New Budget Deal Gives IRS New Rules To Better Audit PE, Hedge Funds

New Budget Deal Gives IRS New Rules To Better Audit PE, Hedge Funds

A close look at the new budget deal hammered out by the John Boehner-led Republicans and the White House-led Democrats reveals it is a true compromise. Clearly neither side got everything they want, but they found enough common ground to come up with a deal.

One key piece of common ground that ended up being included in the recent budget deal was the closing of a major tax loophole that had been exploited by the wealthy for some time. Tax experts say the new rules will make it notably easier for the IRS to effectively audit large partnerships such as private equity funds and hedge funds.

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Bipartisan proposal closes major tax loophole exploited by large partnerships such as hedge funds

The unusual bipartisan proposal was developed from ideas from legislators from both parties, will rewrite the rules for partnership audits that requires the IRS to pass additional taxes to each partner. That has proven to be an extremely difficult job for the IRS, and resulted in the largest and most complex PE and hedge fund partnerships being nearly impossible to effectively audit.

Of note, a 2014 GAO study determined that the IRS audited a mere 0.8% of large partnerships (at least 100 partners and $100 million in assets) relative to 27.1% of firms with at least $100 million in assets. Of interest, the majority of the large partnership audits of hedge funds and others resulted in no additional taxes, but GAO said it could not determine if that was due to high compliance or the inability of the IRS to find noncompliance.

The proposed bill calls for the IRS to apply changes in audits to the partnership itself, not the individual partners. Unfortunately, the bill allows small partnerships with less than 100 partners to exempt themselves from the new tax regime, which is slated to take effect in 2018.

Analysts note that these tax-compliance measures in the budget bill are clearly aimed at hedge funds and similar enterprises. Based on a GAO analysis, closing this loophole and one other as called for in the bill will lead to $11.2 billion in additional tax revenues in the next 10 years.

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