Transfer Pricing Implications of the IRS Audit Campaign Targeting Pass-Through Entities
The Large Business & International (LB&I) Division of the IRS is responsible for serving C corporations, S corps and partnerships with assets greater than $10 million, as well as organizations with international operations. In the most recent proposed budget, the IRS—including LB&I—would receive a 4 percent increase in funding, allowing it to increase its staff (proposed net hirings of 1,700 employees). Due to the increased funding and the Bipartisan Budget Act, LB&I plans to enact a large partnership audit regime. Partnerships will now be audited at the entity level because of the centralized partnership audit regime, which allows IRS agents to look through the partnership entity to the shareholder level. In addition, partnership reporting requirements have recently changed to grant the IRS access to information that will assist in auditing the entity, not the partner.
This IRS audit campaign increases the need for robust transfer pricing documentation for pass-through entities. U.S. flow-through entities with foreign entities are required to prepare transfer pricing documentation in the foreign subsidiaries in which they operate. However, in the past, there was less importance placed on the need to prepare U.S. transfer pricing documentation for pass-through entities, as they do not pay tax at the entity level. Given the audit program to conduct audits at the shareholder level, it is important for pass-through entities to prepare U.S. transfer pricing documentation to support and sustain their foreign tax credits in the event of an audit. The IRS could deny the foreign tax credits at the shareholder level if the transfer pricing is incorrect and placed too much income in the foreign entity, which would overstate the foreign tax credit taken by the shareholder. In addition to satisfying the foreign tax authority’s transfer pricing documentation requirements, a transfer pricing analysis provides support to the foreign tax credits claimed by the shareholders on their tax returns.
Overall, this is an important development because it means there is greater tax risk/exposure at the entity level that may not currently be accounted for. Please contact your BKD Trusted Advisor™ or use the Contact Us form below to discuss this IRS audit campaign and the associated risk.