INSIGHTS What Partnerships Need to Know About the New IRS Initiative Targeting

The IRS recently announced a new multistage regulatory initiative to close what it calls a "major tax loophole exploited by large, complex partnerships." This move stems from the IRS’s concern that some partnerships use transactions with related parties to improperly reduce their tax bills.

Tactic in the IRS Crosshairs The primary focus for the IRS is on basis-shifting transactions. In these arrangements, a business operating through multiple legal entities enters a series of transactions intended to leverage partnership tax rules to reduce taxable income and minimize tax liability. This strategy manipulates the rules governing when a partnership can receive a basis step-up in assets, allowing for:

1. Additional depreciation, or
2. Reduced taxable gain or increased taxable loss upon asset disposition.

For example, a partnership might transfer tax basis from non-deductible assets (e.g., stocks or land) to deductible assets (e.g., equipment or machinery). In some cases, taxpayers may also use basis-shifting transactions to depreciate the same asset repeatedly.

The IRS attributes the growth of these "abusive schemes" to its previously limited resources. Although pass-through business filings with assets over $10 million increased by 70% from 2010 to 2019, audit rates for these entities dropped from 3.8% to 0.1% in that period. With new funding from the Inflation Reduction Act, the IRS aims to raise over $50 billion in revenue over the next decade by curbing basis-shifting abuses.

Multipronged Approach In its initial phase to combat this issue, the IRS announced plans to issue three sets of proposed regulations. It released a new revenue ruling to inform taxpayers of forthcoming challenges to specifin transactions.

1. Proposed Rules to Block Basis Shifting: The IRS will introduce regulations targeting basis-shifting transactions among related-party partnerships. If finalized, these rules would effectively eliminate the perceived "inappropriate" tax benefits from these practices. A secondary regulation would apply a single-entity approach to partnerships within consolidated groups to prevent skewed income distribution.
2. Proposed Reporting Requirements: Another set of proposed regulations would require certain partnerships and their advisors to report their involvement in specific basis-shifting transactions. Transactions generating $5 million or more of positive basis adjustments in a single tax year, with no tax paid, would fall under this mandate. Noncompliance could result in penalties.
3. Revenue Ruling 2024-14: This ruling provides that three types of related-party transactions involving basis shifting lack economic substance. It supports the IRS’s position that these transactions create no substantial change in parties' economics aside from the tax benefit, and therefore the tax benefits should be disallowed. Under this ruling, transactions without economic substance would be subject to a 20% underpayment penalty, increasing to 40% for non-reported activity.

The future of these proposed regulations will depend on public feedback and potential legal challenges. In the meantime, partnerships should work closely with their tax advisors to ensure compliance with tax laws while effectively managing their taxable income. For guidance on how these new IRS initiatives might impact your partnership, contact our Reynolds + Rowella tax advisors. We’re here to help you understand these complex regulations and safeguard your financial interests.    

Reynolds + Rowella is a regional accounting and consulting firm known for a team approach to financial problem solving. As Certified Public Accountants, our partners foster a personal touch with our clients. As members of DFK International/USA, an association of accountants and advisors, our professional network is international, yet many of our clients have known us for years through the local communities we serve. Our mission is to operate as a financial services firm of outstanding quality. Our efforts are directed at serving our clients in the most efficient and responsive manner possible, delivering services that exceed the expectations of those we serve. The firm has offices at 90 Grove St., Ridgefield, Conn., and 51 Locust Ave., New Canaan, Conn. For more information, please contact Elizabeth Bresnan at 203.438.0161 or email.