In Monroe’s telling, Subchapter K is irredeemably complex. Complexity in tax law is nothing new, but what makes the complexity of Subchapter K such a problem is that the complexity pervades the law. Subchapter K’s complexity exits not only at its margins, but also at its core, as demonstrated by the partnership allocation rules found in section 704 and its notorious regulations. As a result, taxpayers are forced to improvise as they attempt to comply with the law. For the wealthiest taxpayers—the “elite partnerships,” in Monroe’s terminology—tax professionals guide the improvisation, usually leading to target allocations. For the rest of the taxpayers—the “forgotten partnerships”—the improvisation is essentially rudderless, stressful, and demeaning.
Monroe uses the label “forgotten partnerships” because these taxpayers are the ones that the tax experts—lawyers, lawmakers, and academics—tend to ignore when thinking about Subchapter K. Instead, Subchapter K has developed to serve the interests of the elite partnerships, rendering them the only ones who meaningfully participate in the tax law. Lawyers pursue elite partnerships as clients, lawmakers respond to the concerns of elite partnerships, and academics teach that the complexity of the law is a necessary evil—the solution to which is good partnership tax lawyers.
It is a self-perpetuating cycle—as the law is tweaked to address the needs of elite partnerships who can afford advisors to guide them through complex rules, it further pushes out to sea the forgotten partnerships who do not have those good partnership tax lawyers. Take the substantial economic effect safe harbor. Designed to streamline partnership allocations, it became hopelessly complex. Not even the elite partnerships try to comply with it, opting instead for the riskier target allocations method. Forgotten partnerships try their best to intuit the right approach and hope they are not audited. These forgotten partnerships are thus denied the ability to meaningfully participate in the tax law, eroding faith in the system.
This is a bleak state of affairs, but Monroe sees a way out. The forgotten partnerships must be recognized in discussions about the trajectory of Subchapter K, and the norm that the rules have to be complex must be challenged. These goals are not going to be actualized overnight, but important first steps are attainable. Tax experts should begin to ask how partnership tax provisions affect not only those able to afford professional advice, but also those who are not able to afford that advice. Doing so would open the door for a more inclusive partnership tax law.
More concretely, Monroe proposes that the allocation rules be reformed first by blessing target allocations and second by creating a simplified safe harbor for small partnerships (likely defined similarly to other parts of the Code defining small businesses, such as section 448). This bifurcated regime would begin to address the concerns of both elite partnerships and forgotten partnerships and pave the way for further reform.
Monroe’s detailing of the complexity and resulting vagueness of the partnership tax law is undoubtedly correct, but with that complexity and vagueness comes flexibility for taxpayers in structuring their businesses. Again: do what you want, just don’t screw the government. Monroe’s proposals seem more in line with the “do what you want” principle, in the sense that clarifying the law would make it possible for all types of partnerships to comfortably operate as they please as respected and dignified taxpayers, a luxury that forgotten partnerships do not currently have. (Though we might ask how different the elite partnerships are from the forgotten partnerships if no one is effectively able to take advantage of the substantial economic effect safe harbor designed for the elite partnerships. Monroe focuses on the attention given to elite partnerships and the resulting access to guidance as the distinguishing factor, which seems reasonable but muddies the range of forgotten partnerships a bit.)
However, another way to look at the state of affairs is that the government is not willing to give much ground on the “don’t screw us” front by carving out simpler safe harbors for taxpayers. In other words, the complexity norm is a veneer of sorts for a robust anti-abuse norm, or a reflection that the government does not have a direct say in the terms of the partnership agreement. The substantial economic effect rules are a case in point; the safe harbor is so difficult to enter that it is effectively meaningless, even for elite partnerships. From this perspective, Monroe’s proposals seem less of a fit. The government could lose a lot of flexibility by formalizing these safe harbors; why should it be expected to do so?
The answer, as I take it from Monroe’s piece, is that the cost of that government flexibility is the erosion of taxpayer morale, an erosion that disproportionately falls on the forgotten partnerships. A law that taxpayers have to intuit is no law at all, and the government must do better, even if some power is lost. It is a position difficult to argue with; in my future Partnership Taxation classes perhaps I’ll follow up my introductory comments with a new question for my future excellent partnership tax lawyers: who should bear the burden of this most difficult of tax exercises?