Time to Revoke the Partnership Anti-Abuse Regulation

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Copyright 2017 Monte A. Jackel, Alison L. Chen, and James M. Maynor Jr.
All rights reserved.

 

All M&A transactions that involve a partnership are governed by the statutes under Subchapter K of the Internal Revenue Code. Whether your transaction involves tax issues and structures such as tiered partnerships, reorganizations, FIRPTA withholding tax requirements, business interest expense limitations, or UPREITS, Subchapter K will apply. One of our M&A tax advisers, Monte Jackel, will argue that the subchapter K antiabuse regulation currently in place should be repealed. Aptly named, this regulation was created to combat perceived and real abuses of Subchapter K by crafty tax professionals. As Mr. Jackel will explain, these abuses have arisen in part because the rule relies upon yet-to be codified common law and the rulings that do exist remain sparse. Without clear guidance in the existing statutes, it can be difficult for taxpayers to understand how to approach tax structuring in a M&A transaction without running afoul of the IRS.

 

Note that this article is reprinted from the article first published in Tax Notes, Tax Analysts, Fairfax, VA, on January 29, 2018. See 2018 TNT 31-8. The article has not been updated since that publication.  Note that certain laws may have changed since the initial posting, and the analysis provided herein has not been updated for such changes.

1. Introduction

The partnership antiabuse rule in reg. section 1.701-2 has been in place for over two decades, during which time the government has used or asserted the application of the rule only when the common law doctrine of economic substance or related doctrines also would apply. Given the relatively sparse assertion of the rule by the government in both public guidance and case law — and the rule’s lack of independent utility when the common law doctrines would not apply — it is time to examine the merits of retaining the rule.

2. The Partnership Antiabuse Regulation

1. Background

The IRS and Treasury proposed reg. section 1.701-2, known as the “subpchapter K antiabuse rule,” on May 12, 1994.1 The notice of proposed rulemaking (NPRM) observed that the IRS and Treasury had become aware of an increasing number of transactions that attempted to use the partnership form in a manner inconsistent with the intent of subchapter K. The notice identified two broad types of these transactions: those that (1) try to use a partnership to circumvent other provisions or purport to create tax advantages inconsistent with the substance of the transaction, or (2) rely on the literal language of the tax rules to produce tax results that are inconsistent with those rules.

The NPRM stated that the partnership antiabuse regulation was intended to clarify the authority of the IRS to recast transactions that exploit and misuse the subchapter K provisions to avoid tax. The notice also made clear that the IRS and Treasury intended that partners and partnerships would remain subject to existing judicial doctrines such as the sham transaction doctrine.

The IRS and Treasury finalized the partnership antiabuse regulation on December 29, 1994.2 In the preamble to the final regulation, the IRS and Treasury largely reiterated the underlying rationale set forth in the NPRM and responded to comments received with respect to the proposed regulation. Commentators had addressed several aspects of the proposed regulation, including the relationship between the regulation and established judicial doctrines.

In response, the IRS and Treasury observed that although the antiabuse regulation was consistent with established legal doctrines, those doctrines would continue to apply to partnership-related transactions in tandem with the antiabuse regulation. The IRS and Treasury acknowledged the uncertainty regarding the scope of the regulation’s application but asserted that such uncertainty reflected the uncertainty that already existed in properly evaluating transactions under then-current law. Thus, the IRS and Treasury took the position that an additional layer of uncertainty should not impose any undue administrative burdens on taxpayers or the IRS.

In its final form, reg. section 1.701-2 comprises two parts: the “abuse-of-subchapter-K” rule and the “abuse-of-entity-treatment” rule.

