IRS Battles the Hidden Wealth in Large Partnerships
The complexity of modern financial structures has created a formidable challenge for the Internal Revenue Service (IRS) as it grapples with the task of ensuring tax compliance among the ultrawealthy. The emergence of “large partnerships,” intricate investment vehicles favored by private equity funds and similar firms, has allowed vast amounts of income to become nearly invisible to tax auditors.
Owen Zidar, an economist and former contractor for the U.S. Department of Treasury, was taken aback by the scale of wealth funneled into these opaque structures when he analyzed secret tax data provided by the IRS. Zidar, now a professor at Princeton University, highlighted the significant share of income that the top 1% is channeling into these schemes.
After enduring years of budget cuts, the IRS found itself outpaced by the sophisticated tax strategies employed by the richest taxpayers. With an audit rate of large partnerships close to zero percent, the agency faced an uphill battle. However, a recent $80 billion funding boost from Congress in 2022 has set the stage for an ambitious IRS effort to penetrate these elusive financial bastions.
An investigation by the International Consortium of Investigative Journalists (ICIJ), which included reviews of hundreds of leaked IRS forms and interviews with former tax officials, revealed an agency hindered by a lack of experienced agents and federal rules that have inadvertently aided investors in evading scrutiny. The leaked K-1 forms, which should ideally reveal the identities of investors in these partnerships, often list anonymous shell companies or trusts, further complicating the IRS’s task.
Former IRS agents attest to the daunting layers of complexity that obscure the true owners behind these entities. Damon Rowe, who left the IRS in 2022, likened these entities to holograms, existing only on paper and requiring investigators to delve through multiple layers to uncover the real individuals involved.
The use of shell companies in tax forms is legal, and some foreign entities are exempt from obtaining U.S. tax numbers under IRS rules. This legal framework adds to the workload for tax investigators who are already tasked with deciphering complex partnership structures.
Despite the challenges, there is hope that with its new funding, the IRS can attract top talent in partnership taxation and enhance its capabilities with artificial intelligence programs. However, federal pay rules may limit how much the agency can offer potential recruits, making it difficult to compete with private-sector salaries.
As the IRS embarks on this unprecedented effort to audit large partnerships and enforce tax laws equitably, it faces a labyrinthine task. The agency’s success will not only impact federal revenue but also address concerns about a two-tiered tax system where the ultrarich can seemingly opt out of their tax obligations.
