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IRS to Crack Down on Basis Shifting Transactions, Aiming to Recoup Billions

S.J. Steinhardt
Published Date:
Jun 17, 2024

The IRS announced that, along with the U.S. Department of the Treasury, it will enact rules to close a loophole that currently allows certain large businesses to depreciate the same asset repeatedly; the measure would add billions to tax collections, The Washington Post reported.

This loophole enables a strategy, known as basis shifting, in which complex businesses can move assets among different related entities, on paper, for no reason other than to avoid taxes. In these moves, “high-income taxpayers and corporations strip basis from assets they own where the basis is not generating tax benefits and then move the basis to assets they own where it will generate tax benefits without causing any meaningful change to the economics of their businesses,” the IRS said in a statement. "These basis shifting transactions allow closely related parties to avoid taxes."

“What you do is things like, you’ve depreciated the asset in one entity, so now the basis is zero,” said Mark Luscombe, a Wolters Kluwer tax lawyer who serves on the American Bar Association’s committee on partnerships, in an interview with the Post. “If you sold it, you’d have a big gain and you don’t have any more depreciation. You instead sell it to a related party so you can start the depreciation all over again.”

“These transactions don’t create any economic activity for the U.S.,” said Deputy Treasury Secretary Wally Adeyemo, the Post reported. “Their sole purpose is to reduce tax bills.” Shutting down inappropriate basis shifting can increase tax collections from partnerships by at least $5 billion a year over the next decade, he said.

The IRS and the Department of the Treasury issued three pieces of guidance focused on partnerships following discoveries by IRS audit teams. Currently, the IRS has tens of billions of dollars of deductions claimed in these transactions

The IRS created a new dedicated group in the Office of Chief Counsel specifically focused on developing guidance on partnerships, including closing loopholes. The office will work closely with a new pass-through work group being established in the IRS Large Business and International division that will be formally established this fall.

“It is possible that taxpayers believe their transactions meet the literal regulation,” an IRS official told the Post, speaking on the condition of anonymity to discuss the new rule before specific regulations are announced. “However, they do not have economic substance. We believe they are illegal under current law.”

During the 2010s, there was a 70 percent increase in filings by pass-through businesses with more than $10 million in assets, rising to nearly 300,000 in 2019, the IRS said in the statement.

“They’re the form of business of choice for most new businesses, including businesses that get quite large and very successful,” said Michael Sardar, a partner at Kostelanetz LLP who represents firms under IRS audit, in an interview with the Post. “It’s an area that has seen so much growth in terms of the value that’s sitting inside partnerships. People think of the big bad corporation; that’s maybe not the right character today. Because a lot of the money is in partnerships.”

“I don’t think it’s tax evasion at all,” Robert Kovacev, a lawyer at Miller & Chevalier who represents partnerships under audit, told the Post. “That has a fraudulent tinge to it that I don’t think exists here. It’s a tax planning tool that follows what Congress said you can do.”

The IRS on its own can’t stop basis shifting, Kovacev argued. “If Congress wanted to change the rules to prohibit basis shifting between related parties, they can do that, but it’s Congress’s job to do that,” he said.

But Luscombe told the Post that the IRS doesn’t need additional congressional authorization to crack down on many attempts at basis shifting because “these transactions are probably abusive” under the current system.

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