Recently, the IRS and the Department of the Treasury issued proposed regulations to curtail perceived abusive tax maneuvers under the partnership tax provisions. In a related news release, the IRS stated that this round of guidance is in response to "repeated instances of abusive basis-shifting taking place in sophisticated maneuvers by related-party partnerships."
The IRS is targeting transactions where the income tax basis from certain partnership assets is shifted to generate preferential tax treatments. The IRS has labeled those transactions made solely for the purpose of increasing depreciation deductions or reducing gain recognition on the sale of an asset as "Transactions of Interest." These are defined as transactions that the IRS and the Treasury Department believe are undertaken for tax avoidance or evasion purposes. As such, these types of transactions have been added to the list of reportable transactions and require disclosure to the IRS on tax returns. If an individual, or entity, fails to disclose the required information of a Transaction of Interest, they may be subject to a fine no less than $5,000, or $10,000, respectively.
The targeted transactions include favorable income tax basis adjustments of $5 million or more executed under the partnership rules of the Internal Revenue Code. This includes those distributions of partnership property or, the transfer of partnership interests, to a party related to the partners of the partnership. For purposes of these rules, the term "partnership" includes any entity, including limited liability companies, filing tax returns as a "partnership."
Further, through the publication of Revenue Ruling 2024-14, the IRS is placing taxpayers on notice that it will challenge these basis-shifting transactions as lacking economic substance. The economic substance doctrine specifies that a transaction must have both a substantial purpose and economic effect aside from its sole tax benefits. Thus, if a taxpayer creates disparities in its tax basis and attempts to capitalize on these disparities by claiming a tax deduction under the respective tax code provisions, the IRS may challenge the legitimacy of the transaction.
McCarthy Lebit would like to thank law clerk Anthony Miduri for his effort in assisting with the preparation of this legal blog post for The More Report.
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