LARGE PARTNERSHIPS

Growing Population and 

Complexity Hinder Effective 

IRS Audits

Statement of James R. White,

Director, Strategic Issues

Testimony 

Before the Permanent Subcommittee 

on Investigations, Committee on 

Homeland Security and Governmental 

Affair, U.S. Senate

For Release on Delivery 

Expected at 9:30 a.m. ET

Tuesday July 22, 2014

GAO-14-746T

United States Government Accountability Office
United States Government Accountability Office

Highlights of GAO-14-746T, a testimony 

before the Permanent Subcommittee on 

Investigations, Committee on Homeland 

Security and Governmental Affairs, U.S. 

Senate.

July 22, 2014

LARGE PARTNERSHIPS

Growing Population and Complexity Hinder Effective IRS 

Audits 

Why GAO Did This Study

Businesses organized as partnerships 

have increased in number in recent 

years while the number of C 

corporations (i.e. those subject to the 

corporate income tax) has decreased. 

The partnership population includes 

large partnerships (those GAO defined 

as having $100 million or more in 

assets and 100 or more direct and 

indirect partners). Their structure

varies. Some large partnerships have 

direct partners that are partnerships 

and may bring many of their own 

partners into the structure. By tiering 

partnerships in this manner, very 

complex structures can be created with 

hundreds of thousands of direct and 

indirect partners. Tiered large 

partnerships are challenging for the 

Internal Revenue Service (IRS) to audit 

because of the difficulty of tracing 

income from its source through the 

tiers to the ultimate partners. 

GAO was asked to study the 

challenges large partnerships pose for 

IRS. GAO describes the number of 

large partnerships and their assets, 

IRS's large partnership audit results

and the challenges IRS faces in 

auditing these entities, and options for

addressing these challenges. GAO 

analyzed IRS data on partnerships, 

reviewed IRS documentation,

interviewed IRS officials, met with IRS 

auditors in six focus groups, and 

interviewed private sector lawyers 

knowledgeable about partnerships.

What GAO Recommends

GAO makes no recommendations but 

will issue a report later in 2014 

assessing IRS’s large partnership audit 

challenges. IRS provided technical 

comments, which were incorporated.

What GAO Found

Internal Revenue Service (IRS) data show, from tax years 2002 to 2011, the number 

of large partnerships more than tripled. According to IRS officials, many large 

partnerships are hedge funds or other investment funds where the investors are 

legally considered partners. Many others are large because they are tiered and 

include investment funds as indirect partners somewhere in a tiered structure.

According to IRS data, there were more than 10,000 large partnerships in 2011. A 

majority had more than 1,000 direct and indirect partners although hundreds had 

more than 100,000. A majority also had six or more tiers.

IRS audits few large partnerships—0.8 percent in fiscal year 2012 compared to 27.1 

percent for large corporations. Of the audits that were done, about two-thirds resulted 

in no change to the partnership’s reported net income. The remaining one-third 

resulted in an average audit adjustment to net income of $1.9 million. These minimal 

audit results may be due to challenges hindering IRS’s ability to effectively audit large 

partnerships. Challenges included administrative tasks required by the Tax Equity 

and Fiscal Responsibility Act of 1982 (TEFRA) and the complexity of large 

partnership structures due to tiering and the large number of partners. For example, 

IRS auditors said that it can sometimes take months to identify the person who 

represents the partnership in the audit, as required by TEFRA, reducing the time 

available to conduct the audit. Complex large partnerships also make it difficult to 

pass through audit adjustments across tiers to the taxable partners. 

Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) Audit Timeline 

Note: A 3-year statute of limitations governs the time IRS has to complete partnership audits, 

according to the audit procedures enacted in TEFRA. The first stage is the period from when a return 

is received until IRS begins the audit. The second stage is the period in which IRS conducts the audit. 

The third stage is when IRS assesses the partners their portion of the audit adjustment.

IRS cannot resolve some of the challenges because they are rooted in tax law, such 

as those required by TEFRA. Congress and the Administration have proposed 

statutory changes to the audit procedures for partnerships, such as requiring 

partnerships to pay taxes on net audit adjustments rather than passing them through 

to the taxable partners. In addition, IRS has implemented some changes to its large 

partnership audit process, such as understanding the complexity of large 

partnerships and selecting returns for audits. 

