By Kevin Drawbaugh
WASHINGTON (Reuters) - More large U.S. businesses are organising as partnerships, rather than corporations, and the tax-collecting U.S. Internal Revenue Service is not doing enough to keep an eye on them, a government watchdog said on Thursday.
Echoing concerns raised by other Washington officials about the surge, the Government Accountability Office (GAO) said more than 10,000 large businesses were set up as partnerships in 2011, three time as many as in 2002.
Partnership structures were especially prevalent in finance, such as hedge funds and private equity firms, and in the energy sector, said the GAO, the investigative arm of Congress.
Fewer than 1 percent of large partnerships were audited by the IRS in 2012, compared with 27 percent of large corporations, the GAO said, defining both as having $100 million (60.84 million pounds) or more in assets, and in the case of partnerships, 100 or more partners.
"It doesn't make sense for large corporations to face a nearly 30 times greater chance of an IRS audit than highly profitable large partnerships," said Democratic Senator Carl Levin, chairman of a Senate panel examining this issue.
The IRS said in a statement it is "mindful of the need to do everything possible, within our limited resources, to improve the efficiency and effectiveness of our enforcement efforts in regard to large partnerships."
Congress has slashed the IRS's budget in recent years, constraining its ability to hire staff and upgrade computers.
A partnership is an unincorporated organisation with two or more members that runs a business. Partnerships pay no federal income tax. Instead, profits or losses from the business flow directly to the partners, who have to include them on their personal income tax returns. In contrast, corporations do pay federal corporate income taxes on their profits.
Large partnerships are often highly complex, with multiple tiers of pass-through entities, making IRS audits long and difficult. The GAO said many large partnerships have more than 100,000 partners, while some have more than 1 million.
About 73 percent of large partnerships were financial or insurance businesses in 2011, with many being hedge funds or private equity funds, the GAO said.
The watchdog recommended that Congress require partnerships to designate a partner as responsible for tax issues. In addition, the IRS should develop a clear definition of its own for large partnerships and do more to track them, the GAO said.
The Treasury Department said last month it was looking into the impact on federal tax revenues of the increased use of master limited partnership (MLP) structures.
One large U.S. partnership-based business is Houston-based Kinder Morgan Inc (N:KMI), the nation's biggest pipeline company. It said last month it was converting into a corporation by folding together its multiple MLPs.
This prompted some analysts to say the increased use of these structures had peaked, but MLPs, which are restricted to certain kinds of businesses and which can be publicly traded like corporations, are just one of several types of partnerships.
(Reporting by Kevin Drawbaugh.; Editing by Andre Grenon)