On June 17, Senator Ron Wyden released two bills, the PARTNERSHIPS Act and the Basis Shifting Is a Rip-Off Act, which are intended to close perceived partnership loopholes. This legislation follows up on Senator Wyden’s 2021 discussion draft, which addressed many of the same issues.
Impact on large partnerships
At their core, the proposed bills eliminate much of the optionality that has let partners decide when – or whether – to recognize income or adjust basis. However, the bills allow for an exemption from many of the provisions for small businesses, a concession to those who argue that the provisions will result in a substantial compliance burden. Among other reforms, the legislation would:
- Make basis adjustments mandatory: Section 734, 743, and 754 elections no longer would be voluntary, forcing partnerships to conform basis to economic reality each time an interest changes hands.
- Accelerate built-in gain on contributed property: The seven-year deferral rules in sections 704(c)(1)(B) and 737 (the mixing bowl rules) would be repealed.
- Expand application of net investment income tax: The net investment income tax would apply to all income derived in the ordinary course of a trade business, unless it already is subject to employment taxes.
- Curtail related-party basis shifting: Certain related-party transactions, including property contributions and distributions, would be treated as taxable events.
- Limit flexibility for allocations under Section 704(b): The allocation rules would be modified and the partner’s interest in the partnership (PIP) test would be required if the operating agreement does not provide for a partner’s distributive share. In controlled group structures, allocations would be required to follow a consistent percentage method determined by relative net equity.
- Limit flexibility for Section 704(c): Using the remedial method under 704(c) and making 704(b) revaluations would be mandatory under a new Section 704(f).
- Debt-basis rules redefined: Section 752 liability allocations would be revised to ignore guarantees until such time as the partner is called upon to pay. Liabilities otherwise would be allocated in accordance with PIP except where there is bona fide indebtedness to a partner or related party to a partner. Any resulting tax would be able to be paid over six years.
- Curtail disguised sale avoidance: The exception for preformation expenditures that currently allows certain posttransaction payments to be excluded from disguised sale treatment would be removed.
- Repeal retirement rules under Section 736: The rules under Section 736 and Section 761 for liquidating distributions would be repealed.
- Codify that partnership debts and partnership interests are securities under Section 165(g): Section 165 would be amended to treat worthlessness of partnership debt and interest as a security giving rise to sale or exchange treatment.
- Other provisions:
- Anti-abuse rules would be codified.
- Partnership terminations would be clarified.
- The swap fund rule’s definition of assets would be expanded to prevent taxpayers from pooling investment assets in a partnership to increase portfolio diversification.
Crowe observation
The legislation would undermine the flexibility of partnership structures, which has been a hallmark of partnership planning for decades and is a key distinction between partnerships and corporate entities.
What this could mean for partnership owners
Owners of investment funds, real estate ventures, and other capital-intensive partnerships should view the bills as a potential inflection point:
- Less flexibility, faster tax. Mandatory basis adjustments, required use of the remedial method, changes in Section 704(b) profit and loss allocations and Section 752 liability allocations, and accelerated gain recognition for property distributions compress the timeline for deducting losses and deferring income, likely increasing the tax burden under time-value of money principles.
- Transaction modeling will change. Common planning techniques used to avoid the mixing bowl and disguised sale rules would lose effectiveness and could alter the structures and entity types that taxpayers choose for forming new ventures.
- Compliance burden could grow. Codifying the anti-abuse rule and clarifying termination standards might streamline disputes, but the new rules also would require closer tracking of partner-level items and more frequent valuations, which could increase the compliance cost for routine business transactions.
Looking ahead
If enacted, these proposals would be the most sweeping rewrite of partnership taxation since 1986. Whether they advance wholesale or piecemeal, the underlying theme is unmistakable: Congress is hunting for revenue, and flexible partnership rules are an attractive target. Partnership owners should consult with their tax advisers and monitor the legislative process closely. The implications could be significant, and early engagement will be critical in navigating potential changes.