View GAO-14-746T. For more information, 

contact James R White at (202) 512-9110 or 

whitej@gao.gov.
Page 1 GAO-14-746T 

The Honorable Carl Levin

Chairman

The Honorable John McCain

Ranking Member

Permanent Subcommittee on Investigations

Committee on Homeland Security and Governmental Affairs

United States Senate

Chairman Levin, Ranking Member McCain, and Members of the 

Subcommittee:

I am pleased to be here today to discuss the growing number and 

complexity of large business partnerships—those with 100 or more direct 

and indirect partners and $100 million or more in assets.1 I will also 

discuss the Internal Revenue Service’s (IRS) large partnership audit 

results as well as the challenges IRS faces in auditing these entities, and 

options for addressing these challenges.

Partnerships are pass-through entities that generally do not pay taxes 

themselves on income (unlike C corporations which pay corporate income 

tax), but instead, pass income or losses through to their partners, who 

must include that income or loss on their income tax returns. Large 

partnerships can have very complex structures. Since partnerships may 

be partners in other partnerships, their structures may include tiers or 

levels of partnerships. Some have dozens of tiers with hundreds of 

thousands of direct and indirect partners (partners in a lower-tier 

partnership are indirect partners in higher tiers). Businesses may have 

legitimate reasons to set up such tiered networks, such as isolating one 

part of a business from liabilities or losses of another part. However, 

partnership networks can also be used to evade taxes. IRS faces the 

daunting task of verifying that income is properly reported for tax 

purposes as it passes through the tiers and is ultimately distributed to the 

direct or indirect partners responsible for making tax payments.

 1

Direct partners are partners that have a direct interest in the large partnership during the 

tax year. Direct partners may include taxable (such as a corporation or individual) and 

nontaxable partners (such as a partnership) that also have direct partners. Indirect 

partners are partners that have an interest in a partnership through interest in another 

partnership or other form of pass-through entity.
Page 2 GAO-14-746T 

My testimony today builds on a body of work on large partnerships, 

including an interim report we issued in March 2014 as well as a recently 

issued report on all partnerships.2 We are doing broader, ongoing work on 

large partnerships and plan to issue a report in fall 2014 but will discuss 

some preliminary findings today. The fall report will provide a more indepth analysis of IRS data on large partnerships, IRS’s audit challenges, 

and the potential steps to mitigate them.

There is no statutory, IRS, or industry-accepted definition of a large 

partnership. Throughout this statement, we define a large partnership as 

having 100 or more direct and indirect partners and $100 million or more 

in assets. This definition is consistent with how IRS identifies certain 

partnerships based on the number of partners and asset size.3

A partnership has become the tax entity of choice for many businesses in 

recent years. IRS’s strategic plan for 2014-2017 notes that businesses 

with U.S. tax obligations are increasingly adopting more complex 

structures, shifting away from C corporations and moving towards passthrough entities, such as partnerships. Between tax years 2002 and 2010, 

the number of businesses organized as a partnership rose 45 percent 

from about 2.2 million to 3.2 million. In contrast, the number of C 

 2

GAO, Large Partnerships: Characteristics of Population and IRS Audits, GAO-14-379R

(Washington, D.C.: Mar. 19, 2014) and GAO, Partnerships and S Corporations: IRS 

Needs to Improve Information to Address Tax Noncompliance, GAO-14-453 (Washington, 

D.C.: May 14, 2014).

3

For our March 2014 report, we defined a large partnership as having 100 or more direct 

partners and $100 million or more in assets based on IRS data available on direct 

partners in the Business Return Transaction File. For this testimony and our ongoing 

work, we expanded the partner threshold to 100 or more direct and indirect partners and 

$100 million or more in assets after identifying an IRS data source that captures the 

number of indirect partners, the Enhanced Large Partnership Indicator file. This is 

consistent with how IRS defines large partnerships for an ongoing improvement effort. We 

used the “$100 million or more in assets” threshold because it is consistent with how IRS’s 

annual study of partnership tax returns being filed segregates partnerships by asset size. 

See IRS Statistics of Income, Partnership Returns, 2011 (Washington, D.C.: Fall 2013).
Page 3 GAO-14-746T 

corporations decreased about 14 percent from 1.9 million to 1.6 million 

over the same time period.4

Because of tiering, measuring the number of unique partners, the assets, 

and the income of a large partnership is complicated. For example, in 

figure 1, partnership B has three direct individual partners, and 

partnership C has two. Partnerships B and C are direct partners in 

partnership A, which also gives A five indirect partners of which four are 

unique. Adding up the income (or assets) of partnerships A, B, and C 

would result in double counting of income among the partnerships 

because income from partnership A is divided between partnerships B 

and C as it passes through to these unique partners.

