Senate Tax-Writing Chief Proposes Dramatic Changes to Partnership Tax Rules

Senate Finance Chairman Ron Wyden (D-Ore.) released a “discussion draft” on Friday for legislation that seeks to tighten tax reporting rules for partnerships.

A “discussion draft” is not legislation that is introduced to become law. Instead, it is released for comments from other lawmakers. Wyden could incorporate those comments into the legislation and, at some point in the future, release legislation that he hopes will become law.

It is unclear if Wyden’s proposals will be a part of the $3.5 trillion tax and spending bill that congressional Democrats hope will pass Congress by mid-October. That legislation can pass both chambers with only Democratic support.  If the Senator’s proposals are not included in the Democratic package, the odds for these provisions becoming law are slimmer because it would require Republican support, which is unlikely to occur.

What is clear, according to reporting, is the changes that Wyden has proposed would be dramatic.

“If it takes effect, the proposal would upend many existing arrangements in private-equity funds and elsewhere, said Monte Jackel, a partnership tax lawyer and former IRS official who worked with the committee on the plan. He described the changes as the most significant for partnerships since 1984. ‘A lot of people will be aggravated over this,’ Mr. Jackel said,” the Wall Street Journal reported.

The proposed changes in Wyden’s discussion draft includes:

• Repealing the exception from corporate tax treatment for all publicly traded partnerships;
• Removing the “substantial economic effect" test for many partnership allocations under Subchapter K;
• Requiring that all partnerships use the remedial method for section 704(c) allocations, as described in Treas. reg. sec. 1.704-3(d);
• Repealing section 707(c), guaranteed payments;
• Requiring that all debt be shared between the partners in accordance with partnership profits;
• Revising IRC section 163(j)(4) so that the interest limitation rule applicable to partnerships and S corporations would become a true entity-level limitation. “It provides that excess limitation (i.e., excess business interest income and excess taxable income) cannot be used to deduct interest expense from other sources, as it does under present law,” the discussion draft states.
• Requiring Regulated Investment Companies to recognize gains when distributing property in kind to a redeeming shareholder.

The discussion draft can be found here.