IRS Uses Inflation Reduction Act Funding to Launch Unit for Audits of Pass-Through Businesses

A new unit within the IRS’ Large Business and International (LB&I) division dedicated to large or complex pass-through entities began work on October 22, 2024. The unit will focus specifically on “more efficiently conducted audits” on pass-through businesses. 

Audits on pass-through entities may increase

The IRS’ latest efforts focus on businesses that pay no taxes on their revenue, but instead pass the income onto owners who file taxes based on their individual income tax rates. These businesses include sole proprietorships, partnerships, limited liability companies, and S-corporations.

The new unit will enforce compliance on pass-throughs of any size and form including S-corps, partnerships, and trusts, which are believed to be used for tax evasion. 

With the formation of the specialized unit, the IRS seeks to be able to reverse their “historically low audit rate for a complex arrangement used by high-net-worth individuals and large entities.”

High-income groups are primary target, but audits on lower-income groups may increase

In the past, audits of pass-throughs were divided between LB&I and the Small Business/Self-Employed divisions and cases were assigned based on entity size. The new unit will be grouped into teams based on geography allowing for a more efficient process.

The goal of the unit is to focus on complex audits, but the IRS has previously stated that if there was a funding crunch, the unit would be forced to focus on low to middle income groups who often have simple tax returns. The result would be a higher share of audits falling on these lower income groups and a decrease of audits on high-income and large corporate filers.

Qualified business income deduction set to expire in 2025

Many provisions of the 2017 Tax Cuts and Jobs Act are set to expire in 2025, including a provision that allows a 20 percent deduction of qualified business income for pass-through entity owners. Opinions vary on the provision with one side saying that wealthy filers benefited disproportionately and the other side pushing for the deduction to be retained. Proponents of the QBI deduction argue that eliminating the provision would put pass-through entities at a disadvantage to corporations who benefit from a corporate income tax reduction from 35 percent to 21 percent in 2017.

It remains to be seen how a new presidential administration would handle the issue, but given the possibility of increased audits on pass-through entities and the possibility of the qualified business income deduction being eliminated business owners need to be prepared and plan accordingly.