The Internal Revenue Service announced on November 7, 2013, that it intends to make auditing and examining partnership and other pass-through entities, such as LLCs, S-Corporations, and sole proprietorships a top priority in 2014. This comes after years of targeting corporations for exam.
Pass-Through Entity returns are subject to the same tax audit selection process as individual returns. Some areas of particular focus for tax audits of entities are: disclosure statements, international issues, additional contributions that should be characterized as sales or exchanges, disproportionate allocation of losses or specific deductions to partners, withdrawal of partners may include ‘phantom gain’ through assumption of liabilities by others, characterization of sales or exchange of partnership assets, depreciation methods, and more.
In response to this our senior partner, tax attorney Steve Moskowitz said that “now is the time to head off potential partnership tax audit problems by coordinating the partnership and owners tax transactions, including adjusted basis considerations because these audits do more than just financial damage.”
Pass through (or flow through) entities are of particular appeal to the taxing authorities because an audit of the entity provides a gateway to individual tax returns associated with that entity. Therefore, not only will an audit of an entity result in an invasive review for the company, it will almost most certainly result in audit of individual tax returns or an assessment of tax liability that flows down to the individuals.
Moreover, additional complications can arise as to individual members having differing interests in how the tax audit is handled; for example:
A five member, Northern California medical service corporation was selected for audit. Some of the items that the IRS requested were related to a number of rents paid by the medical service corporation. These rents paid were to an S-Corporation, with two (of the five) members being shareholders. The IRS then chose to audit the S-Corporation and the tax audit was not limited to rents received from the medical services corporation. Ultimately, the IRS tax audit revealed a number of issues wherein significant legal representation was needed with respect to un-reported income, potential criminal tax allegations that directly affect some, but not all of the members. This made these members not only business partners but also potential witnesses against each other in both the civil tax case and the potential criminal case. Ultimately, we were successful in limiting the potential criminal tax issues, which alleviated some of the concerns of the ongoing business partners. However, the civil tax case will still affect each and every member for years to come, not only in business relations but also with business tax matters and the corresponding individual tax adjustments by the IRS and the State of California.
Faris Fink, the IRS Small Business Commissioner who made this announcement had a nice little jab for us tax attorneys and professionals when he outlined the IRS’ increased training for field examiners and revenue agents in partnership issues last year. He then warned tax professionals, “it's going to be challenging for you, because you're going to be interacting with some of those folks.”
For over thirty years, we here at Moskowitz LLP, a tax law firm, have dedicated our lives to tax law disputes and representation. We save financial lives by relentlessly pursuing all avenues to successfully resolve client tax matters. See our success stories. From controversy work and tax returns to tax opinions and criminal tax defense, we help individuals and businesses understand their entire tax picture and act accordingly. We defend your personal liberty and dignity through skill, experience and an aggressive approach. Besides delivering top quality, non-judgmental representation, we strive to help you save your life’s work, resolve tax matters for good, and to thrive. Many of the tax attorneys and C.P.A.’s that work in Moskowitz LLP have worked together for over 20 years; we also have a number of multilingual speaking employees, including but not limited to, Mandarin, Cantonese, and Korean.
Related Services: IRS Audit Representation