 4

Internal Revenue Service, “Partnership Returns: Selected Balance Sheet and Income 

Statement Items, Tax Years 1999-2011, Historical Table 11,” Statistics of Income (SOI) 

Bulletin, accessed June 3, 2014, http://www.irs.gov/uac/SOI-Tax-Stats-Historical-Table-11

and Internal Revenue Service, “Returns of Active Corporations, Form 1120 and 1120S, 

Tax Years 2002-2010,” Corporation Complete Book, accessed April 4, 2014, 

http://www.irs.gov/uac/SOI-Tax-Stats-Corporation-Complete-Report. All estimates derived 

from samples have 95 percent confidence intervals that are within +/- 10 percentage 

points of the estimate itself, unless otherwise specified. Calculating percentage changes 

of numbers presented above may not equal those we present due to rounding. 
Page 4 GAO-14-746T 

Figure 1: Example of Partnership Structure with Tiers, and Direct and Indirect Partners

If a separate large partnership, call it D, with 1,000 partners, were to buy 

partnership C’s ownership interest in A, then partnership A would itself 

become a large partnership. It would then have two direct partners and 

1,003 indirect partners.

We analyzed data on the number and characteristics of large 

partnerships and what IRS knows about the cost and results of audits of 
Page 5 GAO-14-746T 

large partnership returns.5 We reviewed IRS documentation and our 

recent reports on partnerships. Finally, we interviewed a number of IRS 

officials, held six focus groups with IRS auditors that had worked on 

audits of large partnerships, and interviewed private sector lawyers 

knowledgeable about partnerships. The results of the analyses of focus 

group data are not generalizable to all IRS audits and do not necessarily 

represent the official viewpoint of IRS. Instead the results were used to 

identify themes in conjunction with the other forms of data we analyzed. 

To determine data reliability, we reviewed relevant documentation, 

interviewed knowledgeable IRS officials, and electronically tested the 

data to identify obvious errors or outliers. We determined that the data 

were sufficiently reliable for the purposes of this report. Our prior reports 

include a detailed description of our scope and methodology.

Our prior reports and ongoing work was conducted in accordance with 

generally accepted government auditing standards. Those standards 

require that we plan and perform the audit to obtain sufficient, appropriate 

evidence to provide a reasonable basis for our findings and conclusions 

based on our audit objectives. We believe that the evidence obtained 

provides a reasonable basis for our findings and conclusions based on 

our audit objectives. 

 5

Data cover partnerships that filed Form 1065, U.S. Return of Partnership Income and had 

100 or more direct and indirect partners and $100 million or more in assets. Our data on 

the number and characteristics of partnerships are from the Enhanced Large Partnership 

Indicator (ELPI) file and Business Return Transaction File while audit data are from the 

Audit Information Management System. Data in the ELPI file may be incomplete because 

the file is based on data from Schedule K-1s, which partnerships use to report their 

partners’ share of the partnership’s income, deductions, and other items to the partners. In 

general, the amounts of tiering shown represent minimums and entity counts are 

approximate. See GAO-14-453.
Page 6 GAO-14-746T 

According to IRS data, between tax years 2002 to 2011, the number of 

large partnerships more than tripled from 2,832 to 10,099. Over the same 

time, total assets of large partnerships more than tripled to $7.49 trillion. 

However, these numbers suffer from the double-counting complexities 

illustrated in figure 1. For comparison, our interim report on large 

partnerships, which defined large partnerships as those with 100 or more 

direct partners and $100 million or more in assets, found that over the 

same time period the number of large partnerships more than tripled, 

from 720 in tax year 2002 to 2,226 in tax year 2011. Similarly, total assets 

tripled to $2.3 trillion in tax year 2011.6

Without an accepted definition of a large partnership, there is not 

necessarily a right or wrong answer of whether direct and indirect 

partners should be included. Direct partners do not capture the entire size 

and complexity of large partnership structures. Accounting for indirect 

partners does, but it also raises the issue of double counting discussed 

above. Given the size and complexity of large partnerships, IRS does not 

know the extent of double counting among this population.

Large partnerships, especially those in higher asset brackets, are 

primarily involved in the finance and insurance sector.7 For example, in 

2011, 73 percent of large partnerships reported being involved in the 

finance and insurance sector and the majority of large partnerships that 

reported $1 billion or more in assets were in this sector. IRS data also 

showed that almost 50 percent of large partnerships with 100,000 or more 

direct and indirect partners reported being in the finance and insurance 

sector.

According to IRS officials and data, many of these entities are investment 

funds, such as hedge funds and private equity funds, which are pools of 

assets shared by investors that are counted legally as partners of the 

 6

This included a small number of large partnerships that filed a form 1065-B, U.S. Return 

of Income for Electing Large Partnerships. See GAO-14-379R.

