IRS Targets Pass-Through Businesses with New Unit

A new unit has been officially launched by the IRS to “more efficiently conduct audits” of pass-through businesses. This initiative is aimed at businesses that do not pay taxes on their revenue. Instead, the income they generate is passed on to their owners who then file taxes based on their individual tax rates. Pass-through businesses include sole proprietorships, partnerships, limited liability companies, and S-corporations.

IRS's New Unit for Large or Complex Pass-Through Entities

In September, the IRS announced the establishment of a unit within the agency’s Large Business and International (LB&I) division, focusing on large or complex pass-through entities. The unit officially began its work on Oct. 22. The new department aims to ensure compliance from pass-through entities of all sizes and forms, including S-corporations, partnerships, and trusts. According to the agency, these businesses are being used to evade taxes.

Increasing Fairness in Enforcement

IRS Commissioner Danny Werfel stated that the establishment of pass-through field operations is a significant step towards increasing fairness in enforcement while improving service. He added that by using Inflation Reduction Act funding and enhancing their expertise in this area, they will be able to reverse historically low audit rates for complex arrangements employed by certain high-wealth individuals and large entities. Previously, pass-through examinations were divided between two IRS divisions—LB&I and the Small Business/Self-Employed, based on the size of the entity. The new pass-through unit will group revenue agents into teams based on geography, and they will be tasked with the primary examination of returns related to pass-through businesses.

Potential Impact on Lower-Income Groups

While the IRS maintains that funds from the Inflation Reduction Act will be used to target high-income groups, it has previously acknowledged that lower-income groups could be targeted in the event of a funding crunch. This could result in a more than 50 percent reduction in enforcement staff by fiscal year 2030, severely affecting the agency’s ability to carry out complex audits.

Pass-Through Deductions Under Threat

The new IRS unit targeting pass-through entities has been established at a time when a key tax deduction available to these businesses is under threat. In 2017, a provision was signed into law by President Donald Trump allowing pass-through entity owners to deduct 20 percent of their qualified business income when calculating taxes. This law is set to expire in 2025.

Criticism and Defense of Pass-Through Deductions

The deduction has been criticized for disproportionately benefiting the wealthy and encouraging businesses to manipulate the tax code to maximize qualifying income. However, the U.S. Chamber of Commerce argues for retaining the tax deduction, stating that it ensures that these businesses are not at a tax disadvantage compared to corporations.

Bottom Line

The IRS's new unit targeting pass-through businesses is a significant development in the agency's efforts to ensure tax compliance. While it aims to target high-wealth individuals and large entities, there are concerns about potential impacts on lower-income groups. The future of pass-through deductions, a key benefit for these businesses, is also uncertain. What are your thoughts on these developments? Share this article with your friends and sign up for the Daily Briefing, delivered every day at 6pm.