2. The Abuse-of-Subchapter-K Rule

Under the abuse-of-subchapter-K rule, “if a partnership is formed or availed of in connection with a transaction a principal purpose of which is to reduce substantially the present value of the partners’ aggregate federal tax liability in a manner that is inconsistent with the intent of subchapter K,” the IRS can recast the transaction to achieve tax results consistent with the intent of subchapter K.3 So even if a partnership-related transaction meets the literal requirements of the statute or regulation at issue, the IRS has the authority to treat the transaction in a manner that the IRS determines will achieve tax results that are consistent with the intent of subchapter K.4

 

Reg. section 1.701-2(a) provides that the intent of subchapter K encompasses the following implicit requirements: (1) a partnership must be bona fide and each partnership transaction or series of related transactions must be entered into for a substantial business purpose; (2) the form of each partnership transaction must be respected under substance-over-form principles; and (3) the tax consequences for each partner must properly reflect income unless a different result is expressly contemplated by a specific statutory or regulatory provision.5

 

The abuse-of-subchapter-K rule is applied based on all surrounding facts and circumstances, including a comparison of the business purpose for a transaction and the resulting tax benefits.6 The regulations provide the following list of illustrative factors that may indicate, but not establish, that a partnership was used in a manner that conflicts with the rule:

 

  1. the present value of the partners’ aggregate federal tax liability is substantially less than had the partners owned the partnership’s assets and conducted the partnership’s activities directly;
  2. the present value of the partners’ aggregate federal tax liability is substantially less than would be the case if purportedly separate transactions that are designed to achieve a particular end result are integrated and treated as steps in a single transaction;
  3. one or more partners who are necessary to achieve the claimed tax results either have a nominal interest in the partnership, are substantially protected from any risk of loss from the partnership’s activities, or have little or no participation in the profits from the partnership’s activities other than a preferred return that is in the nature of a payment for the use of capital;
  4. substantially all the partners (measured by number or interests in the partnership) are directly or indirectly related to one another;
  5. partnership items are allocated in compliance with the literal language of reg. section 1.704-1 and -2 but with results that are inconsistent with the purpose of section 704(b) and those regulations;
  6. the benefits and burdens of ownership of property nominally contributed to the partnership are substantially retained directly or indirectly by the contributing partner or a related party; or
  7. the benefits and burdens of ownership of partnership property are substantially shifted directly or indirectly to the distributee partner before or after the property is actually distributed to the distributee partner or a related party.7

 

The partnership antiabuse regulation provides several examples to illustrate the application of the abuse-of-subchapter-K-rule.8 However, these examples do not purport to define the boundaries of permissible types of transactions.9 Moreover, the facts in the examples are necessarily simplified, and the partnership antiabuse regulation provides that the addition or deletion of any facts or circumstances may alter the analysis.10

3. The Abuse-of-Entity-Treatment Rule

Subchapter K is understood to reflect a hybrid approach between the aggregate and entity treatment of partnerships.11 Under a pure aggregate approach, partners would be considered co-owners of a partnership’s assets and each partner would separately account for his proportional share of partnership transactions.12 In contrast, under a pure entity approach, a partnership would be treated as a separate entity and the partners would be considered as owners of interests in the partnership.13

 

In recognition of these competing theories, the abuse-of-entity-treatment rule allows the IRS to treat a partnership as an aggregate of its partners (as opposed to a separate entity) as appropriate to carry out the purpose of any statutory or regulatory provision.14 However, the IRS has no such power under the partnership antiabuse regulation if a statutory or regulatory provision prescribes the treatment of a partnership as an entity and that treatment and the ultimate tax results are clearly contemplated by that provision.15 The regulations illustrate the rule though a series of examples that, again, do not purport to define the boundaries of permissible types of transactions and provide analysis limited to the simplified facts presented.16

3. Judicial Application of the Regulation

1. Overview

Despite the seemingly broad scope of the partnership antiabuse regulation and the fact that it was finalized more than 20 years ago, there are relatively few cases in which courts have analyzed the regulation. Nonetheless, this small sample of cases demonstrates the lack of independent utility that the regulation holds in practice.

On review of the reported cases that cite the partnership antiabuse regulation, it becomes clear that these cases — without exception — fall into two general categories. In the first, the court declines to consider whether the regulation applies because its holdings can be based exclusively on well-established common law doctrines. In the second, the court applies the partnership antiabuse regulation in tandem with common law and reaches the same conclusion under both approaches.