7

Industry classifications are based on the North American Industry Classification System 

(NAICS). NAICS codes are self reported by businesses and judgment may be needed to 

determine the most appropriate NAICS code. 

Large Partnerships 

Have Grown in 

Number, Size, and 

Complexity Since 

2002 with Hundreds 

Now Having More 

Than 100,000 

Partners
Page 7 GAO-14-746T 

large partnership.8 Being investment vehicles, these funds tend to invest 

in other partnerships, as well as other types of business entities. One IRS 

official said that these investments can affect the partner size of other 

partnerships based on where they choose to invest (e.g., buying an 

interest in other partnerships). For example, if an investment fund with a 

million partners chose to invest in multiple small operating partnerships, 

such as oil and gas companies organized as partnerships, all of those 

partnerships would count as having more than a million partners as well. 

One IRS official said the partnerships with more than a million partners 

increased from 17 in tax year 2011 to 1,809 in tax year 2012. The official 

attributed most of the increase to a small number of investments funds 

that expanded their interests in other partnerships. If in the future those 

investment funds choose to divest their interests in other partnerships, the 

number of large partnerships would decrease significantly. Although the 

reasons for the changes are not clear, from tax years 2008 to 2010, the 

number of large partnerships with 500,000 or more direct and indirect 

partners changed from 70 in 2008 to 1,088 in 2009, and decreased to 70 

in 2010.

IRS data on large partnerships also show their complexity, as measured 

by the number of partners and extent of tiering, or levels, below the large 

partnership. Almost two-thirds of large partnerships in 2011 had more 

than 1,000 direct and indirect partners, although hundreds of large 

partnerships had more than 100,000. See figure 2 for more detail.

 8

Hedge funds and private equity funds are generally available only to institutions and 

individuals able to make investments in excess of $200,000. Aside from the fund 

managers, who guide the investment strategy and are general partners, the funds 

partners would be comprised of individual and institutional investors who contribute capital 

but have no say in investment or management decisions and are the limited partners. See 

CRS, Taxation of Hedge Fund and Private Equity Managers, RS22689 (Washington, D.C.: 

Mar. 7, 2014). We also issued a report that discussed the use of financial derivatives by 

these types of entities and the tax implications involved. See GAO, Financial Derivatives: 

Disparate Tax Treatment and Information Gaps Create Uncertainty and Potential Abuse, 

GAO-11-750 (Washington, D.C.: Sept. 10, 2012).
Page 8 GAO-14-746T 

Figure 2: Number of Large Partnerships by Number of Direct and Indirect Partners, 

Tax Year 2011

Note: For our data set from the ELPI file, IRS traced indirect partners through the first 10 tiers. After 

that, it stopped if the ownership percentage in the large partnership dropped below 0.00001 percent. 

To the extent this ownership percentage was changed, the size and number of large partnerships 

may change.

In 2011, about two-thirds of large partnerships had at least 100 or more 

pass-through entities in the partnership structure. Because almost all 

large partnerships tend to be part of multitiered networks, their partners 

could be spread across various tiers below those partners that have a 

direct interest in the partnership. For example, in 2011, 78 percent of the 

large partnerships had six or more tiers.

Determining the relationships and how income and losses are allocated 

within a large partnership structure through multiple pass-through entities 

and tiers is complicated. For example, in figure 3, the allocation from the 

audited partnership on the far left side of the figure crosses eight passthrough entities along the bold path before it reaches one of its ultimate 

owners on the right. This path also may not be the only path from the 

audited partnership to the ultimate owner.
Page 9 GAO-14-746T 

Figure 3: Example of Partnership Structure

Note: Figure 3, adapted from IRS documentation, is an illustration of a hypothetical, complex 

partnership structure, which shows the relationship between various types of entities. In IRS’s 

example, the allocation of income and losses from the audited partnership on the far left side of the 

figure crosses eight pass-through entities, all of which are partnerships themselves, along the bold 

line before it reaches one of its ultimate partnership owners on the right side.

While figure 3 appears complex, it has only 50 partners and 10 tiers. 

Large partnership structures could be much more complex. In 2011, as 

noted above, 17 had more than a million partners. According to one IRS 

official, there are several large partnerships with more than 50 tiers.
Page 10 GAO-14-746T 

IRS audits few large, complex partnerships. According to IRS data, in 

fiscal year 2012, IRS closed 84 field audits of the 10,143 large 

partnership returns filed in calendar year 2011—or a 0.8 percent audit 

rate.9 This is the same audit rate we found for fiscal year 2012 in our 

interim report, which defined large partnerships as having 100 or more 

direct partners and $100 million or more in assets.10 The audit rate for 

large partnerships remains well below that of C corporations with $100 

million or more in assets, which was 27.1 percent in fiscal year 2012. See 

table 1.

