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IRS, Treasury going after abusive basis transactions

IRS HQ WDC by David Boeke via Flickr CC_cropped
Credit: David Boeke via Flickr

You’ve probably read that some of the country’s wealthiest people are warming to a second Donald J. Trump presidency.

Today’s announcement from the U.S. Treasury and Internal Revenue Service might be part of the reason.

The country’s financial division and its tax collection arm agency say they are going after “a major tax loophole exploited by large, complex partnerships.”

The initiative, say Treasury and IRS, is one step in ongoing efforts to “shut down abusive transactions using existing regulatory authority and ensure wealthy individuals, complex partnerships, and large corporations pay taxes owed.”

Focus on opaque business structures: Treasury and IRS say today’s announced tax compliance efforts are just the beginning of a multi-stage regulatory effort. Its target is opaque business structures that federal officials say often are used by large, complex partnerships to inflate tax deductions and avoid taxes.

The IRS and the Department of the Treasury today also issued three pieces of guidance focused on partnerships following discoveries by IRS audit teams.

When the full program is in place, Treasury estimates the initiative could raise more than $50 billion in revenue over 10 years, and potentially much more when compared to allowing these transactions to continue.

Basis shifting shell game: Partnership basis shifting transactions are used by wealthy taxpayers to make billions of dollars in taxable income disappear, according to the Treasury and IRS.

In these transactions, a single business that operates through many different legal entities, also known as related parties, enters into a set of transactions that manipulate partnership tax rules to maximize tax deductions and minimize tax liability.

These transactions defy congressional intent to avoid tax liability with little to no other economic consequences for the participating businesses. For example, a partnership might shift tax basis from property that does not generate tax deductions, such as stock or land, to property that does, such as equipment.

The IRS says wealthy taxpayers and businesses are paying accountants and lawyers millions of dollars to develop these complex, abusive transactions, costing the federal government billions of dollars each year. In some cases, these techniques are used to depreciate the same asset over and over.

“In essence, basis shifting amounts to a shell game where 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 IRS Commissioner Danny Werfel.

Added funds for enforcement: These abusive schemes flourished, says the IRS, during a time when it didn’t have the money to audit suspected transactions.

Filings from passthrough businesses with more than $10 million in assets increased 70 percent, from 174,100 in 2010 to 297,400 in 2019. But the audit rate for these partnerships fell from 3.8 percent in 2010 to 0.1 percent in 2019.

IRS says that fiscal combination made it easier for wealthy taxpayers to avoid paying what they owe, contributing to the estimated $160 billion per year Tax Gap attributed to the top 1 percent of filers. 

Currently, the IRS has tens of billions of dollars of deductions claimed in these transactions under audit. But the effort will ramp up with the today’s announced initiative.

As part of the increased focus on this area, IRS Chief Counsel Margie Rollinson also announced the creation of new Associate Office that will focus exclusively on partnerships, S-corporations, trusts and estates. The IRS also will establish this fall a new pass-through work group as part of the IRS Large Business and International division to focus on these abusive transactions.

The money for this effort comes from the Inflation Reduction Act’s added IRS funding.

“These complicated maneuvers take time and resources for the IRS to uncover,” said Werfel. “The new guidance is aimed at telling promoters that the IRS considers these transactions inappropriate, and we are bringing new Inflation Reduction Act resources into play to beef up our compliance work in the overlooked partnerships and pass-throughs area.”

“Treasury and the IRS are focused on addressing high-end tax abuse from all angles, and the proposed rules released today will increase tax fairness and reduce the deficit,” added U.S. Secretary of the Treasury Janet L. Yellen.

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