IRS Announces Intent to Close Basis-Shifting Tax Loopholes

The IRS and Treasury say the changes could raise about $50 billion over 10 years.

The Internal Revenue Service and Treasury Department announced Monday a new regulatory initiative that they intend to issue proposed regulations focusing on basis-shifting tax strategies used by partnerships. The IRS says the forthcoming guidance will address “hedge funds, real estate investment partnerships, publicly traded partnerships, large law firms and many other industries.”

“Treasury and IRS guidance released today kicks off a multi-stage regulatory effort that will stop large, complex partnerships from using opaque business structures to inflate tax deductions and avoid taxes,” the agencies wrote in a press statement.

Basis-shifting transactions are considered abusive when “high-income taxpayers and corporations strip basis from assets they own where the basis is not generating tax benefits and then move the basis to assets they own where it will generate tax benefits without causing any meaningful change to the economics of their businesses,” according to the IRS.

The IRS announcement contained a revenue ruling that would “inform taxpayers that certain transactions will be challenged for lack of economic substance.”

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One example of this is pass-through businesses. A pass-through is an entity, such as an S-Corporation, that is not subject to corporate income tax, and income can be passed to them and then on to the corporate owners. The IRS says that “income is passed through onto the income tax returns of the individual or corporate owners and taxed at their income tax rates.”

Another related strategy the IRS identified as potentially abusive is when taxpayers “shift tax basis from property that does not generate tax deductions (such as stock or land) to property that does (such as equipment). Taxpayers may also use these techniques to depreciate the same asset over and over.”

To address these issues, the IRS says it intends to:

  1. Issue “mechanical rules” related to the “effects of basis adjustments resulting from related party partnership basis-shifting transactions.”
  2. Apply a single entity approach to a partnership held by members of a consolidated group, “which are groups of corporations that share an 80 percent vote and value stock ownership and file a consolidated tax return.”
  3. Require taxpayers and advisers to “report if they and their clients are participating in these abusive partnership basis-shifting transactions” if the total amount is $5 million or more in a year.
  4. Challenge partnerships on the economic basis of certain basis-shifting transactions.

The IRS estimates that closing these loopholes would raise about $50 billion in revenue over ten years, and the agency says it currently has billions of dollars’ worth of basis-shifting transactions under audit.

The agencies are seeking written public comment on the proposed rules.