Table 1 also shows that most large partnership field audits closed from 

fiscal years 2007 through 2013 did not find tax noncompliance. In 2013, 

for example, 64.2 percent of the large partnership audits resulted in no 

change to the reported income or losses. In comparison, IRS audits of C 

 9

IRS defines the audit rate as the number of returns audited in a fiscal year divided by the 

number of returns filed in the previous calendar year. In fiscal year 2013, IRS completed 

95 field audits but we did not have 2012 calendar year filings at the time of our analysis to 

compute the audit rate. The audit rate does not include an activity known as Campus 

audits because they are not audits of the books and records of large partnerships. 

Instead, Campus audits are an administrative process in which the related partners’

returns are linked, or connected, to the large partnership return being audited in the field. 

This linking facilitates passing through any audit adjustments as a result of the field audit 

to the taxable partners. Even though these steps generally do not include any audit work, 

IRS counts the pass-through activity as an audit of each affected partner return. For 

information on Campus audits, see GAO-14-379R.

10See GAO-14-379R.

IRS Audits Few Large 

Partnerships Due to 

Challenges 

Presented by the 

Complexity of Both 

the Audit Procedures 

and the Large 

Partnership 

Structures

IRS Audits Large 

Partnerships at a Much 

Lower Rate than Large 

Corporations and the 

Audits Produce Minimal 

Results for Audit Time 

Spent
Page 11 GAO-14-746T 

corporations with $100 million or more in assets had much lower no 

change rates. For example, audits of large corporations had a no change 

rate of 21.4 percent in 2013.

Table 1: Audit Rate and No Change Rate for Large Partnerships and Large Corporations, Fiscal Years 2007 to 2013

Fiscal Year

2007 2008 2009 2010 2011 2012 2013

Large Partnerships 

Audit Rate 0.5% 0.6 0.6 1.4 0.7 0.8 N/A

No Change Rate 85.3 77.8 82.6 51.6 77.0 66.7 64.2

Large Corporations

Audit Rate 20.6 21.4 20.8 20.6 23.1 27.1 27.4

No Change Rate 16.2 22.1 18.6 18.7 20.4 27.2 21.4

Source: GAO analysis of IRS data book and Audit Information Management System (AIMS), Compliance Data Warehouse (CDW). I GAO-14-746T

Note: For any large partnership, the number of audited returns closed in a given fiscal year may 

include returns from multiple tax years. Calendar year 2012 partnership filings were not available in 

the ELPI file when we did our analysis to compute the audit rate for fiscal year 2013. For 

partnerships, the no change rate means that the audits made no changes to the partnership’s 

reported income, loss, deductions, or credits reflected on the tax return or Schedule(s) K-1 for 

partners. The no change rate for corporations means that the audits made no changes in the tax 

liability reported on the corporate tax return (e.g., tax, penalties, or refundable credits).

When the field audits of large partnership returns did result in changes, 

the changes to net income that the audits recommended were minimal in 

comparison to audits of large corporations, as shown in table 2.11 This 

could be because positive changes on some audits were cancelled out by 

negative changes on other audits. In 3 of the 7 years, the total 

adjustments from the field audits were negative. That is, they favored the 

large partnerships being audited. This did not occur for audits of large 

corporations. See table 2.

 11For pass-through entities, such as partnerships, which are nontaxable entities, audit 

adjustments are recommended changes to the entities’ reported net income, after 

accounting for losses, deductions, or credits reflected on the return or Schedule(s) K-1. 

For taxable entities, such as corporations, audit adjustments are additional recommended 

tax liability in the form of taxes, penalties, or changes to refundable credits. Our recent 

work highlighted that partnerships’ recommended audit adjustments may be double 

counted if they are passed through multiple tiers. See GAO-14-453. 
Page 12 GAO-14-746T 

Table 2: Total and Average Recommended Audit Adjustments to Net Income for Large Partnership and to Additional Taxes for 

Large Corporate Field Audits Closed by IRS, Fiscal Years 2007 to 2013 (in millions of dollars)

Fiscal Year

2007 2008 2009 2010 2011 2012 2013

Large Partnerships 

Total $ (99.2) (46.4) 22.5 75.7 569.5 160.4 (370.4)

Average (2.9) (1.0) 0.5 0.6 9.3 1.9 (3.9)

Large Corporations

Total 21,967 22,595 26,864 22,824 22,984 15,952 14,895

Average 5.2 5.0 5.6 5.1 4.7 2.8 2.4

Source: GAO analysis of IRS data book and AIMS, CDW. I GAO-14-746T

In terms of audit costs, the number of days and hours spent on the audits 

of large partnerships in fiscal year 2013 has increased since fiscal year 

2007, but varied from year to year in the interim, as shown in table 3.12 In 

contrast, the audit days and hours spent on audits of large corporation 

are decreasing while obtaining audit results that are noticeably better than 

those of large partnership audits.