Emblematic of the first category is AD Investment 2000 Fund.17 In that case, the Tax Court faced a “son-of-BOSS” transaction in which a taxpayer used offsetting options in an attempt to obtain an artificially high basis in a partnership interest and then claim a significant tax loss from the disposition of that interest. The IRS asserted three bases for not treating the arrangements at issue as partnerships: the sham transaction doctrine, the economic substance doctrine, and the partnership antiabuse regulation. The taxpayer argued that the antiabuse regulation did not permit the IRS to disregard a partnership or, if it did, that the regulation was invalid. Citing cases applying the economic substance doctrine to similar facts, the Tax Court held that the arrangements would not be respected as partnerships for tax purposes. In so holding, the Tax Court noted that it did not have to address the taxpayer’s arguments directed at the partnership antiabuse regulation because there was a separate ground for reaching its conclusion (the common law economic substance doctrine).18

 

The Tax Court employed a similar analysis in Santa Monica Pictures.19 There, a taxpayer contributed high-basis, low-value receivables and stock in a financially distressed corporation to a partnership and sold the partnership interest a few weeks later in an attempt to generate a large tax loss. The IRS disallowed the purported loss — citing the economic substance doctrine, the step transaction doctrine, and the partnership antiabuse regulation — and the Tax Court held in favor of the IRS. Again, the Tax Court explicitly declined to apply the partnership antiabuse regulation because its decision could be grounded in other well-developed judicial doctrines.

 

The Tax Court and other courts in several cases have followed this method.20

 

Nevada Partners illustrates the second, smaller category of cases in which the courts applied the partnership antiabuse regulation in tandem with common law doctrines.21 Although the facts of Nevada Partners are complex, the taxpayer at issue used a “family office customized” transaction that was designed to allow the taxpayer to purchase losses embedded in a tiered-partnership structure to offset other large capital gains. In holding against the taxpayer, the district court cited the economic substance doctrine, the sham transaction doctrine, and the substance-over-form doctrine during its analysis, but appeared to rest its conclusion on the economic substance doctrine. The court then found that the IRS’s recasting of the transaction under the partnership antiabuse regulation was appropriate because of the lack of economic substance.22

The second category of cases also indicates that, when common law doctrines do not apply, neither does the partnership antiabuse regulation. For example, in Historic Boardwalk Hall,23 two parties entered into a partnership and allocated all the partnership’s historic rehabilitation tax credits to one partner. The IRS argued: first, that the partnership lacked economic substance because it was created for the express purpose of passing tax benefits from one partner to the other; and second, that the IRS had the authority to disregard the partnership under the partnership antiabuse regulation. The Tax Court rejected both arguments, and the IRS appealed the case to the Third Circuit. Interestingly, the IRS chose not to appeal the Tax Court’s holding regarding the antiabuse regulation. The IRS won the appeal based on economic substance, so the partnership antiabuse regulation was superfluous in any event.

In summary, based on our review of the reported cases citing the partnership antiabuse regulation since its promulgation, we are unaware of any reported case in which a court has based a holding solely on the regulation. See the appendix for a chart of the relevant reported cases.

 

2. Grecian Magnesite

In Grecian Magnesite,24 Tax Court Judge David Gustafson sided with the taxpayer in rejecting the aggregate approach set out in Rev. Rul. 91-32 for taxing foreign partners’ gains on the redemption of U.S. partnership interests.25 In so holding, the court expressly noted that the government had failed to raise the abuse-of-entity-treatment rule in the partnership antiabuse regulation to attack the transaction.

 

The facts of Grecian Magnesite are straightforward. The taxpayer was a foreign corporation that invested in a U.S. limited liability company (taxed as a partnership for U.S. income tax purposes) that was engaged in a trade or business in the United States. From the 2001-2008 tax years, the taxpayer received allocations of income from the partnership that the taxpayer reported on Form 1120-F as effectively connected income under sections 864, 865, and 882. In the 2008 tax year, the taxpayer exercised an option to put (sell) its interest back to the partnership. The taxpayer was redeemed out of the partnership with two payments, the last of which was agreed to be deemed received on the last day of 2008.

