Wednesday, November 30, 2011
By their very nature, partnerships present problems for the U.S. tax system. Are they separate entities or just aggregates of their partners? It depends on the situation. Prior to 1982, the IRS had little choice but to audit the tax consequences of partnership activities by auditing each partner. Congress flipped that aggregate treatment on its head by enacting entity-focused partnership audit rules in the Tax Equity and Fiscal Responsibility Act of 1982. It’s time to flip them back.
Neither the practical problems that drove creation of the entity-focused partnership audit rules nor the tax policy rationales used to justify them retain strength today. Indeed, almost thirty years of experience with those rules has unearthed numerous negative consequences. Furthermore, improvements in the substantive law applicable to partnerships and in the technology available to the IRSce for use in auditing partnerships have significantly reduced the benefits derived from the current partnership audit rules. In short, their costs now outweigh their benefits and they should be repealed.