Table 3: Audit Time Measures for Field Audits of Large Partnerships and Large Corporations, Fiscal Years 2007 to 2013

Fiscal Year

2007 2008 2009 2010 2011 2012 2013

Large Partnerships 

Average field hours charged 139 383 164 104 255 255 409

Average days from field audit open to audit closure 467 382 381 307 341 513 555

Large Corporations

Average field hours charged 791 724 694 694 580 521 496

Average days from field audit open to audit closure 709 658 601 585 556 536 598

Source: GAO analysis of IRS data from AIMS, CDW. I GAO-14-746T

Note: These audit time measures do not cover all of the costs of large partnership audits, such as the 

time IRS spends passing through audit adjustments at the Campus.

 12The time spent on large partnership field audits includes time spent examining the books 

and records of the large partnership return as well as time spent following the Tax Equity 

and Fiscal Responsibility Act of 1982 audit procedures.
Page 13 GAO-14-746T 

IRS does not track its audit results for large partnerships and therefore 

does not know what is causing the results in tables 1, 2, and 3.13

Consequently, it is not clear whether the results are due to IRS selecting 

large partnerships that were tax compliant versus IRS not being able to 

find noncompliance that did exist.

The high no change rates and minimal adjustment amounts for IRS audits 

of large partnerships may be due to a number of challenges that can 

cause IRS to spend audit time on administrative tasks, or waiting on 

action by a large partnership or IRS stakeholder rather than doing actual 

audit work. Under the Tax Equity and Fiscal Responsibility Act of 1982 

(TEFRA),14 the period for auditing partnerships does not expire before 3 

years after the original due date of the return or date of return filing, 

whichever is later.15 IRS on average takes approximately 18 months after 

a large partnership return is received until the audit is started, leaving on 

average another 18 months to conduct an audit, as illustrated in figure 

4.

16

 13According to IRS officials, IRS also does not know the reasons for variations in audit 

results for other types of tax entities.

14Pub. L. No. 97-248 , §§ 401–407, 96 Stat. 324, 648–671 (1982). TEFRA established 

unified audit procedures for covered partnerships and, as amended, are found generally at 

Internal Revenue Code sections 6221 through 6234. A partnership would fall under the 

TEFRA audit procedures if at any time during the year it had (1) more than 10 partners or 

(2) certain types of partners (e.g., another partnership, a Limited Liability Company (LLC) 

which files as a partnership or is treated as a single member LLC disregarded for federal 

tax purposes, any type of trust, a nominee, a nonresident alien individual, and a S 

corporation).

1526 U.S.C. § 6229(a). Assessments of taxpayers are generally subject to a 3-year statute 

of limitations. 26 U.S.C. § 6501(a). This provision of TEFRA can extend, but never shorten 

the statute of limitations. According to IRS officials, it does audit partnerships covered by 

TEFRA beyond the 3-year timeframe established in section 6229 in cases where the 

statute of limitations under section 6105 has yet to expire for one or more partners. 

16Although partnerships do not pay taxes directly, they do file a Form 1065, U.S. Return of 

Partnership Income, and this is what IRS would audit.

Several Challenges 

Related to Complexity 

Hinder IRS’s Audits of 

Large Partnerships
Page 14 GAO-14-746T 

Figure 4: Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) Audit Timeline

Notes: A 3-year statute of limitations governs the time IRS has to complete partnership audits, 

according to the audit procedures enacted in TEFRA.

a

In fiscal year 2013, the stage in which the large partnership return is received by IRS until it starts the 

large partnership audit took IRS on average 1.4 years.

b

In fiscal year 2013, the stage in which IRS conducts a large partnership audit took IRS on average 

1.5 years.

c

The period in which partners of the large partnership are assessed their portion of the audit 

adjustment is generally completed by IRS within 1 year.

Once a large partnership audit has been initiated, it falls under the 

TEFRA audit procedures. Congress enacted the TEFRA audit procedures 

in response to concerns about IRS’s ability to audit partnership returns. 

