IRS, States Begin Crackdown on Partners' Tax Returns

The New York Times reported last week that the Internal Revenue Service (IRS) is sharing information to help state tax authorities crack down on underreporting of income by partners and other participants in pass-through tax entities. The Times said the data was made available to the states in the fall of 2001, but some states lack the enforcement resources needed to take advantage of the information ("Cuts in Tax Enforcement Cost the States Billions," April 12, 2002.)

State Initiatives

Although there are no known official reports on the status of the state initiatives, the Times was able to piece together a rough scorecard by interviewing Jerry J. Curnutta, a retired IRS official and expert on partnership taxation who has been offering to help states take the lead in this area. Mr. Curnutta said some states are waiting until the IRS is geared up to handle the crackdown at the federal level. However, New York, New Jersey, Massachusetts, Wisconsin and nine other states now have the information needed to identify partners who underreport income. Another 16 states have enough data to find these tax cheats but with more difficulty. The remaining states lack the data.

IRS Initiative

General Accounting Office Tax Issues Director Michael Brostek provided additional details about the status of the IRS's program at a Finance Committee hearing on abusive tax schemes on April 11, 2002. He said the IRS started to transcribe tax year 2000 K-1 information during the spring of 2001 with the objective of checking the data against individual returns. This matching process had been resumed in 2001 after a five-year suspension from 1995 to 2000 because the IRS noticed a significant increase in the number of flow-through entities. In effect, it places taxpayers who receive flow-through income on a more equal footing with taxpayers who are wage earners because it subjects K-1s to the same scrutiny and cross-checking as W-2s and 1099s.

According to Mr. Brostek's report, the transcription process was completed in December 2001, and the schedule called for the matching of the K-1 information against individual tax returns to commence in March 2002.

Download Mr. Brostek's statement.

-Rosemary Schlank

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