IRS to Crack Down on Tax-Dodging Asset Shifts

What You Need to Know

IRS and Treasury will issue regs to curb basis shifting.
Sens. Warren and Van Hollen said the move could raise $50 billion in tax revenue in 10 years.
Basis shifting allows wealthy individuals and partnerships to transfer assets in a way that reduces their tax basis.

The Internal Revenue Service and Treasury Department have announced a forthcoming crackdown on “basis shifting,” a technique that allows for complex business partnerships to move assets from one entity to another to avoid taxes.

The IRS and Treasury Department announced in a just-released notice that they plan to publish two sets of proposed regulations that would address certain basis-shifting transactions, referred to as “covered transactions,” involving partnerships and related parties.

These transactions, according to Garrett Watson, senior policy analyst at the Tax Foundation, “in some cases can ‘shift’ the cost basis of an asset to another entity with tax liability, lowering taxable income and therefore tax liability.”

For instance, “an asset may be fully depreciated by one partnership, sold at cost to another, and the related entity could depreciate the asset again at a renewed tax basis,” Watson told ThinkAdvisor via email.

The IRS and Treasury are targeting the practice of “shifting assets around to numerous related ‘shell’ type entities with no business purpose other than as a receptacle to receive assets, inflate basis and in essence keep depreciating the same property over and over through these different entities, resulting in large deductions, with the ultimate goal of reducing taxable income,” IRA and tax expert Ed Slott of Ed Slott & Co., told ThinkAdvisor Tuesday in an email.

These practices, Watson continued, “have generally been understood as legal tax avoidance rather than evasion, but they may fall afoul of the ‘economic substance doctrine,’ a common law idea that otherwise legal tax strategies may be disallowed if they have no business purpose or economic rationale behind them.”

The tricky part: “where to draw the line in this doctrine, as some transactions may have an economic basis and be part of tax planning at the same time (just to name one example of a complication),” Watson maintained.

The IRS and Treasury “will have their hands full getting more information from businesses to identify when these practices are occurring and businesses will need to adjust their planning departments too, assuming this survives legal scrutiny (the IRS has wide berth as of now to promulgate rules of this sort),” Watson said.

‘Shell Games’

Treasury and IRS anticipate that the forthcoming Proposed Consolidated Return Regulations “would provide for single-entity treatment of members that are partners in a partnership, so that covered transactions cannot shift basis among group members and distort group income.”