According to the congressional Joint Committee on Taxation (JCT), the 

complexity and fragmentation of partnership audits prior to TEFRA, 

especially for large partnerships with partners in many audit jurisdictions, 

resulted in the statute of limitations expiring for some partners while other 

partners were required to pay additional taxes as a result of the audits.17

TEFRA addressed these issues by altering the statute of limitations and 

requiring each partner of a partnership to report certain items like income, 

consistent with how the partnership reports them. However, according to 

IRS officials and in focus groups we held with IRS auditors, using the 

TEFRA procedures to audit large, complex partnership structures present 

a number of administrative complexities for IRS. These complexities may 

 17JCT, General Explanation of the Revenue Provisions of the Tax Equity and Fiscal 

Responsibility Act of 1982, JCS-38-82, (Washington, D.C.: December 1982).
Page 15 GAO-14-746T 

reduce the time IRS spends on actual audit work, adversely affecting IRS 

audit results for large partnerships. For example, one of the primary 

challenges for doing large partnership audits under TEFRA that IRS focus 

group participants reported was identifying the Tax Matters Partner 

(TMP). The TMP is the partnership representative who is to work with IRS 

to facilitate a partnership audit. The responsibilities of the TMP include (1) 

supplying IRS with information about each partner, (2) keeping the 

partners of the partnership informed and getting their input on the audit, 

and (3) executing a statute of limitations extension, if needed. Without 

being able to identify a qualified TMP in a timely manner, IRS may 

experience delays during large partnership audits.

IRS focus group participants cited numerous examples of difficulties in 

identifying the TMP. One difficulty is that the TMP can be an entity, not a 

person. If an entity is designated as the TMP, IRS has to track down an 

actual person to act as a representative for the TMP.18 Focus group 

participants said that some large partnerships do not designate a TMP or 

designate an entity as TMP to delay the start of the audit, which would 

limit the audit time remaining under the statute of limitations.

Entities will often be elusive about designating the TMP. The entities will 

use this tactic as a first line of defense against an audit.

Source: IRS focus group participant. I GAO-14-746T

The burden for ensuring that the TMP meets the requirements of TEFRA 

largely falls on IRS. Time spent identifying a qualified TMP, according to 

IRS focus group participants, could take weeks or months. As shown in 

figure 4, IRS has a window of about 1.5 years to complete large 

partnership audits. A reduction of a few months from the 1.5 years IRS 

has to complete large partnership audits means that the time IRS has for 

the audit would be markedly reduced.

Another challenge TEFRA poses is determining the extent to which IRS 

passes through audit adjustments to the taxable partners in a large 

partnership structure. In that large partnerships are nontaxable entities, 

TEFRA requires that audit adjustments be passed through to the taxable 

partners, unless the partnership agrees to pay the related tax at the 

partnership level. To pass through the audit adjustments to the taxable 

 18If an entity is designated as the TMP, the partnership has the option of designating a 

TMP representative on Form 1065.
Page 16 GAO-14-746T 

partners, IRS has to first link, or connect, the partners’ returns to the 

partnership return being audited. However, IRS officials said linking a 

large number of partners’ returns can be a significant drain on IRS’s 

resources. If a large partnership has hundreds or thousands of partners at 

multiple tiers, the additional tax owed by each partner as a result of large 

partnership audit may not be substantial enough to be worth passing 

through once those partners’ returns are linked.19 If the audit adjustment 

is lower than a certain level, IRS will not pass it to the taxable partners; 

and the time and resources spent linking the partners’ returns, and 

preparing a plan to pass through the audit adjustment to certain taxable 

partners’ returns, becomes effectively meaningless.

Aside from the TEFRA challenges, another challenge involves the 

complexities arising from large partnership structures, which hinder IRS’s 

ability to identify tax noncompliance with complex tax laws. For example, 

IRS officials reported having difficulty in identifying the business purpose 

for the large partnerships or in determining the source of income or losses 

within their structures (i.e. knowing which entity in a tiered structure is 

generating the income or losses). Without this information, it is difficult for 

IRS to determine if a tax shelter exists, an abusive tax transaction is 

being used, and if income and losses are being properly characterized.

I think noncompliance of large partnerships is high because a lot of what 

we have seen in terms of complexity and tiers of partnership structures... 

I don’t see what the driver is to create large partnership structures other 

than for tax purposes to make it difficult to identify income sources and 

tax shelters.

Source: IRS focus group participant. I GAO-14-746T

To help IRS auditors better understand the complexity of the TEFRA audit 

procedures and the large partnership structures, various IRS 

stakeholders and specialists are to provide support during the audit. 

However, IRS focus group participants stated that they do not have the 

needed level of timely support. These include TEFRA coordinators to help 

with the TEFRA audit procedures, IRS counsel to help navigate the 

TEFRA audit procedures and provide input on substantive tax issues, and 

specialists who have expertise in a variety of areas. The support provided 

 19As long as adjustments exceed a tolerance on a certain amount, IRS passes through 

the adjustments to the taxable partners. Due to the sensitive nature of the tolerance 

levels, IRS does not make them public.
Page 17 GAO-14-746T 

by IRS stakeholders is important because many IRS focus group 

participants said that their knowledge of partnership tax law was limited 

and they may only work on a partnership audit once every few years.

