The IRS may be operating at a limited capacity this year, but that does not mean companies should put any less effort into their transfer pricing documentation, as one expert cautions that the area remains a high priority for targeted enforcement.
Transfer Pricing Requirements
Transfer pricing generally refers to the pricing of transactions between related entities within a multinational enterprise (MNE), such as the sale of goods, provision of services, or transfer of intangible property. The fundamental principle is the ‘arm’s-length standard,’ which requires that related-party transactions be priced as if they were conducted between independent, unrelated parties under similar circumstances.
Transfer pricing rules were put in place to ensure that profits are appropriately allocated among the various jurisdictions in which an MNE operates, thereby preventing tax avoidance through the artificial shifting of income or expenses.
Taxpayers must prepare and maintain contemporaneous documentation that supports the arm’s-length nature of their intercompany transactions. This can include a master file (group-wide information), a local file (local entity and transaction-specific details), and a country-by-country, or CbC, report (global allocation of income, taxes, and economic activity).
U.S. companies are also required to disclose related-party transactions and transfer pricing methods on their tax returns, and large multinational groups must file a CbC report annually. Failure to comply with these documentation and reporting requirements can result in significant penalties, including transfer pricing adjustments and additional tax assessments.
Exactera Lead Senior Manager Laksha explained in a September 12 webinar that October 15 is the deadline for companies to substantially complete their contemporaneous transfer pricing documentation.
While the documentation does not need to be submitted with a company’s tax return, it must be prepared in advance because if the IRS requests it, taxpayers have only 30 days to provide it. Nahar stressed that failing to have contemporaneous documentation can result in a penalty of up to 40% of the adjustment. She also pointed out that the U.S. does not have transaction size thresholds, so all related party transactions must be documented, and annual updates are required.
According to Nahar, the IRS has recently sent a wave of compliance letters, particularly targeting distributors with low margins. These letters question why limited-risk distributors, who perform basic functions and carry lower risk, are consistently making losses.
Speaking with Checkpoint ahead of the October 15 due date, Nahar warned that companies receiving such letters and failing to adjust their pricing or provide a “robust defense” for their losses are essentially signaling to the IRS that they are “ready for a full-scope audit.” Failing to respond adequately to IRS warnings or compliance letters increases the likelihood of a comprehensive audit, she said.
IRS Cuts and Shift Towards AI
Prior to the current government shutdown, the IRS shed about a quarter of its workforce over the course of this year since President Trump’s inauguration, both from governmentwide reductions-in-force and voluntary resignations. The Large Business and International (LB&I) division particularly lost about 20% of its workforce in just six months. Following the government shutdown that began October 1, the Trump administration furloughed roughly half of the remaining workforce, as its emergency funding contingency plan only covered the first five business days.
Despite these reductions, enforcement remains a high priority. Nahar noted that a sizable portion of the once-$80 billion appropriation to the IRS from the Inflation Reduction Act (IRA) was earmarked for transfer pricing enforcement. Former IRS Commissioner Danny Werfel, in the wake of the IRA, spearheaded several compliance enforcement initiatives, including an emphasis on transfer pricing.
Nahar said that the IRS is compensating for fewer staff by leveraging technology and artificial intelligence to enable smarter case selection, more targeted audits, and faster identification of high-risk structures. She warned that companies should not assume reduced scrutiny due to downsizing, as the agency may conduct “catch-up” audits in the future.
“The IRS is smaller but smarter, using technology to maintain and even enhance enforcement capabilities,” she said.
Echoing this, Nahar told Checkpoint the IRS will rely on data analytics to screen and flag returns with a high probability of non-compliance, particularly focusing on foreign-owned U.S. distributors with persistent losses. She explained that the IRS is using algorithms to identify companies with unreasonable losses or very low margins.
She recommended that businesses “must remain disciplined and ensure their transfer pricing documentation is robust and aligns profits with value creation.” Audits for tax year 2025 may occur in 2026 or 2027, so companies would be wise to “prepare now” to be in the “best position” for when “scrutiny inevitably ramps up.” Nahar expects the IRS to “be more aggressive than ever” after “they come back” given “all the lost time and all the lost funds” attributable to the workforce reductions and shutdown.
Also worth considering is the IRS’ likelihood of initiating an audit if another tax authority also opens an exam. But different countries may allocate the same income from transfer pricing transactions differently. Substantial documentation may mitigate the risk of exposure to double taxation, said Nahar.
Reliance on FAQs
A series of IRS FAQs on the agency’s website provide guidance on documentation best practices to satisfy IRC § 482 rules and avoid penalties under IRC § 6662(e). Nahar described the FAQs as a valuable tool for companies to use as a checklist and tailor their documentation to the agency’s expectations. The guidance features specific requirements, especially regarding method selection. Generic or boilerplate explanations are not sufficient, she explained, as the agency will closely scrutinize the functional analysis in transfer pricing documentation.
This means the IRS wants detailed explanations of why a particular method was chosen, what data sources were reviewed, and why other methods were rejected. If a report does not sufficiently argue why the selected method is the most reliable measure of an arm’s length result, the IRS can substitute its own method and issue an adjustment.
Nahar warned against “the most common mistake” in creating “check-the-box” documents that lack substance, use generic or copied company descriptions, or rely on outdated benchmarking studies. Reports should discuss “specific value-drivers … or the risk-takers for the intercompany transactions that are being tested.”
For more on Section 482 transfer pricing documentation requirements and related penalties, see Checkpoint’s Federal Tax Coordinator 2d ¶ V-2215.
Reproduced with permission. Published October 15, 2025. Copyright 2025 Thomson Reuters. For further use please visit then their website. For further use please visit Transfer Pricing Expert: ‘Prepare Now’ for Best Chance to Avoid Scrutiny.
