IRS Proposes Tax Deduction Change for Partnerships that Deal with Related Entities

On November 24, The Internal Revenue Service (IRS) announced a set of proposed regulatory amendments intended to refine and modernize the tax code’s approach to transactions between partnerships and related entities. This proposal aims to align regulations, some of which date back to the 1950s, with legislative intent and ensure consistency with the statutory provisions.

Background

Currently, losses from transactions involving related parties, such as family members or specific business entities, are not deductible for taxpayers. A regulation from 1958 treats partnerships as a collective of individuals rather than a unified entity, meaning that deals made with external parties were treated as separate dealings with each partner, not with the partnership as a whole.

While these regulations were created to prevent people from making deals just to get tax benefits, they have inadvertently led to complex and often inequitable tax treatment. For example, if a business were to create an agreement with a partnership consisting of two individuals and had a familial or business connection to one of the partners, that partner would not be eligible to claim a tax deduction for any losses from the deal. The other partner, who is not related, would typically be able to claim such a deduction. However, if the related partner held a controlling interest in the partnership—more than 50%—then the partnership as a whole would be precluded from deducting any of the loss.

The Proposed Changes

The proposed changes would update the rules to reflect more recent legislative intent, which treats partnerships as single entities instead of aggregates of partners. This shift is in line with a series of bills from the 1980s that imposed further restrictions on transactions between partnerships and related individuals.

Under the new regulations, partnerships will be able to claim deductions for losses from transactions with related parties, provided these transactions comply with the broader tax code. This could result in partnerships being able to claim losses in situations where they currently cannot. This adjustment would streamline tax proceedings, treating partnerships similarly to individual taxpayers, thus simplifying the process and ensuring uniform application of the tax laws.

The proposed regulations would be applicable to tax years concluding after the date they are finalized.

The IRS is accepting public comments on these proposed changes through February 25, 2024. Reference IRS and REG–131756–11 if you would like to comment.

How Tonneson Can Help

The ultimate goal of these amendments is to simplify and modernize the tax code in a way that accurately represents legislative intentions and provides clarity and fairness to taxpayers. As the IRS moves toward finalizing these changes, partnerships and the people involved in them will need to closely monitor developments to understand how their tax positions and obligations may be affected. The tax experts at Tonneson help our clients navigate these and other changes by staying informed, providing strategic guidance, and ensuring compliance. Reach out to us today.