On April 17, the Internal Revenue Service issued a notice announcing its plans to withdraw a set of controversial regulations, finalized in January of this year, aimed at transactions designed to shift tax basis in partnership interests among related partners.
As previously covered in Brass Tax, the basis-shifting regulations designated certain partnership transactions among related partners as "transactions of interest," requiring parties who engage in transactions meeting the criteria in the regulations, as well as their material advisors, to report the transactions to the IRS. Although aimed at abusive transactions entered into for the purpose of tax avoidance, the regulations have been widely criticized by tax practitioners, including the Tax Sections of the New York State Bar Associationand theAmerican Bar Association, as overbroad, picking up legitimate transactions that were not entered into for tax purposes. Additionally, practitioners criticized the retroactivity of the rules, requiring disclosure of transactions that took place up to six years before the date of the final regulations.
The IRS notice was issued pursuant to a February executive order directing agencies to review regulations to identify and remove those that, among other criteria, "impose significant costs upon private parties that are not outweighed by public benefits." The IRS cited the criticism of the tax bar in explaining the reason for the notice, observing that many "have criticized the Basis Shifting TOI Regulations as imposing complex, burdensome, and retroactive disclosure obligations on many ordinary-course and tax-compliant business activities, creating costly compliance obligations and uncertainty for businesses."
The IRS's notice further announced that the revised regulations will be retroactive to January 14, 2025, the effective date of the current basis-shifting regulations, that taxpayers and their advisors may rely on the notice until the new regulations are published, and that no penalties for failure to disclose basis-shifting transactions will be assessed. As a practical matter, therefore, the notice effectively eliminates any current requirement for taxpayers and their advisors to disclose what would otherwise have been basis-shifting transactions of interest.
That said, while the reporting regime has been effectively withdrawn, the IRS has not withdrawn Revenue Ruling 2024-14, which held that the economic substance doctrine could apply to disallow tax benefits—and even impose penalties—in transactions in which "parties engage[] in a concerted effort to create disparities between inside and outside basis in partnerships" in order "to inappropriately reduce taxable income through increased deductions or reduced gain." In other words, while this month's notice may reflect an attempt to reduce the administrative burden on taxpayers and their advisors, it does not appear to reflect a change in the IRS's underlying substantive view that at least certain transactions of the type at issue represent abusive tax-avoidance transactions. Accordingly, while taxpayers engaged in transactions that have the effect of shifting basis among related parties need not engage in up-front reporting, they would still be well advised to thoroughly document the non-tax business purposes driving those transactions in order to defend their economic substance in the event of an IRS audit.
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