Tax Policy Groups Seek Withdrawal of Partnership Basis Shifting Guidance

The IRS should withdraw guidance issued last year providing that certain partnership transactions between related parties lack economic substance when conducted purely to reduce federal tax liability through basis adjustments, stakeholders told the agency, in light of the new administration’s decision to eliminate relevant final regs.

Biden-era enforcement initiative.

Former IRS Commissioner Danny Werfel, appointed by former President Joe Biden, launched a series of compliance enforcement initiatives in 2024 to increase scrutiny on high-income individuals and large corporations before stepping down as commissioner when President Donald Trump took office in January.

Last June, Werfel announced a campaign to prevent complex partnerships from using certain loopholes to generate tax benefits. At the time, Werfel said the IRS had identified the trend of partnerships abusing the Tax Code, specifically Code Sec. 732, Code Sec. 734(b), Code Sec. 743(b), and Code Sec. 755.

He explained that the initiative would course-correct from decades of declining partnership audit rates. An accompanying Treasury press release estimated that stopping complex partnerships “from using opaque business structures to inflate tax deductions and avoid taxes” would generate $50 billion in revenue over a 10-year period.

In these so-called basis shifting transactions, related parties — or “different legal entities” through which a single business operates — “manipulate” tax rules to “maximize deductions” in ways counter to congressional intent, said Treasury. The release used the example of a partnership that shifts basis from stock or land to property like equipment in order to generate deductions.

“Taxpayers may also use these techniques to depreciate the same asset over and over,” it added.

Guidance package.

To combat this, the IRS broke basis shifting categories into three general categories: 1) transfers of partnership interest to a related party; 2) distributions of property to a related party; and 3) liquidations and subsequent distributions of assets to a related party.

Notice 2024-54 discussed the IRS’ plans to identify these transactions as transactions of interest subject to reportable transaction rules. One set of proposed regs addressed Sections 732, 734(b), 743(b), and 755. Additional regs proposed under Code Sec. 1502 provided treatment of the covered transaction types to consolidated groups.

In Rev Rul 2024-14, the IRS said it would disallow basis adjustments under Sections 732(b), 734(b), and 743(b) using the economic substance doctrine. Generally, if a transaction or series of transactions do not serve an economic purpose, it can be disregarded for federal income tax purposes.

Depending on the facts and circumstances, the basis shifting transactions are also subject to the partnership anti-abuse rule, as well as potentially the substance-over-form doctrine and the step-transaction doctrine, the revenue ruling concluded.

Final regs and repeal.

Days before Trump’s inauguration, the IRS finalized the proposed regs with some modifications to reporting thresholds, the lookback window, and due dates for taxpayers and material advisors to file disclosure statements.

The final regs took effect January 14. But the Treasury Department under Trump and Secretary Scott Bessent issued Notice 2025-23 in April announcing it will remove the final regs, meaning the basis shifting transactions will no longer be reportable transactions of interest.

The notice also waived failure-to-file penalties for taxpayer and material advisor disclosure statements, as well as penalties for failing to maintain a Code Sec. 6112 list.

According to Treasury, the regs are set for elimination in adherence to a Trump executive order directing agencies to do away with burdensome regulations.

Calls to eliminate the revenue ruling.

While April’s notice spells the end of the basis shifting regs, as well as Notice 2024-54, it does not affect the revenue ruling.

National Taxpayers Union (NTU) President Pete Sepp sent a letter May 5 to Treasury Deputy Secretary and current acting IRS Commissioner Michael Faulkender recommending the administration also withdraw the revenue ruling, or at least provide additional clarifications on its authority.

“Allowing Revenue Ruling 2024-14 to perpetuate itself would drive uncertainty among taxpayers and practitioners, as well as foment administrative mischief at the Internal Revenue Service,” wrote Sepp. The revenue ruling is “inextricably linked” to the soon-to-be-withdrawn regs, he continued.

Sepp’s letter quotes previous NTU comments submitted in August during the proposed regs’ open comment period. Then, NTU said “applying the economic substance doctrine to the entire spectrum of examination and enforcement powers” is a “controversial position.” (emphasis in original)

NTU has raised concerns about the broad usage of the economic substance doctrine as part of the IRS’ crackdown on partnerships to raise tax revenues. “Since the fall of 2023, the IRS and Treasury have operated a combined enforcement unit whose primary purpose was to wield [economic substance doctrine] claims against pass-through businesses,” according to Sepp.

“As long as this entity exists, it will be driven in search of activities to justify its original remit-that partnerships are some mother lode of undiscovered revenue,” he said, adding that the doctrine is a “convenient tool to mine it regardless of how badly the tax administration landscape is scarred.”

These comments echo similar sentiments by the Taxpayers Protection Alliance (TPA), which wrote to Treasury April 29 also seeking the withdrawal of Revenue Ruling 2024-14. “Doing so would strengthen consumer protections against rogue enforcement, particularly through the passthrough exam unit” mentioned by NTU, the TPA said.

“The unit, emboldened by the economic substance doctrine and the partnership anti-abuse rule, has enabled the further weaponization of the agency through unconstrained enforcement,” TPA’s letter continued. “The unit can, and has, set aside the text of the tax code to favor interpretations of ‘intent’ in its action. This gives the agency undue discretion to reinterpret the law as it sees fit, regardless of what is actually written.”