The IRS received 140,577 returns for Tax Year (TY) 2011 for partnerships with at least $10 million in assets. This increased to 334,686 returns for TY 2023. Meanwhile, the examination rate for these partnerships fell from 2.7% to less than 0.1%. The IRS previously set the target audit rate for TY 2026 at 1%. However, that ambition was premised on the $79.4 billion the IRS received through the Inflation Reduction Act. Instead, Congress rescinded $53.5 billion in funding, including $41.8 billion from the IRS’s enforcement budget. Furthermore, the IRS’s workforce decreased by 27%. The IRS has yet to assess the effects of these developments. The Treasury Inspector General for Tax Administration (TIGTA) reviewed the situation.
In October 2023, the IRS issued a letter to 483 large partnerships with balance sheet discrepancies (the assets did not equal equity plus liabilities). This letter was Letter 6585, Soft Letter Pass-Through Entity Campaign. “A soft letter is not an examination activity but can be a way to alert taxpayers of potential noncompliance.” Of these 483 letters asking for documentation, 163 simply lacked a response, and 182 had an inadequate response. Only about 29% had responses acceptable to the IRS. In April 2024, the IRS declined to examine any of these partnerships for lack of resources. TIGTA sympathized with the partnerships that complied. “We believe the decision not to conduct examinations on partnerships that did not respond or whose responses were rejected presents a fairness issue and a burden for partnerships who potentially spent time and money responding to the letter.” The IRS explained that less than 12 months remained before the statute of limitations expired. TIGTA countered that it was the IRS’s own fault for delaying.
The TIGTA report contained precious information regarding IRS examination practices. The IRS generally initiates examinations only when there are more than 12 months left before the statute of limitations period bars action. The Large Business and International (LB&I) Division is tasked with administering partnership tax returns. In 2018, the LB&I Division launched the Partnership Model Project, which classifies partnership returns as high, medium, or low risk through a weighted algorithm of “potential risk factors.” “High-risk returns are sent to examiners. Beginning in 2021, the LB&I Division has used AI for this process through the Large Partnership Compliance (LPC) Program. This AI is trained through the manual identification of “high-risk domestic and international business transactions that affect income, gains, expenses, or losses in the largest partnerships.” For TY 2021, the LPC Program filtered 1,617 out of 282,884 large partnerships for potential examination. This was manually reduced to 150 “returns spread across a distribution of industry categories within the large partnership population.” In turn, 82 were ultimately selected for examination. Of these, 3 still awaited assignment to an examiner as of December 31, 2025, but the LB&I Division closed examination on 36 other partnerships by that time. Interestingly, the LPC Program did not consider 2,204 large partnership returns simply because they were filed too late (after February 2023 for TY 2021). The AI risk assessment was only conducted once. Relatively few of the TY 2021 examinations were attributable to the LPC Program. The IRS agreed to TIGTA’s recommendation to expand the LPC Program’s scope to all large partnerships by September 30, 2027. This may be beneficial for large partnerships. The average no-change rate for closed examinations TY 2021 returns was 47%, yet it was 92% for the closed examinations selected with the assistance of the LPC Program.
If you believe your partnership may be audited, please call 916-822-8700 or email info@lawburton.com.