IRS, Treasury Begin Initiative to Close $50 Billion Tax Loophole

Treasury Secretary Janet Yellen speaks about goals for the 2024 tax-filing season, at the IRS headquarters in Washington, on Nov. 7, 2023. (Stefani Reynolds/AFP via Getty Images)

The U.S. Treasury Department and the IRS have begun an initiative aimed at closing major tax loopholes they say are used by wealthy taxpayers and corporations, including hedge funds, law firms, and real estate and investment partnerships, to avoid paying full taxes.

On June 17, the two agencies announced a regulatory effort “that will stop large, complex partnerships from using opaque business structures to inflate tax deductions and avoid taxes.”

The agencies highlighted the issue of “partnership basis shifting transactions,” a technique that wealthy taxpayers use to make billions in taxable income “disappear.” In such transactions, a single business operates through multiple entities and manipulates tax rules to “maximize tax deductions and minimize tax liability.”

For instance, the tax basis is the cost or value of an asset and is used to determine the equity of a business for tax assessment. A business engaged in partnership basis shifting transactions may shift the tax basis from a property that doesn’t have tax deductions, such as stock, to a property with such deductions, such as equipment. This allows the business to minimize taxes.

The IRS and the Treasury have proposed regulations that would effectively eliminate tax benefits resulting from partnership basis shifting transactions.

“Treasury and the IRS are focused on addressing high-end tax abuse from all angles, and the proposed rules released today will increase tax fairness and reduce the deficit,” U.S. Treasury Secretary Janet Yellen said.

The Treasury estimates that once completed, the initiative could increase tax revenue by $50 billion, or even much more, over 10 years.

Preston Brashers, a research fellow at The Heritage Foundation, told The Epoch Times that even though the new initiative is aimed at “large, complex partnerships,” there is a chance that small businesses would also be impacted by the crackdown.

“There’s nothing in their [rules] that would limit this to just the larger partnerships.”

President Joe iden had pledged that tax enforcement efforts would not go after small businesses or taxpayers making less than $400,000, he noted. After signing the Inflation Reduction Act in 2022, President Biden said that no Americans making below $400,000 annually would pay more taxes.

However, this pledge may not be upheld, Mr. Brashers said. He gave an example of a partnership that makes $1 million to $2 million in profits and passes this down to several partners. Each partner may only get a fraction of the profits.

“So, if you’re cracking down on these transactions, and you have certain individual partners that income passes down through … [who] make significantly less [than $400,000], I think this is a violation of this pledge of not going after taxpayers earning less than $400,000,” he said.

“Because I think there’s certainly going to be some examples of cases where that would apply here.”

Mr. Brashers think the regulatory crackdown will have a chilling effect on the business community.

He expects increased regulatory compliance burden on the alleged “abusive transactions.” This is going to make businesses “less likely to want to make these transactions both for the tax avoidance reasons but also for just what is in their business interest or personal interest.”

Low Audit Rates

The agencies pointed out that the audit rate for pass-through partnerships declined to 0.1 percent in 2019 from 3.8 percent in 2010, despite filings from such entities with more than $10 million in assets jumping by 70 percent during this period.

A pass-through entity is a business that doesn’t pay tax on its revenues. Instead, its income is passed to business owners, who then file taxes based on their individual tax rates.

Pass-through entities help proprietors avoid the issue of double taxation when the income is taxed at the business level and then at the individual level when they receive dividends. The IRS has previously blamed pass-through entities for facilitating tax avoidance by wealthy people.

The businesses currently apply loopholes in the current law and follow legal guidelines to bypass paying higher taxes.

Once enforced by agencies, the new rules will likely be challenged in court.

A recent report by the International Consortium of Investigative Journalists (ICIJ) found that the IRS’s Large Business and International Division took a “comparatively light approach” when dealing with powerful taxpayers.

The ICIJ’s analysis of IRS data showed that the Large Business and International Division flagged a maximum of 22 possible instances of tax crimes over the past five years. During the same period, the IRS division that handles self-employed people and small businesses flagged about 40 times more possible crimes, even sending 848 referrals to criminal investigators.

“I was putting butchers, bakers, and candlestick makers in jail, but the big stuff we really wanted to go after was being ignored,” former IRS agent Michael Welu told the ICIJ.

Complex Partnerships

The IRS has already taken steps to boost compliance among high-income individuals and partnerships. It has launched audits targeting 76 large partnerships with assets of more than $10 billion. This includes big law firms, real estate investment partnerships, and hedge funds.

These audits are ongoing and could take several years to complete based on the complexity and size of the businesses.

With the IRS’s increasing focus in this area, the agency’s chief counsel, Margie Rollinson, has announced a new associate office that will exclusively focus on S-corporations, trusts and estates, and partnerships.

The new office is expected to allow “more attention to legal guidance and other priorities in the partnership arena,” she said.

IRS Commissioner Danny Werfel said the agency was boosting its expertise to reverse “long-term compliance declines” that allowed corporations and wealthy people to “hide behind complexity to avoid paying taxes.”

“Billions are at stake here,” he stated. The IRS’s latest announcement indicates that the agency is accelerating its work in the partnership arena, “which has been overlooked for more than a decade and allowed tax abuse to go on for far too long.”

Crackdown on Wealth

In September 2023, the IRS stated that it was looking to hire more than 3,700 additional tax enforcers to assist with the agency’s “expanded enforcement work” that focuses on complex partnerships, large corporations, and high-income earners.

The new division was set to use funding that the IRS received from the Inflation Reduction Act, which was enacted in August 2022.

GOP lawmakers had rallied against the funding boost, raising concerns that the agency would use the funds to increase enforcement on middle-income Americans and small-business owners.

In January, the IRS said its enforcement efforts had led to $482 million in tax collections from 1,600 millionaires who hadn’t paid their taxes due.

These efforts were aimed at taxpayers with more than $1 million in income and more than $250,000 in tax debts. The agency also said it was looking into discrepancies in the balance sheets of partnerships that have more than $10 million in assets.