 

The Tax Court, through Gustafson, rejected the IRS’s reliance on Rev. Rul. 91-32, finding that the ruling was poorly reasoned and not entitled to deference. The Tax Court found that the ruling’s reliance on the congressional statement from the 1954 code that a partnership can be treated as an aggregate of its partners “as appropriate” for the code provision at issue was too general a statement to override the clear wording of sections 731(a) and 741, that a single indivisible capital asset was sold in the transaction. The court found that only when Congress has provided an express exception, such as under section 897(g)26 (or section 751), can a sale or exchange of a partnership interest be treated as a sale of the partnership’s underlying assets.

 

As noted, the IRS did not invoke the abuse-of-entity-treatment regulation. If the IRS had relied on the regulation,27 the Tax Court likely would have said that aggregate treatment was appropriate because the partnership itself was engaged in a U.S. trade or business, and thus the partners should be treated as so engaged for purposes of applying sections 864, 865, and 882. Then the taxpayer would have had to argue that entity treatment is clearly mandated by sections 731(a) and 741. However, the taxpayer would bear a heavy burden in establishing that the tax results of entity treatment were clearly contemplated, meaning Congress was aware that selling a partnership interest in which the partnership is engaged in a U.S. trade or business would result in the gain not being subject to U.S. tax.28 Would showing that section 897(g), for example, provides for an express exception be taken to mean that Congress was aware that in all other cases (except when the code provides otherwise, such as under section 453(i) or 751(a)) the gain would not be taxable? These types of questions were academic because the IRS failed to raise the regulation when it could have made a difference.

4. Observations

1. Questionable Validity

As evident from this summary of the case law, the partnership antiabuse regulation should be repealed because it has not been used effectively by the IRS — perhaps partly because of concerns about its validity. Although the government has never publicly expressed a view on the validity of the partnership antiabuse regulation, commentators have speculated that the failure of the IRS to assert the regulation when it could have changed the result in a case indicates a lack of confidence in the rule.29 The recent Grecian Magnesite case really brings this point home because it is entirely possible that the government could have won if the abuse-of-entity-treatment rule had been raised. We will just never know.

If the IRS is indeed concerned about the regulation’s validity, its continued existence is a disservice to both the government and taxpayers. On the one hand, the IRS should not be hamstrung in its ability to bring the full weight of its administrative regulations to bear in attacking what it perceives to be abusive transactions and structures. From a taxpayer’s perspective, however, the failure of the IRS to consistently assert the rule in judicial proceedings when it apparently would apply might lead to concerns over selective enforcement.

2. Sufficiency of Judicial Doctrines

There has been a proliferation of cases dealing with the economic substance doctrine over the years.30 The partnership antiabuse regulation is, thus, arguably unnecessary because the common law doctrines of economic substance, substance over form, sham transaction, and step transaction are sufficient to police the perceived abusive transactions. Despite the government’s failure to raise the partnership antiabuse regulation when the common law doctrines would not otherwise apply, the government has won most cases that have been litigated since the partnership antiabuse regulation was issued.31 It thus appears that the regulation is no longer needed.

 

Moreover, the codification of the economic substance doctrine in section 7701(o), with its conjunctive standard of business purpose and nontax effects, has arguably made the economic substance doctrine stronger than it was before the codification. This is because before codification several courts applied a disjunctive standard whereby either business purpose or nontax economic effects would have been sufficient to sustain the transaction. Although it is unclear when the economic substance doctrine is relevant within the meaning of the statute,32 the amended doctrine is clearly stronger than it was in its common law form when the partnership antiabuse regulation was issued two decades ago. The need for the partnership antiabuse regulation, assuming it ever existed, is arguably no longer relevant given the codification of the economic substance doctrine.

3. Obsolescence of Regulatory Examples

Several examples in the partnership antiabuse regulation are out of date, meaning that they no longer reflect current law.33 More specifically, the regulation provides 11 examples addressing the abuse-of-subchapter-K rule, three of which purport to illustrate the use of a partnership in a manner inconsistent with the intent of subchapter K.34 Since the issuance of the regulation, however, the anticipated tax consequences of two of these three “bad” examples have been altered by legislative amendments to subchapter K.35 Thus, only one example in the regulation illustrates a transaction that is impermissible under current law.

