Two years after the Internal Revenue Service announced a plan to address a lack of audits of private equity, venture capital and real estate investment firms, the initiative appears to be faltering. Senior leaders have exited the agency and audits of large partnerships have slowed dramatically.
For decades, the IRS had conducted few significant audits of these entities, which are structured as partnerships and lacked the technical expertise to do so. Under the initiative launched two years ago, the IRS hired and trained hundreds of examiners to audit these partnerships and uncover aggressive tax shelters that the Treasury Department estimated had cost the public at least $100 billion over the past decade, according to a report in The New York Times.
Now, several of the 15 senior leaders overseeing the operation have left the agency, audits have been abandoned and the initiative is struggling. While some audits continue, the pace has dropped by 80 to 90 percent, estimated Gary Huffman, a tax lawyer at Vinson & Elkins.
The Times report suggests the exodus is tied to organizational challenges and a series of tax policy changes under the current administration. Cost-cutting measures by the Department of Government Efficiency led to the layoff of thousands of probationary employees, disproportionately affecting the partnership audit team, which was largely composed of recently hired technical experts. The IRS declined to comment.
Partnerships create inherent complexity that can be exploited for tax planning, the report said. Unlike corporations, partnerships do not pay income taxes directly; obligations flow through to individual partners, with each partner’s share determined by their portion of profits or losses. Tax rules for partnerships were originally designed in the 1950s for small businesses like family grocery stores, but they have since been applied to multi-billion-dollar investment vehicles. Profits reported by partnerships exploded to $2.6 trillion by 2022, up from $267 billion in 2000, while profits reported by traditional corporations grew at roughly half that pace.
A 2021 NYT investigation revealed that the IRS’s lack of expertise had allowed major private equity firms, including Blackstone and Apollo, to avoid audits. Under the partnerships audit program, the IRS had planned 75 audits of the largest partnerships in the U.S., including hedge funds and real estate investment partnerships with average assets exceeding $10 billion.
Opponents of the program argued it created unduly burdensome administrative tasks and represented an example of government overreach or “weaponization” targeting political opponents.
Despite these challenges, studies show the audits are highly effective. A recent analysis by researchers at Stanford, the University of Georgia, New York University and the University of Chicago found that complex partnership audits generate $20 in collected taxes for every $1 spent, more than eight times the return on corporate audits.
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