21 Jun 2024 IRS Issues Guidance to Combat Partnership Basis-Shifting Transactions
Authored by RSM US LLP, June 21, 2024
Executive Summary:
The IRS is using its Inflation Reduction Act funding to combat certain related party partnership basis-shifting transactions
As part of ongoing efforts to combat certain related party transactions the IRS and Treasury view as abusive partnership transactions, the Office of Chief Counsel announced the creation of a new Associate Office that will focus exclusively on partnerships, S-corporations, trusts, and estates, and which will work closely with a new pass-through work group being established in the IRS’s Large Business & International Division. Additionally, the Department of the Treasury and IRS issued three pieces of guidance designed to address what the IRS and Treasury believe to be the transactions among partnerships and related parties that involve the inappropriate use of certain basis adjustments to avoid taxes.
IRS Large Business & International Division targeting abusive basis-shifting transactions
As part of ongoing efforts to combat certain related party partnership transactions, the Office of Chief Counsel announced the creation of a new Associate Office that will focus exclusively on partnerships, S-corporations, trusts and estates and which will work closely with a new pass-through work group being established in the IRS’s Large Business & International Division. In addition, the IRS and the Department of Treasury issued three pieces of guidance focused on what the IRS and Treasury believe to be abusive basis-shifting transactions.
Creation of New Associate Office
IRS Chief Counsel Margie Rollinson announced the creation of a new Associate Office that will focus exclusively on developing guidance for partnerships, S-corporations, trusts and estates. The Associate Office will be drawn from the current Passthroughs and Special Industries (PSI) Office1 and will work closely with a new pass-through work group being established in the IRS Large Business and International Division (LB&I) that will be formally established this fall. For the new workgroups in both Chief Counsel and LB&I, the IRS plans to bring in outside experts with private-sector experience regarding pass-throughs to work alongside the expert in-house knowledge of current IRS employees.
New Guidance
The Department of the Treasury and IRS issued three pieces of guidance—a Notice, proposed regulations, and a Revenue Ruling, discussed in more detail below—focused on combating what the IRS believes to be inappropriate use of partnership rules to engage in basis-shifting transactions that lack economic substance and generate inappropriate tax benefits.
In Notice 2024-54, the IRS announced its intent to issue two sets of proposed regulations addressing basis shifting transactions involving partnerships and certain identified related parties engaging in “covered transactions” – the Notice announces that the “covered transactions” that are intended to be governed by these regulations would involve certain basis adjustments under Internal Revenue Code sections 732, 734(b) and/or 743(b).
The first set of proposed regulations (announced by the Notice as intended to be issued, but not yet actually issued) would require certain partnerships and their partners engaging in these “covered transactions” to treat the basis adjustments arising from the “covered transactions” in a way that would greatly restrict the partners’ or the partnership’s (or both) ability to avail themselves of those basis adjustments. The second set of regulations announced by the Notice (as intended to be issued, but also not yet actually issued) would provide rules intended to prevent what the IRS believes to be distortion of taxable income and tax liability of a consolidated group of corporations when members of the group own interests in partnerships and engage in such “covered transactions.”
In addition to the Notice, the IRS and Treasury also issued a set of proposed regulations that identify related-party partnership basis adjustment transactions and substantially similar transactions as transactions of interest (TOI) – a type of reportable transaction. Pursuant to the proposed regulations, these transactions include (a) a distribution of partnership property to a partner that is related to one or more other partners in the partnership and (b) the transfer of a partnership interest in which the transferor is related to the transferee, or the transferee is related to one or more of the partners. The proposed regulations provide that for a transaction to be considered a TOI, it must involve positive basis adjustments of $5 million or more under sections 732(b) or (d), 734(b) or 743(b). Notably, this $5 million dollar threshold would be applied to the cumulative adjustments from the transactions described in the proposed regulations for a taxable year.
The proposed regulations go on to provide that the determination of whether parties are related is generally made by considering relationships described in section 267(b), such as members of a family or a grantor and a fiduciary of any trust, among many others. These proposed regulations would be effective on the date the regulations are published as final regulations in the Federal Register.
The third piece of guidance is Revenue Ruling 2024-14, which notifies taxpayers and advisors using partnerships that engage in three variations of transactions involving consolidated groups owning partnership interests that the IRS will apply the codified economic substance doctrine to challenge what they believe to be inappropriate basis adjustments and other aspects of these transactions. The Ruling walks through each scenario in detail and concludes that the transactions in each scenario lack economic substance.
Washington National Tax Takeaways
The IRS had previously announced a series of steps to improve compliance involving high-income individuals and partnerships, including launching audits on 76 of the largest partnerships with average assets over $10 billion that include hedge funds, real estate investment partnerships, publicly traded partnerships, large law firms and partnerships in other industries. These new announcements provide further evidence of the IRS’ intent to focus efforts and resources on the audit of partnerships and showcase the types of transactions the Service views as abusive. Taxpayers and their advisors should consider the guidance and its potential impact on taxpayers and advisors carefully.
RSM US subject matter experts from a range of disciplines are currently in the process of a more detailed review of this guidance issued by the IRS and Treasury, with additional analysis and insights anticipated to be forthcoming.
[1] The “Special Industries” piece of Chief Counsel’s former PSI Office will form a new Associate office as well to focus on energy, credits and incentives and excise taxes, joining another office that has been focused on clean energy guidance.
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This article was written by Mike Zima, Kyle Brown, David McNeely and originally appeared on 2024-06-21. Reprinted with permission from RSM US LLP.
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