 

The obsolescence of the examples in the partnership antiabuse regulation creates additional uncertainty in the application of the tax law. Given the recent presidential executive orders regarding tax regulations and regulations generally,36 the complexity and burden that the antiabuse regulation creates because of its inherent ambiguity can no longer be justified by any in terrorem effect the rule may still have.

 

Also, there are many uncertainties in applying the codified economic substance doctrine under section 7701(o) to standard partnership transactions.37 Because of the uncertainty, the continued existence of the partnership antiabuse regulation only creates more unnecessary confusion, complexity, and burden to the tax law, contrary to the presidential executive orders on tax regulations.

5. Conclusion

What’s the verdict? It seems that the partnership antiabuse rule has outlived its usefulness. The regulation, when it was issued, had an in terrorem effect on partnership transactions. That is clearly no longer the case. And the codification of the economic substance doctrine has further strengthened that common law doctrine. Given the failure of the IRS over the past two decades to apply the rule when the common law doctrines would not have otherwise applied, now is the time to revoke the partnership antiabuse regulation and finally put it to rest.

 

Our M&A tax consultants at Leo Berwick have years of experience in advising partnerships on the tax strategy that best balances your business goals with the most efficient tax structure. Subchapter K is a challenging set of statutes, and in urgent need of tax reform, but our knowledgeable tax advisers are more than capable of navigating its murky waters.

 

As you approach the mergers and acquisitions process, keep in mind that the partnership antiabuse rule is not the only Subchapter K tax issue that you’ll confront. The tax-related traps associated with M&A transactions involving partnerships are numerous. Business owners and deal professionals will want to consult with one of our M&A tax advisers to conduct tax due diligence as early as possible to avert the possibility of falling into traps posed by the Internal Revenue code, such as Subchapter K and the antiabuse rule. Businesses considering purchasing, selling, or forming an UPREIT should consider REIT planning. If your M&A transaction involves a non-U.S. partner or other business entity similarly domiciled in a different country, there are a host of cross-border tax strategies that will need to be considered in order to best take advantage of international tax structuring. For example, you’ll want to take advantage of FIRPTA planning to avert falling for traps involving FIRPTA, such as the FIRPTA withholding requirements. There are a lot of pieces to consider when approaching partnership mergers and acquisitions, and our top-rate tax advisers at Leo Berwick here to help you make your M&A transaction as efficient as possible.

 

 

 

Appendix Reported Cases Citing the Partnership Antiabuse Regulation  (ordered by year of decision)
Case Court’s Application of Common Law Doctrines Court’s Application of Partnership Antiabuse Rule Validity of Partnership Antiabuse Rule Challenged by Taxpayer?
New Millennium Trading LLC v. CommissionerT.C. Memo. 2017-9 Government’s sham partnership argument accepted Not considered because case decided on common law doctrines Yes

 

AD Investment 2000 Fund LLC v. Commissioner, T.C. Memo. 2015-223, vacated, T.C. Memo. 2016-226 Government’s sham partnership and economic substance arguments accepted Not considered because case decided on common law doctrines Yes

 

Gail Vento LLC v. United States, 715 F.3d 455 (D.V.I. 2013), aff’d595 Fed. Appx. 170 (3d Cir. 2014), cert. denied, 135 S. Ct. 1910 (2015) Government’s assignment of income argument accepted Not considered because case decided on common law doctrines Not discussed in opinion

 

