(Bloomberg) Large partnerships, including private-equity firms and hedge funds, are often so complex that the U.S. Internal Revenue Service can’t audit them effectively, the Government Accountability Office found.

In a report released yesterday, the GAO focused on more than 10,000 large partnerships, which each have at least 100 partners and $100 million in assets. Most of those are in the finance and insurance industries.

In fiscal year 2012, the IRS audited 0.8 percent of large partnerships, similar to its audit rate for all individual taxpayers. Many large corporations, by contrast, have teams of IRS auditors working at their corporate offices; their audit rate is 27.1 percent.

“Large partnerships are a significant part of the economy and are increasing in number, size and complexity,” the report said. “However, the relatively low rate at which IRS audits large partnerships and the minimal results achieved raise concerns about IRS’s ability to ensure the tax compliance of large partnerships.”

When the IRS audits such large partnerships, more than half of the inquiries result in no action. The report said that often stems from the partnerships’ complexity and from statutes of limitations that can cause the IRS to close audits without recommending additional taxes.

Multi-tiered and interlocking partnerships can be hard for the IRS to untangle, especially given recent IRS budget cuts, the GAO found.

‘Never Able’
“You are never able to find out where the real problems or duplication of deductions exist,” said an IRS official quoted anonymously in the report. “The reporting of income, expenses could be duplicated but there is no way to figure it out unless you drill down and audit all tiers, all tax returns.”

Unlike corporations, partnerships face one level of taxation in the U.S. Income flows through to the partners and is reported on their individual tax returns and taxed at individual rates.

In most cases, current law requires the IRS to pass through any changes in audits to all partners, so they can appropriately share any additional burden, which is a cumbersome process, according to the report.

Better Oversight
In a statement Thursday, the IRS said it has been trying to improve its oversight of the businesses.

“The IRS is mindful of the need to do everything possible, within our limited resources, to improve the efficiency and effectiveness of our enforcement efforts in regard to large partnerships,” according to the statement, which cited congressional cuts in the IRS budget. “We have been unable to hire additional staff, and thus fulfill our need for more examiners with specialized knowledge of partnerships.”

President Barack Obama and House Ways and Means Chairman Dave Camp, a Michigan Republican, have each proposed a streamlined audit process that would make it easier for the IRS to assess taxes at the partnership level during audits.

Camp’s plan, contained in a draft revamp of the U.S. tax code, would raise $13.4 billion over a decade, according to the Joint Committee on Taxation. Obama’s proposal, which is part of his budget, would raise $1.8 billion for the government, according to the Treasury Department.
Neither plan has advanced in Congress.

“All points lead to the need for comprehensive, bipartisan tax reform and this is yet another example,” Senate Finance Chairman Ron Wyden, an Oregon Democrat, said in a statement. “We need a 21st-century tax code that is equitable to all taxpayers and the current system for partnerships makes it almost impossible to determine if they are paying their fair share.”

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