IRS Tax Loopholes: Closing the Gap on Basis-Shifting Practices

The IRS has announced new guidance and regulations to end the major tax loopholes for high-income earners. The article covers the upcoming regulations and rules to close the tax loopholes worth ten billion for US people who wish to explore the new rules of the IRS to combat the abusive use of partnerships. 

IRS Tax Loopholes

On Monday, 17 June 2024, the IRS announced new steps & measures to eliminate the abusive use of partnerships that allow wealthy taxpayers to avoid taxes they owe to the agency. 

The tax loopholes allow individuals to reduce their tax liability by finding some gaps or loopholes in tax law. It’s a form of tax avoidance that many wealthy taxpayers use to reduce the tax amount they pay to the agency and maximize their income. 

According to the IRS, the tax loophole is the failure to pay or deliberately pay the underpayment of taxes. Many wealthy taxpayers utilized tax loopholes or other tax avoidance methods.

The most common tax loophole to avoid taxes is partnership basis shifting, meaning a practice where financial assets are moved on paper from one entity to another as these transactions do not count as economic activity.

In a recent announcement, the agency plans to eliminate this major tax loophole through its new guidelines and regulations. According to the agency, the end of this tax loophole could raise more than $50 billion of revenue for the US government in the next decade. 

The decision comes into the picture through the 2022 Inflation Reduction Act passed by the Biden administration as additional IRS funding because the funding has enabled increased awareness and oversight of the basis shifting practiced by high-income taxpayers.  

According to the IRS, the IRS has found out that the practice of tax avoidance has hiked by 70% from 174,100 in 2010 to 297,400 in 2019, resulting in underfunding in previous years. 

IRS Guidance to stop the basis shifting

The US Department of Treasury and IRS addressed the abusive use of partnership transactions by wealthy taxpayers from all ends and issued some pieces of guidance in the context. 

Here is the IRS-issued guidance for the tax loopholes:

  • The authorities release a notice of intent regarding the proposed regulations underlying the future rules. The first notice of proposed rulemaking (NPRM) provides the mechanical rules for partnership tax provisions and the effects of basis adjustments due to the partnership basis shifting transactions. Once the proposed regulations are finalized, they will eradicate the tax loophole practice between related parties. 
  • The agency and treasury department would require the taxpayers and the tax advisers of wealthy taxpayers to report if they or their clients are practicing basis-shifting transactions. The authorities have set the threshold for reporting the transaction at $5 million or above the positive basis adjustments granted through covered transactions in a single tax year where no tax has been paid. 
  • The authorities have released the revenue ruling that certain parties related to partnership transactions lack economic substance. 

Basis shifting transactions targeted in IRS new guidance 

According to the guidance issued by the IRS, the basis-shifting transactions fall into three groups that are targeted in the new guidance: 

  • Distribution of property to a related party: Here the related partners distribute the high-basis assets to related partners with a low basis to reduce the basis of distributed assets. The transactions let related partners increase the basis of partnerships’ retained assets and ultimately, generate tax savings.
  • TOI (Transactions of Interest): When a partner with a low share of partnerships inside tax basis shares the interest with a high outside tax basis, the generated interest is tax-free The transfer of partnership interest among the related parties helps the parties to reduce tax liability.
  • Partnership or Partner liquidation: The partners distribute or liquidate the low-basis asset subject to high-end cost recovery terminating the entire interest of the partnership. 

IRS’s upcoming two regulations 

IRS has planned to bring the following two regulations to address the above-mentioned targeted areas of basis shifting:

  • The first set of regulations would mandate the parties involved in the partnership transactions to treat basis adjustments in a way that limits them from deriving tax loophole benefits from the basis adjustments from covered transactions.
  • The second set of guidelines would present the rules to ensure a clear determination of the taxable income and tax liability of the corporations when group members own the interests in partnerships. The IRS also directed that the covered transactions would cover the basis adjustments under Internal Revenue Code sections 732, 734(b) and 743(b).

IRS other measures to combat tax loopholes 

The IRS plans the following measures to eliminate the basis-shifting transactions that allow wealthy taxpayers to practice inappropriate tax benefits:

  • The agency will create a new Associate Office focused on this matter exclusively for S-corporations, real estate, and trusts to stop the avoiding method. The Chief Counsel’s Former PSI office will create the Associate office focused entirely on removing such tax practices. The Office directly focuses on complex areas of tax law to provide more legal guidance in tax loopholes. 
  • The agency plans to raise the audit rates on high-end companies with assets above $250 million to 22.6% in the coming years from the initial lower rate to assess the financial information compliance with the law. The agency plans to raise the audit rates for complex partnerships involving assets above $10 million. 
  • The IRS will use the Inflation Reduction Act funding to strengthen the enforcement of the tax law among wealthy taxpayers and corporations involved in a partnership transaction to eliminate the major tax loopholes. 

IRS and the US Department of Treasury are committed to bringing the needed changes in the tax law that will end the tax avoidance practices among high-income earners and generate revenue for the government. 

Categories US

Leave a Comment