Senate Finance Committee Chair Ron Wyden, D-Ore., today unveiled draft legislation to close loopholes that allow wealthy investors and mega-corporations to use pass-through entities, primarily partnerships, to avoid paying their fair share of taxes.
Seventy percent of partnership income accrues to the top 1 percent. Current partnership tax rules are too complicated for the IRS to enforce, turning partnerships into a preferred tax avoidance strategy for wealthy investors and mega-corporations. Although computers can check a wage earner’s return, the IRS needs highly-skilled specialists to audit partnerships. It audited only about 0.03 percent of the partnership returns filed for tax year 2018.
Wyden’s bill would remove the complexity in current partnership rules by closing loopholes that essentially allow partners to pick and choose how, and whether, to pay tax. Simply closing these loopholes would raise at least $172 billion, without raising tax rates.
“The constant theme running through our tax code is paying taxes is mandatory for working people, but optional for wealthy investors and mega-corporations. That’s especially true when it comes to pass-through businesses and partnerships, the preferred tax avoidance tools for those at the top,” said Wyden. “On the one hand, the rules are too complex for working people who don’t have armies of lawyers and accountants. On the other hand, complexity allows the wealthiest individuals and most profitable corporations to decide when, and whether, to pay taxes at all. This proposal simply reduces complexity by closing loopholes that allow those at the top to pick and choose when, and whether, to pay tax. Raising more than $172 billion for priorities like child care and paid leave by closing off these loopholes is a no-brainer.”
“These proposals are directed to the major areas of abuse or ambiguity in the partnership law dealing with allocations by a partnership to a partner, basis adjustments of partners, and liabilities allocated to partners for tax basis and disguised sale purposes and should help the IRS in auditing more partnerships in an efficient manner. The IRS is behind the curve in terms of auditing partnerships and applying the complex partnership tax law to them, and these proposals will provide much needed simplification to help improve the overall effectiveness of the tax law. Although some flexibility in applying the partnership rules will be curtailed or eliminated, this was a necessary effect of the simplification of the provisions. Sufficient regulatory authority is granted to the Treasury and IRS in the proposals to help interpret and apply the new provisions in a fair and balanced manner to taxpayers who are partners in partnerships,” said Monte A. Jackel, Of Counsel Leo Berwick, who reviewed these proposals in his personal capacity.
Examples of loophole closures in Wyden’s bill:
- Contributions and distributions of appreciated (or depreciated) property are generally tax free. Partnerships are supposed to allocate built-in gains and losses on contributed property in a way that limits abuse, but they get to choose among three or more allocation methods. Only one—the “remedial method”—actually prevents tax from being shifted between the partners. The discussion draft would require partnerships to use the remedial method making sure gain, and the related tax liability, cannot be shifted.
- Upon a change in the interests of the partners, a partnership can elect—but is not required—to revalue its assets to prevent the shifting of built-in gain and loss. The discussion draft would require such revaluations.
- The partnership tax rules afford tremendous flexibility in the allocation of partnership income and losses among partners. The discussion draft would remove options to decide when and whether to pay tax, and in doing so, simplify administration and curtail abuse. For certain related-party partnerships, the discussion draft would require all income and loss to be allocated pro-rata.
A one-page summary is available here.
A section-by-section summary is available here.
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