The U.S. Treasury Department and the Internal Revenue Service (IRS) are looking to close a major tax loophole exploited by large, complex partnerships.
The Treasury estimates that this initiative could raise more than $50 billion in revenue over 10 years – and potentially much more. The new guidance will also complement the IRS’s ongoing campaign to recover revenue from large partnerships that are not paying the taxes they owe.
Among the techniques these taxpayers rely on to make billions of dollars in taxable income disappear are what are known as partnership basis shifting transactions.
In these transactions, a single business that operates through many different legal entities enters into a set of transactions that manipulate partnership tax rules to maximize tax deductions and minimize tax liability. These transactions defy congressional intent to avoid tax liability with little or no consequences for the participating businesses.
For example, a partnership might shift tax basis from property that does not generate tax deductions to property that does. Taxpayers may also use these techniques to depreciate the same asset over and over.
The agencies said that wealthy taxpayers and businesses are paying accountants and lawyers millions of dollars to develop these complex transactions that cost the federal government billions of dollars each year. And while these abusive schemes flourished, the IRS was severely underfunded, so audit rates for these increasingly complex structures plummeted.
Filings from passthrough businesses with more than $10 million in assets increased 70 percent from 2010 to 2019. But the audit rate for these partnerships fell from 3.8 percent in 2010 to 0.1 percent in 2019. The combination of fewer resources to deal with more complicated business structures made it easier for wealthy taxpayers to avoid paying what they owe. Thus, it contributes to the estimated $160 billion per year tax gap attributed to the top 1 percent of filers.
“Treasury and the IRS are focused on addressing high-end tax abuse from all angles, and the proposed rules released today will increase tax fairness and reduce the deficit,” U.S. Secretary of the Treasury Janet Yellen said.
The first Notice of Proposed Rulemaking (NPRM) would provide rules under the partnership tax provisions regarding the effects of basis adjustments resulting from related party partnership basis shifting transactions. The proposed regulations, once finalized, would effectively eliminate the inappropriate tax benefits created from these abusive transactions between related parties.
The other NPRM would apply a single-entity approach with respect to interests in a partnership held by members of a consolidated group. This would prevent partnership basis shifting amongst members of a consolidated group.
Treasury and IRS are also releasing an NPRM that would require taxpayers and their material advisers to report if they and their clients are participating in these abusive partnership basis shifting transactions.
Finally, Treasury and IRS are releasing a Revenue Ruling that provides that certain related-party partnership transactions involving basis shifting lack economic substance.
Treasury and IRS encourage the public to submit written comments in response to these proposed rules.