IRS establishes new pass-through division to tax high earners

The Internal Revenue Service (IRS) is setting up a new division with the billions in new funding it received in the Inflation Reduction Act to go after uncollected taxes sheltered in companies that pass their tax liability through to their individual owners.

These kinds of businesses are known as “pass-through entities” and often take the legal designation of limited liability partnerships, S-corporations, general partnerships and sole proprietorships.

The new division will be contained within the IRS’s Large Business and International (LBI) Division, which collects taxes on corporations, S-corps, and partnerships with assets greater than $10 million.

The IRS said in a Wednesday statement that the creation of the new unit is part of an effort “to restore fairness in tax compliance by shifting more attention onto high-income earners, partnerships, large corporations and promoters abusing the nation’s tax laws.”

“This is an important change we will be making, and we will be working in the months ahead to efficiently and effectively transition to this new group,” IRS large business chief Holly Paz said in the statement.

The new enforcement initiative has been enabled by an initial $80 billion funding boost for the IRS as part of Democrats’ Inflation Reduction Act, passed last August.

Republicans have railed against the new funding for the IRS, immediately repealing it in a House bill when the GOP retook the lower chamber at the beginning of this year. That bill was a nonstarter in the Democrat-controlled Senate.

Republicans did manage to scale back roughly $20 billion of the funding as part of an oral agreement with Democrats to avoid a government debt default over the summer. That $20 billion would mostly come out of regular appropriations for the IRS as opposed to being removed from the funding allotment directly.

The IRS announced last week that it intends to hire 3,700 personnel to work on audits and enforcement of “partnerships, large corporations, and high-income and high-wealth individuals.”

The government fails to collect hundreds of billions of dollars in taxes that it is owed each year, an amount known as the “tax gap.” Former IRS Commissioner Charles Rettig told Congress last year that number could be as high as $1 trillion — roughly 3 percent of the national deficit, which stands now at $33 trillion.

The last time it was definitively measured for tax years 2014 to 2016, the tax gap included $130 billion in uncollected individual business income and $37 billion in uncollected corporate income tax.

IRS Commissioner Danny Werfel said on a call with reporters earlier this month that during the last decade, pass-through entities and wealthy individuals have been besting the IRS as the agency’s resources and funding have declined.

“During that 10 years, it essentially enabled wealthy individuals, large partnerships, complex and large corporations to come up with increasingly creative ways of reaching their most tax-advantaged status. The issue is that in many of those cases, they took steps that are technically tax evasion under the tax law. That’s where this focus is,” he said.