IRS eyes partnerships in tax evasion crackdown

Former President Trump isn’t the only one being accused of playing games with business valuations for financial gain.

The strategy of undervaluing and overvaluing business assets to keep money away from the IRS is increasingly a cause for concern for the agency.

Tax experts are preparing for a wave of intensified enforcement against large partnerships as the IRS gets ready to fight back.

Starting this month, hundreds of large partnerships will start getting special compliance notices from the IRS. The notice will alert them to discrepancies on their balance sheets that the IRS wants explained.

These partnerships will include hedge funds, real estate investment partnerships, big law firms, and publicly traded partnerships, among other types of businesses. Many wealthy people prefer their businesses to be designated as partnerships so their business income can be reported directly on their personal tax returns.

IRS Commissioner Danny Werfel said some partnership tax returns “are showing discrepancies in the millions of dollars in their year-to-year balance sheets.”

“The number of such discrepancies has been increasing over the years. Many of these taxpayers are not attaching required statements explaining the difference,” Werfel said in a call with reporters last month.

Accountants say those discrepancies are often due to strategically inaccurate estimates of what businesses and their assets are actually worth. These inaccuracies help them to minimize tax liability.

“What you’re seeing is some extraordinarily high valuations of these potential businesses with not a lot of oversight from analysts that are doing those valuations,” forensic accountant Dean Driskell of consulting firm J.S. Held told The Hill.

Personal business income

Partnerships are known as pass-through entities because they don’t file tax returns directly with the IRS. Instead, they pass their tax liability through to their individual owners.

This means partners in a company who report business losses or who significantly undervalue their businesses can use them to offset what they make in their regular salary.

“Let’s say you have a wealthy individual who may have a corporate job and makes a couple million dollars a year. If he or she is invested in a partnership and can show losses on those to offset the $2 million, they virtually have no tax liability,” Driskell said.

Trump employed a similar strategy, distributing tens of millions of dollars’ worth of business and real estate losses throughout his tax returns, allowing him in some of the years he was president to pay nothing in tax.

The amount of personal business income owed to the government but not collected totaled $130 billion a year between 2014 and 2016, the last time it was definitively measured. It is almost certainly much higher now.

Money for nothing?

One well-known strategy that exploits overvalued businesses involves a tax deduction called a conservation easement, which is meant to encourage owners of large tracts of land not to develop them in the interest of the environment.

These deductions, when applied to partnerships that contain those overvalued businesses, can wipe out their tax liability.

“Let’s say that we’re a family business that has three or four profitable businesses. They develop this conservation easement and get this very large tax credit, and it basically wipes out all of the tax liability for the other companies,” Driskell said.

“And now the IRS is becoming very interested to see how these valuations were done, whether the projects ever broke ground, et cetera.”

The IRS is aware of abuses concerning the conservation easement and shoddy valuations.

“We have seen taxpayers, often encouraged by promoters and armed with questionable appraisals, take inappropriately large deductions for easements,” the agency wrote in a statement earlier this year.

But similar strategies making use of less well-known deductions are still likely taking place under the agency’s nose. They may also not even require specific deductions due to the “pass-through” nature of partnerships.

What’s the ‘basis’?

Tax lawyers also say the discrepancies the IRS is looking to resolve with big partnerships could lie in what companies tell themselves they’re worth and what they tell others they’re worth.

These differences in internal and external “basis” could be hiding big money.

“When you get into conversations about basis and income and loss, you’re going to get into conversations about valuation issues,” Robert Wall, a partner specializing in tax law at law firm Akerman, told The Hill in an interview. “What’s something actually worth and how do you substantiate that?”

Howdy, partner

Another common tax dodge for partnerships that accountants say they frequently see has to do with partners’ contributing different amounts to their shared business ventures.

One partner can contribute the totality of the capital to a partnership while another legally designated partner contributes only their business acumen, an intangible skill or a set of connections.

Equity interest and the allocation of profits and losses can fall equally between the partners, even though only one of them has put up any money.

“The government says, ‘OK. You can be 50-50 partners, and you can be allocated, say, a $50,000 loss.’ But if [one partner] didn’t put in at least $50,000 into the business in cash, they’re not going to be able to take that loss at that time. They’re going to have to defer that loss either to when money is contributed or when there’s income from the business that will carry that loss forward to future years,” Mark Gottlieb, a forensic accountant and business valuation specialist in New York, told The Hill.

Gottlieb, who testifies regularly in court about business valuations, said he sees issues arising from this kind of fiscally imbalanced partnership structure “every day.”