IRS Launches Effort to Target Partnerships and Other Pass-Through Entities

The Internal Revenue Service (IRS) recently announced the launch of a new enforcement initiative specifically targeting partnerships and other pass-through entities. As the agency explains in an October 22, 2024 News Release, it has created a new pass-through field operations unit that is “specifically devoted to ensuring compliance of pass-throughs of every size and form—including partnerships, S-corporations and trusts—reflect[ing] the IRS’ broader efforts to focus more attention and resources on an area that has historically been under-scrutinized.” Learn more from Boston tax attorney Kevin E. Thorn, Managing Partner of Thorn Law Group.

The IRS Plans to Increase Audits Targeting Pass-Through Entities and Their Owners

The October 22 News Release also makes clear that one of the IRS’ goals in creating this new unit is to “increase[] audit rates” of pass-through entities. Thus, pass-through entities (and their owners) will be at increased risk of facing scrutiny going forward. While the IRS may be primarily focused on “higher-income groups” that use pass-through entities in “complex tax arrangements,” the new field operations unit includes personnel from both the IRS’ Large Business and International (LB&I) division and its Small Business/Self-Employed (SB/SE) division.

Common Tax Compliance Issues Involving Pass-Through Entities

What will the revenue agents on the IRS’ new pass-through field operations unit be looking for when auditing partnerships, S-corporations, limited liability companies (LLCs), trusts and other entities? Some of the most common tax compliance issues related to pass-through entities include:

Improper Recordkeeping, Reporting and Payment

Audits targeting partnerships and other pass-through entities (and their owners) frequently focus on these entities’ and individuals’ recordkeeping, reporting and payment obligations. This includes internal recordkeeping and distributions, as well as reporting income and paying income tax to the IRS.

Improper Deductions

Pass-through entities and their owners can also face scrutiny related to improper deductions. In some cases, deductions that are available to C-corporations are not available to partnership, LLC and S-corporation owners.

Failure to Pay Entity-Level Tax

While pass-through entities are generally not liable for tax at the entity level, there are exceptions. For example, as the IRS explains, “S-corporations are responsible for tax on certain built-in gains and passive income at the entity level.”

Failure to Maintain Pass-Through Eligibility

If an entity fails to maintain its pass-through eligibility, it must report and pay tax at the entity level. Continuing to claim pass-through status despite ineligibility can lead to liability for substantial back taxes, interest and penalties.

Unlawful Tax Avoidance Schemes

A particular focus of the IRS’ new pass-through field operations unit will be on targeting high-income taxpayers who incorporate pass-through entities into unlawful tax avoidance schemes. Entities and individuals accused of leveraging pass-through entities to facilitate unlawful tax avoidance schemes can face not only civil liability but potentially criminal charges as well.

Request a Consultation with Boston Tax Attorney Kevin E. Thorn

If you have questions or concerns about pass-through entity tax compliance, we invite you to get in touch. To request a confidential consultation with Boston tax attorney Kevin E. Thorn, Managing Partner of Thorn Law Group, please call 617-692-2989 or inquire online today.