Widely adopted in the United States of America (“USA”), transparent entities for tax purposes are types of business structures aimed to limiting taxation and, in turn, avoiding double taxation.
The profits and losses obtained by the entity are directly transferred to its shareholders or owners, who report these results in their personal income tax returns according to their share of the company’s profits. Therefore, companies are not subject to corporate taxes, and are considered transparent for tax purposes.
This model can be used in Partnerships, Limited Liability Companies (“LLCs”), Sole Proprietorships (LLCs with only one member), and S-Corporations with up to 100 shareholders. The US Internal Revenue Service (“IRS”) will establish a special tax audit department to focus on pass-through entities with assets exceeding $10 million due to their greater complexity.
The department will assess which entities need to provide more clarity regarding their accounting and tax information. Subsequently, it will request internal audits to be conducted within these entities and/or request additional information and documents through compliance letters.
According to the IRS, the opening of this new audit department aims to “restore fairness in tax law enforcement by concentrating more attention on high-income individuals, partnerships, large corporations, and promoters who abuse the country’s tax laws.” The mentioned audit department is planned to open in the next 12 months and will focus on a more critical analysis of digital assets, as it has been observed that about 75% of taxpayers do not report these assets as required. Additionally, there will be increased control over reports of foreign bank accounts.
The need for a new tax audit department, as determined by the IRS, arises due to the fact that the government is losing, annually, billions of dollars in revenue. Furthermore, Danny Werfel, IRS Commissioner, emphasized that “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.”
As a result, pass-through entities should prepare for audit notices or compliance letters after the IRS’s new department becomes operational. Nevertheless, owners of pass-through entities established in the USA are recommended to ensure that their entity is in full tax and accounting compliance from the outset.
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Published on October 20, 2023