Partnership Tax Reform: Some Food For Thought
November 14, 2013
by Monte A. Jackel
I have been giving some thought to some items that could be included as either part of partnership tax reform or as independent items that may be included as part of a tax bill, if one arises later this year. Not in any particular order of priority and realizing that some of these items I or others have already discussed previously, here is a quick and dirty list of items that may warrant consideration. I provide this list without regard to whether the item would or would not generate additional tax revenues. Rather, the items are listed solely based on what I view as, arguably, good tax policy. I am sure some will agree with my list. Others will disagree. Anyway, here are some items to consider.
1. Do not enact the proposed carried interests legislation in any form. As some recent and forthcoming commentary by Jim Sowell of KPMG has and will make abundantly clear, any attempted implementation of the carried interests proposals will be extraordinarily complex. In my view, way too complex and doomed to failure if enacted in any form similar to the proposals previously put forth. I would, in lieu of these proposals, enact some form of blended tax rate that would apply to the net income from designated hedge funds, private equity funds and other funds that are the real targets of the carried interest legislation.
2. Enact A Statutory Definition Of Who Is A Partner for Tax Purposes-Or At Least A General Safe Harbor. The recent talk of providing a safe harbor for investors in rehabilitation tax credit deals leads to the logical question: why not provide for a general definition of what amount of upside potential and downside risk is necessary for an investor to be considered a partner for tax purposes? If this proposed goal of a generalized definition is too ambitious a project for the government to undertake at one time, then why not provide for a safe harbor rule for investors to be treated as partners-not only for rehab tax credits but for all tax purposes? I would not leave this issue to the discretion of the IRS and Treasury. Rather, Congress should mandate this course of conduct.
3. Allow Examination Of Multiple Year Returns Of Partners And Provide Guidance For Targeted Allocations And Repeal The Section 704(b) Foreign Tax Credit Allocation Regulations. The main problem, as I see things, with the IRS providing guidance to the public on targeted allocations is that, when one tax year is examined, another tax year may be closed. In addition, although making cumulative or “true up” adjustments in an open tax year could help alleviate this problem, the technical authority to make these allocations is questionable. If Congress would provide a mechanism to make these adjustments over both open and otherwise closed tax years, the ability to provide guidance to the public on targeted allocations would be that much easier to accomplish without significant risk to either taxpayers or the fisc. Further, the ability to make these adjustments would eliminate the real reason in my opinion that the foreign tax credit allocation regulations under section 704(b) were issued by the IRS several years ago-the inability to audit closed years to correct for the effects of how the foreign tax credit interacts with the partners’ other unrelated tax attributes over a period of years. The stated justification for the issuance of those regulations-that allocations of foreign tax expense lack substantial economic effect-just has never rang true for me.
4. Provide Explicit Statutory Authority To Amend Section 752 Regulations. There has been much discussion lately about regulations being proposed under section 752 to make liability allocations “more commercially reasonable”. To that end, there has been discussion that the section 752 regulations will be proposed to be amended to provide that risk of loss must be “more economically realistic” in order to attract a tax basis allocation; i.e., guarantees must be “more commercial”, special purpose corporate entities must have sufficient assets to support a debt allocation, and similar type concepts. I doubt that the authority for these regulations would or should be under section 357(d)(3), since the principal regulations under section 357(d) have never been issued. Nor would it seem that the rumored proposed section 752 regulations would have as their sole support the general authority under section 7805. Making very fundamental changes in a long-standing regulatory regime, such as section 752, using general rule-making authority would seem to be going out on a thin reed in terms of statutory support for such regulations. One would expect, I think, that changes of such purported magnitude would be in response to a Congressional mandate, such as the one issued by Congress as part of the 1984 tax act to reverse an adverse court decision. This means to me that the rumored section 752 proposed regulations should not be issued without a statutory mandate to do so. Issuing a discussion draft to solicit input for guidance would be, in my opinion, much more reasonable.
5. Provide Detailed Statutory Rules For Investment Companies. The rules governing transfers to investment companies under sections 351(e) and 721(b) are mired in confusion. For whatever reason, the IRS and Treasury will not issue broad-based guidance on the many difficult issues in this area. The Congress should provide a set of governing principles to apply in this area and mandate that the IRS issue regulations to address this important area of the tax law.
6. Rounding Up The Usual Suspects. I have written before about the prospect of making section 754 elections mandatory in all cases, providing for partner-specific section 734 adjustments and/or providing for mandatory remedial allocations or other guidance (such as expanding sections 704(c)(1)(B) and 737 to be applied to reverse section 704(c) allocations). All of these proposals, in one form or another, deal with the fundamental issues in partnership taxation where gain or loss is allocated to the purportedly wrong partner or appreciated property is able to escape the partnership tax system on a tax free basis resulting in further purported partner misallocations. It would seem that the time is coming when it will be “pick your poison” time for one or more of these proposals. Enough said for now.