The IRS announced the establishment of a new division targeting “pass-through” entities, which the agency claims will hold America’s wealthiest tax filers “accountable.”
Pass-through entities are used by the wealthy to 'avoid paying the taxes they owe,' according to the IRS commissioner.
What is a pass-through entity?
A pass-through entity is a business that does not pay tax on its revenues. Instead, its income is passed on to owners of the business, who then file taxes based on their individual tax rate.
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 announced plans to “establish a special area to focus on large or complex pass-through entities,” according to a recent press release.
“Pass-throughs are frequently used by higher-income groups and can be complex tax arrangements,” the agency said. IRS Commissioner Danny Werfel called the focus on such entities “another part of our effort to ensure the IRS holds the nation's wealthiest filers accountable to pay the full amount of what they owe.”
The IRS's initiative to intensify work focused on pass-through entities
“This new unit will leverage Inflation Reduction Act funding to disrupt efforts by certain large partnerships to use pass-throughs to intentionally shield income to avoid paying the taxes they owe.”
“These efforts are consistent with our broader commitment to use Inflation Reduction Act dollars to end the era of historically low error rates for wealthy and large entities.”
The following are considered pass-through business entities: general partnerships, sole proprietorships, limited partnerships, limited liability partnerships, limited liability companies, and S Corporations.
The new unit will be housed in the IRS Large Business and International (LB&I), division with the work group expected to begin operations sometime late next year. However, “work involving pass-through areas will continue to intensify in the meantime.”
The group is set to include LB&I employees as well as employees from the Small Business/Self Employed division. The agency will coordinate with the National Treasury Employees Union (NTEU) on its latest initiative.
Not all pass-through entities are high-wealth tax filers
Though the IRS claims they will target pass-through entities in a bid to hold the wealthy accountable, the fact that such entities include small business structures like sole proprietorships and partnerships has raised concerns about working-class American businesses being potentially targeted by the agency.
The agency has not clearly defined the parameters of what it means to be “wealthy.”
The IRS appears to still be targeting low-income people
The IRS is already under scrutiny for targeting low-income earners in individual filings. A January report by Syracuse University's Transactional Records Access Clearinghouse (TRAC) said that the IRS follows a trend of pursuing more low-income groups compared to billionaires and millionaires.
During fiscal year 2022, millionaires “did have the highest odds of being audited. However, if one ignores the fiction of auditing a millionaire through simply sending a letter through the mail, the odds that millionaires received a regular audit by a revenue agent (1.1 percent) was actually less than the audit rate of the targeted lowest-income wage-earners whose audit rate was 1.27 percent!” the report said.
The rate of income tax audits per 1,000 individuals stood at 12.7 for the lowest-income wage earners and 2.3 for everyone else. This made low-income wage earners the taxpayer class with, by far, the highest audit rates—clocking around five and a half times more than everyone else.
The report notes that low-income wage earners have historically been targeted by the IRS, not because they account for the most underreporting, but because they are seen as “easy marks in an era when IRS increasingly relies upon correspondence audits yet doesn’t have the resources to assist taxpayers or answer their questions.”
The IRS also recently came under criticism from agency watchdog Treasury Inspector General for Tax Administration (TIGTA) for lacking a clear definition of “high-income” earners.
“The high-income terminology is being used loosely inside the IRS with no common understanding of what the term means,” the report said. The IRS relies on the decades-old definition of high income, which classifies anything above $200,000 in income as high.
“This amount is equivalent to more than $1 million in 2023, but the IRS still uses $200,000 as the default high-income threshold,” it said. This is “no longer a reasonable standard for high earners given inflation since 2005.”
New hiring will help populate the new pass-through unit
In its Sept. 20 press release, the IRS said that the new pass-through unit will include people who join the agency under the latest hiring initiative it announced last week.
On Sept. 15, 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 is being set up with the funds that the IRS received from the Inflation Reduction Act (IRA) passed in August last year. The IRA provided the agency with $80 billion in funding.
Some 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.
Republicans eventually reduced the funding by $20 billion when they struck the debt deal with Democrats during the summer.
Are you part of a pass-through entity?
Lots of "smaller" businesses can be considered as pass-through entities, and many of our clients fall into that category. It's not as cut and dried (high-wealth only) as the IRS would portray, so you may find yourself on the receiving end of this new initiative. If you do, or, frankly, if you have tax problems of any kind, don't hesitate to contact us for help and guidance. That's what my team and I are here for.
You can contact me by one of the methods below in the blue box, or email me at Larry@TaxProblemSolver.com and we can review your specific issues and solve them. You can also click here to book a free consultation.
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