The challenges identified by IRS are not recent occurrences but may 

have grown over time as the number and size of large partnerships has 

grown. For example, in 1990, the Department of the Treasury (Treasury) 

and IRS reported that applying TEFRA to large partnership audits 

resulted in an inefficient use of limited IRS resources.20 They cited a 

number of reasons for the inefficient use of resources, such as having to 

collect and review information on a large number of partners and the 

difficulty of passing through audit adjustments to those partners.

IRS by itself cannot fully address the tax law and resource challenges in 

auditing large partnership returns. For example, IRS cannot make the 

structures or laws less complex and cannot change the TEFRA audit 

procedures in statute. In addition, IRS has recently experienced budget 

reductions, constraining the resources potentially available for large 

partnership audits.21

Despite these limitations, IRS has initiated efforts that may help address 

the challenges auditing large partnership returns. First, IRS can 

sometimes use a closing agreement to resolve an audit under the TEFRA 

audit procedures, if both IRS and the partnership agree to its terms. This 

agreement allows the tax owed from the net audit adjustment at the 

highest marginal tax rate to be collected at the partnership level, meaning 

IRS does not have to pass through the audit adjustments to the taxable 

partners. IRS does not track the number of closing agreements but IRS 

officials said that IRS enters into relatively few. IRS officials are 

encouraging audit teams to pursue closing agreements for large 

partnership audits. However, closing agreements come with challenges 

because the partnership must be willing to agree and the IRS review 

process can be extensive.

 20See Treasury and IRS, Widely Held Partnerships: Compliance and Administration 

Issues – A Report to Congress, (Washington D.C.: Mar. 30, 1990). 

21GAO, Internal Revenue Service: Absorbing Budget Cuts Has Resulted in Significant 

Staffing Declines and Uneven Performance, GAO-14-534R (Washington, D.C.: Apr. 21, 

2014).

IRS Has Limited 

Ability to Fully 

Address Challenges
Page 18 GAO-14-746T 

Aside from closing agreements, the IRS efforts affect steps IRS takes at 

the beginning of an audit—such as understanding the complexity of large 

partnerships and selecting returns for audits. However, IRS has not yet 

determined the effectiveness of these efforts.

The Chairman of the House of Representatives Committee on Ways and 

Means and the Administration have also put forth proposals to address 

some of challenges associated with the TEFRA audit procedures.22 While 

the proposals differ somewhat and apply to partnerships with different 

numbers of partners, both would allow IRS to collect tax at the 

partnership level instead of having to pass audit adjustments through to 

the taxable partners.

In our ongoing work on large partnerships, we are assessing options for 

improving the large partnership audit process and, if warranted, will offer 

reforms for Congress to consider and recommendations to IRS.

Chairman Levin, Ranking Member McCain, and Members of the 

Subcommittee, this completes my prepared statement. I would be 

pleased to respond to any questions that you may have at this time.

We provided a draft of this testimony to IRS for comment. IRS provided 

technical comments, which were incorporated, as appropriate.

 22The Chairman of the House of Representatives Committee on Ways and Mean’s 

proposal would apply to partnerships with more than 100 direct partners, or if any partner 

is itself a partnership. See Joint Committee on Taxation (JCT), Technical Explanation of 

the Tax Reform Act of 2014, A Discussion Draft of the Chairman of the House Committee 

on Ways and Means To Reform the Internal Revenue Code Title III – Business Tax 

Reform, JCX-14-14, (Washington, D.C.: Feb. 26, 2014). The Administration’s proposal 

would apply to partnerships with 1,000 or more direct and indirect partners. See 

Department of the Treasury, General Explanations of the Administration’s Fiscal Year 

2015 Revenue Proposals, (Washington, D.C.: Mar. 2014).

Agency Comments
Page 19 GAO-14-746T 

If you or your staff have any questions about this testimony, please 

contact me at (202) 512-9110 or whitej@gao.gov. Contact points for our 

Offices of Congressional Relations and Public Affairs may be found on 

the last page of this statement. GAO staff who made key contributions to 

this testimony included Tom Short, Assistant Director, Vida Awumey, 

Sara Daleski, Deirdre Duffy, Robert Robinson, Cynthia Saunders, Erik 

Shive, Albert Sim, A.J. Stephens, and Jason Vassilicos.

Contact and 

Acknowledgements

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