On June 12, 2024, the U.S. Department of the Treasury and the Internal Revenue Service (IRS) announced a new regulatory initiative aimed at closing a significant tax loophole used by large, complex partnerships. This measure is part of ongoing efforts to ensure wealthy individuals, complex partnerships, and large corporations pay their owed taxes.
The initiative targets abusive related party basis shifting transactions that allow businesses to inflate tax deductions and avoid taxes through opaque business structures. The Treasury estimates this could raise over $50 billion in revenue over the next decade. The guidance released today complements the IRS's ongoing enforcement campaign to recover revenue from large partnerships not paying their due taxes.
These taxpayers employ techniques such as partnership basis shifting transactions to reduce taxable income with minimal economic consequences for the businesses involved. For instance, they might shift tax basis from non-deductible property like stock or land to deductible property like equipment. Wealthy taxpayers and businesses spend millions on accountants and lawyers to develop these schemes, costing the federal government billions annually.
From 2010 to 2019, filings from passthrough businesses with more than $10 million in assets increased by 70 percent while audit rates for these partnerships dropped from 3.8 percent to 0.1 percent. This decline in audits contributed significantly to an estimated $160 billion annual tax gap attributed to the top one percent of filers.
Following extensive study, Treasury and IRS are proposing regulations under existing authority to stop related parties in complex partnership structures from shifting asset tax bases among themselves for abusive deductions or reduced gains upon asset sales. Additionally, they propose increasing transaction reporting requirements and issuing a ruling informing 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," 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 released a notice previewing two future proposed rules under partnership tax provisions regarding basis adjustments resulting from related party partnership basis shifting transactions. These rules aim to eliminate inappropriate tax benefits created between related parties.
Second, an NPRM was issued requiring taxpayers and their advisers to report participation in these abusive transactions if they generate $5 million or more of positive basis adjustments without paying corresponding taxes.
Lastly, a Revenue Ruling was issued stating that certain related-party partnership transactions involving basis shifting lack economic substance. This ruling supports current and future audits by asserting that many such transactions violate economic substance doctrine due to negligible economic change compared with tax benefits or lack substantial business purpose.
Treasury and IRS encourage public comments on these proposed rules before finalizing them.
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