IRS moves to end ‘shell game’ of basis-shifting transactions

The IRS intends to close a tax loophole in several actions that agency leaders say could add over $50 billion to U.S. government coffers over 10 years. The Service announced Monday that it will propose new regulations and release a revenue ruling to challenge the use of basis-shifting transactions by complex partnerships.

The Service also will bring in outside experts to help root out the use of what it described as “abusive partnership transactions” and set up new teams so it can focus on these issues, IRS leaders said in a call with reporters on Friday, ahead of the announcement.

“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 the high-income [taxpayers] to hide from a tax bill,” IRS Commissioner Danny Werfel said on the call. “These complicated maneuvers take time and resources for the IRS to uncover. They’re not easy to spot on the surface of the tax return. The new guidance is aimed at telling the tax community that the IRS considers these transactions inappropriate.”

In these arrangements, a partnership could shift tax basis from a property that does not generate tax deductions, such as stocks or land, to a property that does, such as equipment, Deputy Treasury Secretary Wally Adeyemo said. Businesses also use the technique to depreciate the same asset repeatedly, he said.

The transactions do not create “any real economic value for the United States,” Adeyemo said. “Their sole purpose is to avoid tax bills by moving assets from one pocket to another and generate deductions.”

Werfel added, “We’re also concerned about signs that the use of these maneuvers is increasing.”

Werfel also said that the Service will use outside experts with private sector experience to work with IRS employees. “The outside experience will be critical, helping give the IRS an inside look at some of the maneuvers taking place with partnerships.”

In addition, the IRS Office of Chief Counsel is creating a new associate office to focus exclusively on partnerships, S corporations, trusts, and estates. “This new office will allow the Chief Counsel organization to focus more directly on these troubled areas and provide additional attention to legal guidance and other priorities involving partnerships,” Werfel said.

The actions announced include three notices of proposed rulemaking (NPRM) and a revenue ruling, Treasury said in a news release:

• The first NPRM will provide mechanical rules under the partnership tax provisions regarding the effects of basis adjustments resulting from related-party partnership basis-shifting transactions, the release said. Treasury said the goal is to “eliminate the inappropriate tax benefits created from these abusive transactions between related parties.”
• The second NPRM will apply a single-entity approach to interests in a partnership held by members of a consolidated group, which are groups of corporations that share an 80% vote and value stock ownership and file a consolidated tax return. The goal of this NPRM is to prevent partnership basis shifting among members of a consolidated group, Treasury said.
• A third NPRM (REG-124593-23, posted Monday) identifies partnership related-party basis adjustment transactions and substantially similar transactions as transactions of interest. This will require taxpayers and their material advisers to report if they and their clients are participating in these partnership basis-shifting transactions, which Treasury said will provide the IRS with information “to better assess the scale and characteristics of the abuse and help direct IRS enforcement resources.” The threshold for reporting is $5 million or more of positive basis adjustments in a single tax year for which no tax was paid.
• The revenue ruling (Rev. Rul. 2024-14, also issued Monday) provides that certain related-party partnership transactions involving basis shifting lack economic substance. The IRS will use the ruling “in current and future audits and litigation that many of these transactions violate the codified economic substance doctrine because the transaction creates no meaningful change to the economics of the parties as compared to the tax benefit or has no substantial business purpose,” the Treasury release said.

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