Wyden proposes significant partnership tax changes

In detail

The Discussion Draft includes the following proposed changes to the rules governing the taxation of partners and partnerships:

• Make technical amendments under Section 701 corresponding to the Bipartisan Budget Amendment (BBA) provisions.  According to the summary, the change is intended to “allow the IRS to enhance reporting requirements of partnership tax positions by aligning tax reporting with Financial Accounting Standards Board (FASB) reporting, which may require the reporting of uncertain tax positions that could trigger an entity-level liability.”
• Eliminate the substantial economic effect test under Section 704(b) and mandate partners’ interests in the partnership as the general rule for testing partnership allocations.  Certain partnerships where related persons own 50% or more would be required to allocate items consistently based on partner net contributed capital. 
• Mandate the use of the remedial method for all Section 704(c) allocations. 
• Mandate revaluations of partnership property upon a change in economic arrangement of the partners.  These revaluations currently are optional under Treas. Reg. sec. 1.704-1(b)(2)(iv)(f).
• Eliminate the seven-year limit for ‘mixing bowl’ transactions under Sections 704(c)(1)(B) and 737, such that the rules would apply to contributed property regardless of the time since contribution.
• Permit Treasury to prescribe rules under Section 705 allowing partners to estimate adjusted basis in their partnership interests in scenarios other than partnership terminations.
• Eliminate guaranteed payments under Section 707(c) and mandate that all payments to partners for services or use of capital that are not in substance distributions be treated as payments to a partner not acting in its capacity as a partner under Section 707(a).
• Eliminate special provisions for retiring or withdrawing partners under Sections 736 and 761.
• Clarify that Section 707(a)(2)(B), governing the ‘disguised sale’ of partnership interests, is self-executing and remove the capital expenditure exception from the disguised-sale rules.
• Clarify that a partnership is not terminated under Section 708 if any part of the business is carried on by a person who was a partner in the prior partnership or by a person related to any of those partners.
• Conform Section 751(b) to Section 751(a) by eliminating the “substantially appreciated” inventory requirement.
• Modify Section 752 to allocate liabilities in accordance with partnership profits unless a partner or related person was the lender.
• Make adjustments under Sections 734(b) and 743(b) mandatory.
• Eliminate the exceptions from corporate treatment for publicly traded partnerships under Section 7704.
• Amend Section 163(j)(4) to make the business interest limitation fully apply at the entity level for partnerships and S corporations.
• Revise Section 852(b)(6) such that RICs would be required to recognize gain upon distribution by a corporation of built-in gain property.
• Revise Section 52 to provide that any taxpayer engaged in an activity in connection with a trade or business or for-profit activity, including a foreign entity, is subject to the aggregation rules under Section 52.

The proposals have varying effective dates, ranging from the date of enactment to tax years beginning after December 31, 2021.  The changes relating to Section 704(b) allocations would have a delayed effective date, applying to partnership tax years beginning after December 31, 2023.  The change to Section 7704, requiring all PTPs to be taxed as corporations, would be effective for tax years beginning after December 31, 2022.

Observation: The Biden Administration and Congressional Democrats have indicated that they do not intend to target taxpayers with under $400,000 of income for tax increases.  That policy position will need to be considered in how these proposals are crafted should Congress take them up during the reconciliation bill process.