IRS Finds Insufficient Basis For Basis-Shifting Reporting Regs

Almost one year after signaling that it would scrap the controversial partnership basis reporting rules finalized by the prior administration, the IRS has now proposed regulations formally withdrawing them.

On March 5, the IRS and Treasury issued proposed regulations to formally withdraw the controversial partnership basis reporting regime finalized in the final days of the Biden administration. That regime would have 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.

The move to withdraw the basis-shifting regulations comes as no surprise. As previously covered in BrassTax, the IRS issued a notice in April of last year announcing its intention to withdraw the regulations and stating that no penalties would be imposed for failure to disclose such transactions. In the preamble to the proposed regulations, the IRS and Treasury reiterated and elaborated on the view set out in the April notice, echoing the tax bar’s criticism that the basis-shifting reporting regime would impose a serious and widespread compliance burden on taxpayers and material advisors, a burden the IRS and Treasury estimated to be approximately $163 million a year. The revocation would be retroactive to January 14, 2025, the date on which the final basis-shifting reporting rules went into effect, allowing taxpayers and their advisors to treat the rules “as never having taken effect.”

As with the April notice, the proposed regulations and their preamble address only the “transaction of interest” reporting regime and do not comment on the underlying legality of the transactions targeted by the reporting requirement. Although the IRS has moved to reduce the compliance burden associated with reporting, it has not abandoned the view, set out in Revenue Ruling 2024-14, that certain basis-shifting transactions lack economic substance.

Indeed, only a few days after the new proposed regulations were released, Kenneth Kies, Treasury Assistant Secretary for Tax Policy, reportedly told a U.S. Chamber of Commerce tax policy summit that the IRS and Treasury were actively pursuing basis-shifting partnership transactions that they believe violate the economic substance doctrine, citing a recent IRS win in the Tax Court in which the IRS successfully argued that a deduction should be disallowed following a basis adjustment in a related-party partnership that was alleged to lack economic substance. Accordingly, while taxpayers (and their advisors) can breathe a little easier under the lighter reporting requirements, they should be prepared if audited to demonstrate the business purpose and economic substance underlying partnership transactions that have the effect of shifting basis between related parties.

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