IRS Unveils Plan to End Change of Basis Transactions

The Treasury Department and the IRS said June 17 that a new initiative to close a major tax loophole used by wealthy individuals and large partnerships could generate more than $50 billion in revenue over 10 years.

Treasury and the IRS released three guidance Monday focused on partnerships following the findings of IRS audit teams. The IRS said it currently has tens of billions of dollars in deductions claimed in these transactions under audit.

The new guidelines aim to end the use of “change of basis,” or transactions in which an individual or company transfers assets to a related party to avoid paying taxes.

“In these complex moves, taxpayers and high-income businesses remove the basis from the assets they own where the basis does not generate tax benefits, then shift the basis to the assets they own where it does will generate tax benefits without causing any significant change in the economics of the economy. their businesses,” the IRS said. “These change-of-basis transactions allow closely related parties to avoid taxes.”

The agency also announced Monday the formation of a new group under the Office of Chief Legal Counsel dedicated to developing advice on partnerships, including closing tax loopholes. The office will work closely with a new mid-level working group within the IRS Large Business and International division that will be formally established this fall.

“This announcement indicates that the IRS is accelerating its work in the partnership area, which has been neglected for more than a decade and has allowed tax abuse to continue for far too long,” said the IRS Commissioner. IRS, Danny Werfel, in a press release. “We are building teams and adding expertise within the agency so we can reverse the long-term decline in compliance that has allowed high-income taxpayers and businesses to hide behind complexity to avoid paying taxes. Billions are at stake here.

Tax filings for pass-through businesses with more than $10 million in assets jumped to nearly 300,000 filings in 2019, up 70% from 2010. During the same period, audit rates fell from 3.8% in 2010 to 0.1% in 2019. That contributed to an estimated $160 billion a year tax gap attributed to the top 1 percent of tax filers, the Treasury Department said .

“Treasury and the IRS are focused on combatting high-end tax abuse from all angles, and the proposed rules released today will increase tax fairness and reduce the deficit,” said Treasury Secretary Janet Yellen in a statement. “With resources from President Biden’s Inflation Reduction Act, Treasury and the IRS have the tools to end long-standing abuses.”

The first piece of guidance issued by Treasury and the IRS is a notice of intent to issue proposed regulations that provide for two future proposed rules. The first Notice of Proposed Rulemaking (NPRM) would provide mechanical rules under the partnership tax provisions regarding the effects of basis adjustments resulting from related company rebasing transactions. The proposed regulations, when finalized, would eliminate the improper tax benefits created by these abusive related party transactions, Treasury said.

The other NPRM would apply a single entity approach with respect to partnership interests held by members of a consolidated group, which are groups of companies that share an 80% voting, value ownership and file a consolidated tax return. The regulations, once final, would prevent the change in basis of partnership between members of a consolidated group.

Second, Treasury and the IRS are also issuing an NPRM that would require taxpayers and their significant advisors to report whether they and their clients participate in partnership change basis transactions. The purpose of the NPRM is to provide the IRS with additional information to better assess the extent and characteristics of abuses and help direct IRS enforcement resources, Treasury said. The reporting threshold would be set at $5 million or more of positive basis adjustments generated by covered transactions in a single tax year and for which no taxes were paid.

Finally, Treasury and the IRS issue a revenue ruling that provides that certain related party partnership transactions involving a change in basis lack economic substance. The decision will support the IRS’s position in current and future audits and litigation that many of these transactions violate the codified economic substance doctrine because the transaction does not create any significant change in the economics of the parties relative to the tax advantage or has no substantial commercial objective. , the Treasury said on Monday.

“Essentially, rebasing amounts to a game of window dressing in which sophisticated tax maneuvers take place by shifting the basis of assets between closely related entities, ultimately allowing these complex partnership arrangements to hide from a tax bill” , said Werfel. “These complicated maneuvers require time and resources for the IRS to uncover. The new guidance is intended to tell promoters that the IRS considers these transactions inappropriate, and we are implementing new resources from the Inflation Reduction Act to strengthen our compliance work in the neglected area of ​​partnerships and transfers .

The move comes as the IRS capitalizes on additional funding it received under the Inflation Reduction Act to crack down on wealthy tax evaders who evade the taxman or dramatically reduce their tax bills through loopholes and other methods.

The agency said it has launched audits on 76 of the largest partnerships with average assets above $10 billion, including hedge funds, real estate investment partnerships, publicly traded partnerships, large law firms and many other sectors. The IRS said Monday that these complex audits are ongoing and at various stages of the process and could take several years depending on the size and complexity of the partnerships.

Additionally, the IRS said in January that it has recovered approximately $482 billion in back taxes from wealthy tax evaders since October 2023 thanks to improvements that were made to modernize the agency with funding from the Tax Act. reducing inflation.

As part of the increased focus on this area, IRS Chief Attorney Margie Rollinson announced the creation of a new associate office that will focus exclusively on partnerships, S corporations, trusts and inheritances.

“This new associate office will allow the Chief Counsel organization to focus more directly on this complex area of ​​tax law and provide greater attention to legal advice and other priorities in the partnership area,” Rollinson said.

The associated office will come from the current Passthroughs and Special Industries (PSI) office, according to the IRS. The “special industries” department of the former PSI Office of General Counsel will form a new associated office that will focus on energy, credits and incentives, and excise taxes, joining another office that focused on clean energy guidelines.

The new Office of General Counsel will work in close coordination with IRS business units, including LB&I, which previously announced plans to create a special task force focused on transfers, including complex partnerships. Although work has already begun in this area, LB&I plans to formally establish the new task force this fall.

Werfel noted that for the new Chief Counsel and LB&I working groups, the IRS plans to bring in external experts with private sector pass-through experience to work alongside the IRS’s internal experts. agency.

“This is an area where the IRS has not had the resources to keep pace with the growth in the number of partnerships and the sophisticated tax maneuvers that are taking place,” Werfel said. “We continue to accelerate our work in this area. We need to focus on areas where we believe noncompliance has proliferated over the past decade of IRS budget cuts, and partnerships represent an area where complex business structures have enabled millionaires and High-income earners avoid paying what they legally owe while average taxpayers follow the rules.