Historic Boardwalk Hall LLC v. Commissioner, 136 T.C. 1 (2011), rev’d, 694 F.3d 425 (3d Cir. 2012), reh’g denied, No. 11-1832 (D. Mass. 2012), cert. denied, 133 S. Ct. 2734 (2013) Government’s economic substance argument rejected by Tax Court but accepted by Third Circuit Rejected by Tax Court and not appealed to Third Circuit Not discussed in opinion
K2 Trading Ventures LLC v. United States101 Fed. Cl. 365 (2011) Government’s sham partnership argument accepted Not considered because case decided on common law doctrines Not discussed in opinion
Pritired 1 LLC v. United States, 816 F. Supp.2d 693 (S.D. Iowa 2011) Government’s economic substance argument accepted Accepted Not discussed in opinion
Nevada Partners Fund LLC v. United States, 714 F. Supp.2d 598 (S.D. Miss. 2010), aff’d in partrev’d in part, 720 F.3d 594 (5th Cir. 2013), vacated, 134 S. Ct. 903 (2014), remanded to 556 F. App’x 371 (5th Cir. 2014) Government’s economic substance argument accepted Accepted, but vacated on appeal Not discussed in opinion
Fidelity International Currency Advisor A Fund LLC v. United States, No. 4:05-cv-40151 (D. Mass. 2010) Government’s economic substance, sham partnership, and step transaction arguments accepted Accepted Not discussed in opinion
Southgate Master Fund v. United States, 651 F. Supp.2d 596 (N.D. Tex. 2009) Government’s economic substance, sham partnership, and substance over form arguments accepted Not considered because case decided on common law doctrines Yes

 

Palm Canyon X Investments LLC v. Commissioner, T.C. Memo. 2009-288 Government’s economic substance argument accepted Not considered because case decided on common law doctrines Yes

 

Countryside Limited Partnership v. Commissioner, T.C. Memo. 2008-3 Government’s economic substance argument rejected Rejected Not discussed in opinion
Santa Monica Pictures LLC v. Commissioner, T.C. Memo. 2005-104 Government’s economic substance and step transaction arguments accepted Not considered because case decided on common law doctrines Yes

 

aThis Appendix does not include cases that cite the rule in passing without analysis (such as Grecian Magnesite), in relation to procedural matters (for example, descriptions of notices of deficiency; evidentiary and jurisdictional matters), or in the context of motions for summary judgment.

 

 

FOOTNOTES

1 “Subchapter K Anti-Abuse Rule,” 59 F.R. 25581 (May 17, 1994).

2 T.D. 8588.

3 Reg. section 1.701-2(b).

4 Id.

5 Reg. section 1.701-2(a).

6 Reg. section 1.701-2(c).

7 Id.

8 See reg. section 1.701-2(d).

9 Reg. section 1.701-2(d).

10 Id.

11 See Laura E. Cunningham and Noël B. Cunningham, The Logic of Subchapter K: A Conceptual Guide to the Taxation of Partnerships (2016).

12 Id.

13 Id.

14 Reg. section 1.701-2(e).

15 Id.

16 See reg. section 1.701-2(f).

17 AD Investment 2000 Fund LLC v. Commissioner, T.C. Memo. 2015-223, vacatedT.C. Memo. 2016-226.

18 The common law economic substance doctrine is now codified in section 7701(o).

19 Santa Monica Pictures LLC v. CommissionerT.C. Memo. 2005-104.

20 See, e.g.Southgate Master Fund v. United States651 F. Supp.2d 596 (N.D. Tex. 2009) (“The Government cites the partnership anti-abuse regulation, reg. section 1.701-2, as additional support for disregarding the Southgate partnership as a sham. The parties agree the Court does not need to reach this regulation, which Plaintiff contends is inapplicable or invalid, if it finds the partnership lacked economic substance or is a sham under the judicial doctrines.”); Palm Canyon X Investors LLC v. CommissionerT.C. Memo. 2009-288 (“Because we decide petitioner’s case on other grounds, we need not decide whether the partnership antiabuse regulation is valid or whether it applies to the transaction in this case.”).

21 Nevada Partners Fund LLC v. United States714 F. Supp.2d 598 (S.D. Miss. 2010), aff’d in partrev’d in part720 F.3d 594 (5th Cir. 2013), vacated, 134 S. Ct. 903 (2014), remanded to 556 F. Appx 371 (5th Cir.). See also Pritired 1 LLC v. United States816 F. Supp.2d 693 (S.D. Iowa 2011) (transaction at issue lacked economic substance); Fidelity International Currency Advisor A Fund LLC v. United StatesNo. 4:05-cv-40151 (D. Mass. 2010) (partnerships were shams and lacked economic substance).

