The Internal Revenue Service is targeting the use of basis shifting between related parties as a way for partnerships to avoid paying taxes, setting up a new unit within the Office of Chief Counsel to develop guidance aimed at closing tax loopholes.
The office will work alongside a new pass-through work group that's being established this fall in the IRS Large and Business International Division.
The IRS and the Department of the Treasury also issued three pieces of guidance Monday focusing on partnerships following discoveries by IRS audit teams of related-party transactions using basis shifting. The agency said it has already spotted tens of billions of dollars of deductions claimed in these transactions under audit.
The new guidance aims to stop the use of basis-shifting transactions that use related-party partnerships to avoid taxes. In these complex maneuvers, 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. The basis-shifting transactions allow closely related parties to avoid taxes.
"This is part of a larger effort at the IRS taking place in the compliance arena," said IRS Commissioner Danny Werfel during a press conference. "Using Inflation Reduction Act funding, we're working to reverse more than a decade of declining audits amongst the highest-income taxpayers, as well as complex partnerships and corporations. Our announcement signals the IRS is accelerating our work in the partnership arena, an arena that has been overlooked for more than a decade with our declining resources. We're concerned tax abuse is growing in this space, and it's time to address that. So we are building teams and adding expertise inside the agency so we can reverse these long-term compliance declines."
The Treasury estimates that these abusive transactions, which cut across a wide variety of industries and individuals, could potentially cost taxpayers more than $50 billion over a 10-year period.
"For example, a partnership might shift tax basis from a property that does not generate tax deductions, such as stocks or land, to property where it does, like equipment," said Deputy Secretary of the Treasury Wally Adeyemo during the press conference. "Businesses have also used these techniques to depreciate the same asset over and over again. While depreciation is a legitimate tool used by businesses, these transactions are not tied to any economic activity or create any real economic value for the United States. Their sole purpose is to avoid tax bills, by moving assets from one pocket to another to generate deductions by accountants and lawyers to set up structures to engage in transactions that typically cost millions of dollars. But that is nothing in comparison to the money that they are taking away from the tax system by doing this. The arrangements are only pursued by the very wealthiest of taxpayers."
Accounting Today asked Werfel and Adeyemo what advice they would give to tax professionals who may have been helping their clients with these kinds of tax strategies, and whether there are ways to unwind such strategies if they worry they're going to be audited or find themselves subject to an audit.
"The thing that I would say to those tax professionals who are promoting this type of approach that has no underlying economic value, not only in this area, but in other areas, is that they should know that today the IRS now has the resources because of the Inflation Reduction Act to come after and audit that behavior," Adeyemo said. "And we will aggressively take steps to make sure that the wealthiest taxpayers in this country play by the same rules as everybody else and have to pay their taxes as well. So I think that's the overarching message. We're taking this action today that will, we think, help raise a significant amount of revenue that has been lost because of this action that has been taken by taxpayers to avoid taxes. But we're prepared to do more, and will do more working together with the IRS."
"In many ways, the guidance that we're issuing today is geared toward the promoters out there, those that are marketing their services to complex partnerships, as a way of providing them these tax benefits," Werfel responded. "But this is not the right approach. It is an inappropriate way to shield income. So our message to these promoters is that this is an area that they should no longer be undertaking as a way to help their clients, and the guidance today is intended to end this particular practice."
Stricter new regs
- The first set of regulations would require partnerships to treat basis adjustments arising from covered transactions in a way that would restrict them from deriving inappropriate tax benefits from the basis adjustments.
- The second set of regulations would provide rules to ensure clear reflection of the taxable income and tax liability of a consolidated group of corporations when members of the group own interests in partnerships. The notice also announces that that the covered transactions governed by these regulations would involve basis adjustments under Internal Revenue Code sections 732, 734(b) and/or 743(b).
The
Under Revenue Ruling 2024-14, the IRS announces that the economic substance doctrine will be raised in cases where related parties:
- Create inside/outside basis disparities through various methods, including the use of certain partnership allocations and distributions;
- Capitalize on the disparity by either transferring a partnership interest in a nonrecognition transaction or making a current or liquidating distribution of partnership property to a partner; and,
- Claim a basis adjustment under Internal Revenue Code Sections 732(b), 734(b), or 743(b) resulting from the nonrecognition transaction or distribution.
The new tax guidance is being worked on by the IRS Office of Chief Counsel and the Treasury after IRS examination teams, reviewing partnerships, saw tens of billions of dollars in deductions using basis shifting between related parties. Use of such maneuvers appears to be increasing.
Such tax maneuvers can be difficult for auditors to find unless they know what to look for in a tax return. "In essence, basis shifting amounts to a shell game where sophisticated tax maneuvers take place, by shifting the basis of assets between closely related entities, ultimately allowing a high-income [taxpayer] to hide from a tax bill," said Werfel. "These complicated maneuvers take time and resources for the IRS to uncover. They're not easy to spot on the surface of the tax return."
The new guidance will basically inform the tax community that the IRS considers these maneuvers to be "transactions of interest" — transactions that could be viewed as tax shelters.
"We are also announcing plans to bring more transparency into the process to make it easier to spot abusive transactions," said Werfel. "The new guidance provides greater clarity to taxpayers and examiners and when final regulations are issued after a public comment period, the increased reporting requirements under the transaction of interest announced today would give the IRS greater awareness of these arrangements."
The IRS has already been using funding from the IRA to
There are larger organizational changes taking place to support these efforts at the IRS, including the creation of a new office, he added.
"As part of the increased focus on this area, IRS Chief Counsel Margie Rollinson announced today the creation of a new associate office that will focus exclusively on partnerships, S corporations, trusts and estates," said Werfel. "This new office will allow the chief counsel organization to focus more directly on this complex area and provide additional attention to legal guidance and other priorities involving partnerships. The new chief counsel office will work in close coordination with other IRS business units. This includes our Large Business and International Division, which continues working to establish a special group focused on pass-throughs, including complex partnerships. Work has already started in this area, and LBI plans to formally establish the new work group this fall."
The IRS has been adding more tax experts from outside the agency to help spot tax avoidance strategies.
"We plan to bring in outside experts with private-sector experience regarding pass-throughs to work alongside current IRS employees familiar with these efforts," said Werfel. "The outside experience will be critical, helping give the IRS an inside look at some of the maneuvers taking place with partnerships. Hiring this kind of expertise is an area where the IRS has not had the resources to keep pace with the rapid growth taking place with partnerships. This is another area where Inflation Reduction Act funding is making a difference, where we can recruit and promote top talent to help address issues like this. We are bringing new Inflation Reduction Act resources to play to beef up our compliance work in overlooked areas of concern involving high-income earners, complex partnerships and large corporations. We are continuing to accelerate our work in this area. We need to home in on areas where we believe noncompliance has proliferated during the last decade of IRS budget cuts, and partnerships represent an area where complex business structures have allowed millionaires and high-income earners to avoid paying what they legally owe, while average taxpayers play by the rules."
