Modernizing Partnership Taxation

Modernizing partnership taxation www.hamiltonproject.org Miles Johnson, Sophia Yan, Chye-Ching Huang, and Grace Henley The Tax Law Center at NYU Law Partnership tax reform should be a key part of the current and upcoming tax policy debate, with large parts of the 2017 Tax Cuts and Jobs Act (TCJA) set to expire at the end of 2025. [...] Partnerships represent al- most 30 percent of all business income in the United States, now outnumbering C corporations. For feder- al tax purposes, partners are taxed directly on their share of the partnership’s income and activities. The partnership itself is not a separate taxable entity and partners are not subject to two layers of tax that other businesses like C corporations face. [...] Partnership tax rules have not been the subject of broad reform since their enactment in 1954. [...] This is a source of substantial revenue loss. A 2012 Congres- sional Budget Office (CBO) report estimated that if tax rules for C corporations had applied to partner- ships and S corporations in 2007, total federal rev- enues would have been about $76 billion higher (or $100 billion in 2021 dollars). In 2021, comprehensive partnership tax reform proposals were publicly esti- mated to raise at [...] In this policy proposal, Miles Johnson, Sophia Yan, Chye-Ching Huang, and Grace Henley (The Tax Law Center at NYU Law) exam- ine the current structure of partnership taxation and present a selection of reform proposals that would modernize partnership taxation, focusing on options most relevant to the 2025 tax policy debate. [...] Large partnerships often involve complicated webs of ownership and tax returns that are difficult to decipher. [...] While partnership tax rules can be flex- ible enough to accommodate the taxation of many modern businesses, they can also facilitate wildly complex structures that are engineered to avoid tax- es or even facilitate illegal tax evasion. [...] Opacity: Despite their growing role in the econ- omy and the tax system, it is difficult to obtain some of the most basic information about partnerships, such as the number and identity of partnership own- ers. Research with IRS data found that more than 20 percent of partnership income could not be readily traced to known types of entities or individuals. Weaknesses in the laws governing part [...] This includes a lack of third-party reporting requirements that would allow the IRS to verify partnership income, deficiencies in ownership and structure reporting, and the complexity of partnership tax returns. The proposal The proposal offers a specific selection of suggested legislative and regulatory reforms ranging from tar- geted fixes to broader reforms. Representative ex- amples are [...] For example, the proposal includes a legislative clean-up of section 707(a)(2)(b), addressing disguised sales of partnership interests. As with assets like stocks and bonds, when a taxpayer sells its stake in a partner- ship, the taxpayer should pay tax on any gains. How- ever, a taxpayer can try to achieve more favorable tax treatment by “disguising” what is economically a sale as a differe