22 This was a curious finding. If a transaction were disregarded under the economic substance doctrine, there would not appear to be any need to recast it. Indeed, the Fifth Circuit vacated the district court’s alternative holding under reg. section 1.701-2 while affirming the holding based on the economic substance doctrine. See Nevada Partners Fund, 720 F.3d 594.

23 Historic Boardwalk Hall LLC v. Commissioner136 T.C. 1 (2011), rev’d694 F.3d 425 (3d Cir. 2012), reh’g deniedNo. 11-1832 (D. Mass. 2012), cert. denied, 133 S. Ct. 2734 (2013).

24 Grecian Magnesite Mining, Industrial & Shipping Co. v. Commissioner149 T.C. No. 3 (2017). An appeal of this case is pending in the D.C. Circuit. Also, recent legislation (formerly known as the Tax Cuts and Jobs Act) amended section 864(c) to add a new provision at section 864(c)(8) that will legislatively reverse the results of the case for dispositions of partnership interests occurring on or after November 27, 2017.

25 In Rev. Rul. 91-32, 1991-1 C.B. 107, the IRS took the position that when a partnership has a U.S. trade or business that is operated through a fixed place of business or permanent establishment in the United States, a foreign partner’s disposition of an interest in the partnership should be treated as a sale of partnership assets because the partner is deemed to be engaged in the business actually engaged in by the partnership and so is treated as disposing of the partner’s share of the underlying assets of the partnership in that case.

26 Section 897(g) was applied in this case to some extent.

27 Footnote 15 of the Tax Court’s opinion references the government’s failure to raise the regulation. Grecian Magnesite, 149 T.C. 3, at 44 n.15. The most likely reason for this failure is the concern that the regulation would be declared invalid. The government generally refuses to put regulations in play in such cases.

28 Apparently, the taxpayer would not have been able to rely on the fact that the partnership had historically engaged in substantial bona fide business activities. See reg. section 1.701-2(f), Example 1 (applying section 163(e)(5) to debt obligations issued by a partnership that for several years before the issuance had engaged in substantial bona fide business activities).

29 See William S. McKee et al., Federal Income Taxation of Partnerships and Partners, P1.05[1][c] (2007) (discussing the IRS’s failure to apply the regulation in Jade Trading LLC v. United States); id. P1.05[5] (expressing the general view of the tax community that the rule was an invalid exercise of regulatory authority).

30 PwC, “Summary of Economic Substance Case Law” (July 19, 2010); Monte A. Jackel, “Dawn of a New Era: Congress Codifies Economic Substance,” Tax Notes, Sept. 10, 2012, p. 1273.

31 See Jackel, supra note 30. See also Jackel, “For Better or For Worse: Codification of Economic Substance,” Tax Notes, May 24, 2004, p. 1069.

32 Section 7701(o)(1)(A), (B).

33 The tax consequences of examples 8 and 9 of reg. section 1.701-2(d) are affected by amendments to sections 734 and 743. The tax consequences of examples 10 and 11 of reg. section 1.701-2(d) are affected by amendments to section 732.

34 See reg. section 1.701-2(d), examples 7, 8, 11. The regulation also provides three examples to illustrate the application of the abuse-of-entity-treatment rule. See reg. section 1.701-2(f). These examples are also unhelpful because they are “obvious” applications of aggregate instead of entity treatment. See McKee et al., supra note 29, at P1.05[6].

35 Examples 8 and 11 are obsolete. See supra note 33.

36 See Executive Order 13789 (on tax regulations specifically); EO 13771 (on eliminating two regulations for every new regulation issued); EO 13777 (directing the formation of regulatory reform committees within each governmental agency).

37 See Jackel, “Subchapter K and the Codified Economic Substance Doctrine,” Tax Notes, July 19, 2010, p. 321.

END FOOTNOTES

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