Shutdown of Abusive Related Party Basis Shifting Transactions Estimated to Raise More than $50 Billion Over the Next Decade
WASHINGTON – Today, the U.S. Department of the Treasury (Treasury) and the Internal Revenue Service (IRS) announced a new regulatory initiative to close a major tax loophole exploited by large, complex partnerships. This initiative is one step in ongoing efforts to close loopholes and shut down abusive transactions using existing regulatory authority and ensure wealthy individuals, complex partnerships, and large corporations pay taxes owed.
Treasury and IRS guidance released today kicks off a multi-stage regulatory effort that will stop large, complex partnerships from using opaque business structures to inflate tax deductions and avoid taxes. Once complete, Treasury estimates this initiative could raise more than $50 billion in revenue over 10 years – and potentially much more – compared to allowing these abusive transactions to continue unchecked. The new guidance will also complement the IRS’ ongoing enforcement 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 (“related parties”) 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 to no other economic consequences for the participating businesses. For example, a partnership might shift tax basis from property that does not generate tax deductions (such as stock or land) to property that does (such as equipment). Taxpayers may also use these techniques to depreciate the same asset over and over.
Wealthy taxpayers and businesses are paying accountants and lawyers millions of dollars to develop these complex, abusive transactions, costing 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 174,100 in 2010 to 297,400 in 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 unpack ever more complicated business structures made it easier for wealthy taxpayers to avoid paying what they owe and are contributing to the estimated $160 billion per year tax gap attributed to the top 1 percent of filers.
Following over a year of study of these issues, Treasury and IRS are today announcing their intent to propose regulations under existing regulatory authority to stop related parties in complex partnership structures from shifting the tax basis of their assets amongst each other to take abusive deductions or reduce gains when the asset is sold, effectively making taxable income disappear. In addition, Treasury and IRS are proposing to increase the reporting of these transactions to the IRS and are providing a ruling to inform taxpayers that certain transactions will be challenged for lack of economic substance.
“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,” said U.S. Secretary of the Treasury Janet L. Yellen. “Thanks to resources from President Biden’s Inflation Reduction Act, Treasury and the IRS have the tools to stop longstanding abuses.”
Today’s announcement includes several pieces of guidance.
First, Treasury and IRS are releasing a notice of intent to issue proposed regulations that previews two future proposed rules. The first Notice of Proposed Rulemaking (NPRM) would provide mechanical 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, which are groups of corporations that share an 80 percent vote and value stock ownership and file a consolidated tax return. The regulations, once final, would prevent partnership basis shifting amongst members of a consolidated group.
Second, 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. The goal of the NPRM is to provide the IRS with additional information to better assess the scale and characteristics of the abuse and help direct IRS enforcement resources. The threshold for reporting would be set at $5 million or more of positive basis adjustments generated through covered transactions in a single tax year and for which no tax was paid.
And finally, Treasury and IRS are releasing a Revenue Ruling that provides that certain related-party partnership transactions involving basis shifting lack economic substance. The ruling will support the IRS’ position in current and future audits and litigation that many of these transactions violate the codified economic substance doctrine because the transaction creates no meaningful change to the economics of the parties as compared to the tax benefit or has no substantial business purpose.
Treasury and IRS encourage the public to submit written comments in response to these proposed rules and look forward to receiving further input and benefitting from additional stakeholder perspectives on these issues. Treasury and IRS will carefully consider public comments before issuing final rules.
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