US Senate bill would amend pass-through rules to address corporate tax abuse

By Doug Connolly, MNE Tax

Senate Finance Committee Senator Ron Wyden (D-Ore.) released a discussion draft on September 10 for legislation that would tighten rules around partnerships and other pass-through entities to prevent large corporations and wealthy investors from using the entities and the complex rules relating to them to avoid tax.

Wyden contends that large corporate groups often form partnerships between their own subsidiaries for the sole purpose of avoiding tax. Due to the complexity of the partnership rules, these types of arrangements can be hard for the IRS to identify. In this respect, Wyden notes that 52% of partnership income flows through to other partnerships and corporations. He further cites a study finding that 15% of partnership income is circular, meaning the income flows endlessly between related partnerships, and a further 20% is untraceable even with IRS data.

There are several reasons why the partnership rules are subject to manipulation, according to Wyden. One is that contributions and distributions of appreciated or depreciated property are generally tax-free, and the rules allow options for allocating built-in gains and losses that certain partners can manipulate to shift tax. In addition, partnerships may, but do not have to, revalue assets upon a change in the interest of the partners. Furthermore, partnership rules are also flexible in how they allow allocation of income and losses between partners.

To address these concerns, Wyden’s bill would require using the remedial method for allocating built-in gains and losses on contributed property to limit abuse via shifting tax liability. It would also require revaluations upon a change in the interest of partners to prevent the shifting of built-in gains and losses. In addition, the bill would restrict options related to how partnership income and losses are distributed to both prevent abuse and improve administrability. Pro-rata allocation would be required for all income and loss in the case of certain related-party partnerships.