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IRS Report Shows Increase in Partnership and S Corporation Examinations

By Stephen A. Beck on March 14, 2016

The Internal Revenue Service (“IRS”) recently issued its Fiscal Year 2015 Enforcement and Service Results report (the “Report”), which contains interesting information, particularly for owners of Subchapter K partnerships and Subchapter S corporations. Click here for a copy of the Report. The following is a summary of three notable points contained within the Report.

First, IRS funding and enforcement staffing numbers are declining.  IRS funding has decreased by approximately $900 million between the U.S. Government’s 2010 and 2015 fiscal years.  Accordingly, the number of enforcement personnel at the IRS (including Revenue Officers, Revenue Agents and Special Agents) has declined from 22,710 in fiscal year 2010 to 17,208 in fiscal year 2015.

Second, the reduced enforcement staff is resulting in a declining volume of IRS enforcement activity for most types of taxpayers.  Specifically, the Report shows a steady decline in the number of IRS examinations of individual taxpayers, large and small Subchapter C corporation,¹ and tax-exempt organizations from fiscal year 2010 to fiscal year 2015.  In addition, the Report shows that the rate of “coverage” (which is a comparison of the number of IRS examinations during a fiscal year to the number of federal income tax returns filed by taxpayers during the prior calendar year) is also declining for the aforementioned types of taxpayers.  The Report data for the amounts of examinations, amounts of returns filed, and “coverage” for the aforementioned types of taxpayers is summarized in the below tables.

Individuals

FY 2010

FY 2014

FY 2015

# of Returns Filed in Prior CY

142,823,105

145,236,429

146,861,217

# of Examinations

1,581,394

1,242,479

1,228,117

Coverage

1.11%

0.86%

0.84%

Small C Corporations

FY 2010

FY 2014

FY 2015

# of Returns Filed in Prior CY

2,041,474

1,812,140

1,797,366

# of Examinations

19,127

17,257

16,460

Coverage

0.94%

0.95%

0.92%

Large C Corporations

FY 2010

FY 2014

FY 2015

# of Returns Filed in Prior CY

61,570

64,261

66,484

# of Examinations

10,207

7,858

7,410

Coverage

16.58%

12.23%

11.15%

Tax Exempt Organizations

FY 2010

FY 2014

FY 2015

# of Returns Processed in Prior CY

776,300

765,395

787,339

# of Examinations

11,449

8,084

6,392

Coverage

1.47%

1.06%

0.81%

Third, despite the general downward trend in IRS resources and enforcement activities, the IRS is actually increasing the number and rate of its examinations of “pass-through” entities.  The following tables summarize data in the Report for S corporations and Subchapter K partnerships regarding the number of federal income tax returns filed, the number of IRS examinations, and the related coverage ratio.

S Corporations

FY 2010

FY 2014

FY 2015

# of Returns Filed in Prior CY

4,414,662

4,518,765

4,605,766

# of Examinations

16,327

16,317

18,595

Coverage

0.37%

0.36%

0.40%

Partnerships

FY 2010

FY 2014

FY 2015

# of Returns Filed in Prior CY

3,423,583

3,649,385

3,766,567

# of Examinations

12,406

15,779

19,212

Coverage

0.36%

0.43%

0.51%

Thus, the current trends suggest that the IRS is devoting its increasingly limited enforcement resources towards examinations of S corporations and partnerships.  In addition, it is widely believed that the increasing enforcement efforts for partnerships will continue in the future because recent legislation repealed the TEFRA audit procedures for partnerships for tax years beginning after 2017, which will generally enable the IRS to assess and collect tax directly from the partnership instead of from its various partners.  As a result, although it is always important for taxpayers to make their best effort to report their federal income tax obligations correctly, current indicators suggest that the accuracy of tax returns filed by S corporations and partnerships will be subject to heightened scrutiny, as compared to returns of other taxpayers.

__________________________
¹ According to the Report, a “large” C corporation has assets of at least $10 million, whereas a “small” C corporation has assets of less than $10 million.