer people in our key enforcement positions than in 2010."