IRS to Close Tax Loophole for Large Partnerships, Aiming to Raise $50 Billion Over 10 Years

The IRS is set to shut down a tax loophole utilized by large, complex partnerships, enabling the U.S. Department of Treasury to generate an estimated $50 billion or more in revenue over the next decade. This initiative is the latest in a series of attempts by the IRS to hold the ultra-wealthy more accountable, coming just under three months after an International Consortium of Investigative Journalists (ICIJ) investigation revealed how these opaque partnership structures were being exploited to evade taxes.

The investigation, based on interviews with numerous former tax officials and details from hundreds of leaked IRS forms, highlighted a set of federal rules—some crafted by the IRS itself—that have allowed secrecy-seeking investors to outmaneuver the agency. Accountants and lawyers have readily assisted these investors in exploiting weak regulations and a longstanding pattern of lax enforcement.

“Treasury and the IRS are focused on addressing high-end tax abuse from all angles,” stated U.S. Secretary of the Treasury Janet L. Yellen in a statement accompanying the IRS announcement last week.

The proposed new regulations will specifically target large partnerships, which are the fastest-growing type of business entity in the U.S. These partnerships can invest in one another and form complex, interconnected structures. The audit rate for large partnerships has been nearly zero percent in recent years.

The IRS has particularly flagged a tax strategy known as basis shifting, where assets are moved between entities within a partnership. Taxes on assets sold by a partnership are calculated by subtracting the asset’s original cost, or basis, from the proceeds. Basis shifting allows for assets to be depreciated, sometimes multiple times, by moving them around within the partnership structure, thereby minimizing tax liability, often to zero.

“These transactions defy congressional intent to avoid tax liability with little to no other economic consequences for the participating businesses,” the Treasury statement noted.

The proposed regulations would provide increased guidance on rules to clamp down on abusive basis shifting, as well as requirements for taxpayers' advisors to report potentially abusive transactions.

Additionally, the IRS and Treasury have issued a new revenue ruling to strengthen the agency’s ability to pursue taxpayers abusing large partnership structures. This ruling reaffirms that much of the basis shifting could already be deemed illegal under the codified “economic substance doctrine,” a law that requires transactions to have an economic purpose beyond reducing taxes.

Tax attorney Monte Jackel anticipates that the new revenue ruling will take years to resolve in court, given its implication that these processes have been illegal for years, despite the IRS not issuing any guidance on the matter until now. “I’m all in favor of legislation to fix the issue,” Jackel said. “But there’s going to be severe pushback from practitioners and all, about the retroactivity of this, plus the authority to do it at all.”

By fLEXI tEAM