TAX ALERT |
Senate Finance Committee Chair Ron Wyden has released a ‘discussion draft’ of legislation that, if enacted, would dramatically change the tax rules that apply to partnerships. It is key to note that this is only draft legislation and as such, it is difficult to anticipate whether these ideas and proposals will be considered in any ultimate tax legislation. However, it seems likely Senator Wyden will pursue these proposals, and with a $172 billion revenue estimate, it may be safe to assume at least some of these proposals will receive consideration.
Senator Wyden’s ‘discussion draft’ includes an array of changes to Subchapter K of the Internal Revenue Code (IRC) – the major proposals contained therein are discussed in more detail below. In reviewing some of these proposed changes, taxpayers and their advisors may find that the proposals appear quite substantial but are actually more problematic in theory than in practice. Other proposed changes may appear minor, but would completely reshape the way partnerships are formed and operate.
For example, many may find the proposals to limit or prohibit ‘special allocations’ to be the most dramatic of the proposed changes. However, the language itself may not be as far-reaching as it may initially appear. On the other hand, the proposed changes to partnership debt allocations may, at first blush, appear to be of limited impact – indeed, these proposed changes were not even highlighted in Senator Wyden’s summary. However, if enacted, they would dramatically alter the current regime.
The proposed changes include, among other things:
Requiring that partnership debt is allocated in accordance with profit
While some partnerships may already allocate debt in accordance with profit sharing ratios, many utilize allocation methods designed to align tax and economic treatment. If enacted, this proposal would result in a change in debt allocations for certain partnerships, leading to unexpected taxable gains to certain partners.
Mandating revaluations and the use of the ‘remedial’ method under section 704(c)
Several options exist with respect to how and when unrealized gain is taxed when partners contribute appreciated property to a partnership. If enacted, the proposal would mandate the use of the remedial method in all cases.
Moreover, partnerships currently have flexibility regarding whether or not to ‘revalue’ their assets. If enacted, the proposal would eliminate that flexibility, and (as discussed above) require the use of remedial allocations with respect to the ‘reverse’ 704(c) layer.
Eliminate ‘Safe harbor’ and ‘Substantial Economic Effect’ methods of allocating income
Although more complex ‘target’ allocation methods are increasingly common in the middle-market, many taxpayers still utilize ‘safe harbor’ agreements. The proposal targets perceived ‘abuses’ that can arise under this method, and while it is not certain that this change would result in a change in allocations for all partnerships, it may increase the complexity of the required computations and add administrative burdens.
Mandate pro-rata income allocations for partnerships owned by related corporations
The proposal also includes language requiring partnerships owned by two or more corporations under common control to allocate income in relation to each corporation’s share of capital ownership. While this provision appears limited to a very specific subset of partnerships, the proposal also suggests that this group would be expanded further in the future via regulation.
Requiring section 734 and section 743 basis adjustments
Partnerships are generally required to make downward basis adjustments upon the sale or redemption of a partnership interest (and upon the death of a partner) when unrecognized losses above a certain threshold exist. However, if unrecognized gains exist, this basis adjustment is generally optional. The proposal would make these upward adjustments mandatory.
End guaranteed payments for current and retired partners
Payments to partners would either be taxed in a non-partner capacity (e.g. treated as interest, fees, wages, etc.) or as allocable shares of income.
Changes to ‘mixing bowl’ and ‘disguised sale’ rules
The distribution of assets that were previously contributed by a partner can often generate gain, but this rule does not apply if the asset is held by the partnership for more than seven years. The proposal would remove the exception for assets held more than seven years, resulting in the potential for gain any time such an asset is distributed.
Align treatment of inventory in sales and redemptions
Under current law, gains related to partnership inventory are taxed as ordinary income when an interest is sold. In a redemption, ordinary income treatment only applies if the inventory is ‘substantially appreciated’. The proposal would remove the ‘substantially appreciated’ limitation and tax redemptions similar to sales.
Elimination of Publicly Traded Partnership status
Under current law, certain publicly traded companies are allowed to elect to be taxed as partnerships (so-called, publicly traded partnerships or PTPs). The proposed change would repeal this exception for all publicly traded partnerships.
Questions or Want to Talk?
Call us directly at 972.221.2500 (Flower Mound) or 940.591.9300 (Denton),
or complete the form below and we’ll contact you to discuss your specific situation.
This article was written by Nick Passini, Kyle Brown, Lauren Van Crey, Arlie Hudson and originally appeared on 2021-09-13.
2021 RSM US LLP. All rights reserved.
The information contained herein is general in nature and based on authorities that are subject to change. RSM US LLP guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. RSM US LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein. This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer.
RSM US Alliance provides its members with access to resources of RSM US LLP. RSM US Alliance member firms are separate and independent businesses and legal entities that are responsible for their own acts and omissions, and each are separate and independent from RSM US LLP. RSM US LLP is the U.S. member firm of RSM International, a global network of independent audit, tax, and consulting firms. Members of RSM US Alliance have access to RSM International resources through RSM US LLP but are not member firms of RSM International. Visit rsmus.com/aboutus for more information regarding RSM US LLP and RSM International. The RSM(tm) brandmark is used under license by RSM US LLP. RSM US Alliance products and services are proprietary to RSM US LLP.
KHA Accountants, PLLC is a proud member of RSM US Alliance, a premier affiliation of independent accounting and consulting firms in the United States. RSM US Alliance provides our firm with access to resources of RSM US LLP, the leading provider of audit, tax and consulting services focused on the middle market. RSM US LLP is a licensed CPA firm and the U.S. member of RSM International, a global network of independent audit, tax and consulting firms with more than 43,000 people in over 120 countries.
Our membership in RSM US Alliance has elevated our capabilities in the marketplace, helping to differentiate our firm from the competition while allowing us to maintain our independence and entrepreneurial culture. We have access to a valuable peer network of like-sized firms as well as a broad range of tools, expertise, and technical resources.
For more information on how KHA Accountants can assist you, please call 972.221.2500.