Are significant partnership tax changes coming? 

| 1/6/2022
Are significant partnership tax changes coming?

On Sept. 10, 2021, Senate Finance Committee Chairman Ron Wyden released a discussion draft and legislative text that would dramatically change existing partnership tax rules. While none of the proposed changes were included in the Infrastructure Investment and Jobs Act enacted on Nov. 15, 2021, or the version of the Build Back Better Act passed by the House on Nov. 19, 2021, the proposals have caused partnerships and their advisers to take notice. Wyden’s proposals address a number of perceived abuses related to the optionality and ambiguity that are prevalent in the current partnership tax rules.

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The proposals are broad and if enacted would have far-reaching effects, including closing several perceived loopholes and facilitating the IRS’ ability to increase partnership tax compliance and enforcement. Following are highlights of some of the most significant proposed changes:

  • Repeal the substantial economic effect rules for partnership allocations in IRC Section 704(b) and require that all allocations satisfy a partner’s interest in the partnership (PIP) standard. PIP generally turns on the facts and circumstances associated with the partner’s economic arrangement. The discussion draft assumes that the U.S. Department of the Treasury and the IRS would update and simplify existing PIP regulations. In addition, the proposal requires that certain partnerships comprising related persons would be required to allocate partnership items based on each partner’s net contributed capital.
  • Require that all partnerships apply the remedial method under Section 704(c) when a partner contributes appreciated property to a partnership and when a partnership revalues its property for Section 704(b) book purposes. Under existing regulations, partnerships have flexibility to choose a reasonable Section 704(c) method, including the traditional method and curative method. The requirement to use the remedial method generally would accelerate recognition of income and gain with respect to depreciable property contributed to a partnership.
  • Require that partnerships revalue their assets for Section 704(b) book purposes when a partner’s economic arrangement changes. Presently, revaluations are permitted but are not required in certain circumstances enumerated in current regulations.
  • Repeal the seven-year testing period for the anti-mixing bowl rules so that Sections 704(c)(1)(B) and 737 apply to contributions of appreciated property and certain related distributions occurring at any time during a partnership’s life.
  • Repeal Sections 707(c) and 736, which provide rules for certain partnership-to-partner payments. Specifically, the proposal eliminates guaranteed payments. Under the proposal, payments to a partner for services or for the use of capital, and which are not distributions, generally would be treated as payments to a nonpartner. The proposal also eliminates rules regarding certain payments to retiring partners.
  • Amend the disguised sale rules of Section 707(a)(2), which generally apply to certain transfers between a partnership and partner, to clarify that the rules for disguised sale of partnership interest are self-executing and to repeal the exception for reimbursements of capital expenditures. The amendments would apply to services performed or property transferred after the date of enactment.
  • Require that all partnership debt is allocated among partners for Section 752 purposes in accordance with the partners’ profit shares. Loans to a partnership by a partner (or a person related to a partner) are excepted. Under existing regulations, recourse debt is allocated to the partner that bears economic risk of loss with respect to the liability, and nonrecourse debt is allocated based on a three-tiered approach that can take profit sharing into account. If enacted, this change would result in recognition of taxable gain with respect to negative capital account balances where allocations are based on economic risk of loss or a partner’s share of partnership minimum gain or certain Section 704(c) gain under the existing rules for nonrecourse liabilities. The provision allows the taxpayer to elect to pay any resulting liability over eight years.
  • Repeal Section 754 and instead require mandatory adjustments to the tax basis of partnership property under Sections 743 and 734 to account for disparities between a partner’s tax basis in its partnership interest and the partnership’s tax basis in property. Presently, under Section 754, these basis adjustments are optional except in limited circumstances. The proposal also revises the computation of Section 734 adjustments to preserve each remaining partner’s gain or loss that would be recognized if the partnership sold all of its property for fair market value.
  • Amend the Section 163(j) business interest expense limitation rules to provide that a stricter entity-level approach applies to partnerships and S corporations. Current law, in contrast, requires a hybrid approach. Amended Section 163(j) would apply to taxable years beginning after Dec. 31, 2021.
  • Repeal the exception from corporate treatment for publicly traded partnerships (PTPs) under Section 7704. This change effectively would mean that all PTPs would be taxable as corporations.

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Stay up to speed on regulatory and legislative tax changes with timely updates from Crowe.

The Dec. 15, 2021, event included a federal tax legislative update followed by two concurrent breakout sessions.

Stay up to speed on regulatory and legislative tax changes with timely updates from Crowe.

The Dec. 15, 2021, event included a federal tax legislative update followed by two concurrent breakout sessions.

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Michael Schindler
Michael Schindler
Principal