Clint's Window: Rewriting Partnership Policies (12/17/96)

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	Uneasy Partnerships Clint's Window by Clint Stretch, Director Tax Legislative Affairs, Deloitte & Touche LLP Tuesday, December 17, 1996

Questions and more questions about the Joint Tax Committee inquiry.

Recently, the staff director of the Joint Committee on Taxation, Ken Kies, announced the Joint Tax Committee still is reviewing the new check-the-box rules that make it simpler for a business to set itself up as a partnership.

In a letter to practitioners, Kies solicited opinions on six issues that Kies and his staff are examining. Many tax professionals are worried about the Joint Committee staff investigation, because the proposed rules are popular and simpler than the old system, and practitioners want them to go through.

First, a bit of background information. Businesses can be set up in two basic ways: as a corporation or as a partnership. Both types are taxed differently. Corporate business income is taxed twice: first the corporation pays taxes on its business income and then the stockholders pay taxes on any dividends earned. Partnerships, though, only pay taxes on business income once.

Setting up as a business as a partnership can be tricky. To try to simplify the process, the Internal Revenue Service last May released proposed regulations -- the so-called "check-the-box" regulations -- to simplify and liberalize the current entity classification rules. These regulations would make it much easier for a business to classify itself as a partnership, a welcome development to many in the business community. The main idea was that, to classify your business as a partnership, all you had to do is check off a box on a form, instead of going through tons of red tape.

The final regulations are scheduled to take effect by the end of the year.

Since the check-the-box regulations promise simplification and easier tax planning, lots of folks are worried about anything that might derail them.

Let’s look at the questions Kies posed to see if we can figure out what he might be after. An interesting thought to keep in mind -- which one of these questions is most important to Kies and his staff? (If we knew, we’d be able to say what the committee actually is trying to achieve.)

Question 1: What might be the short-term and long-term effects on the corporate tax base?

If this is the most important question, then the Joint Committee’s staff is saying that it doesn’t want the IRS to do anything to make it harder to balance the budget. An investigation driven by concern about revenue could relegate the check-the-box regulations to the fate of AMT (Alternative Minimum Tax) reform and other proposed simplifications that never happened because they cost too much. When the Republicans were elected in 1994, many wanted to repeal the AMT. Ultimately, though, they were unable to push a repeal through because of its cost as well as the budget stalemate.

Question 2: Is this result [the short-term and long-term effects of the regulations] consistent with the current rules for taxing business income? Alternatively, does this result represent a logical step towards a different regime for taxing business income that is better?

The real question here is: Are the check-the-box regulations consistent with the present law rules, or do they represent a better scheme?

This question goes directly to the heart of the matter: Should we tax corporate income twice, first at the corporate level and then at the individual level? Under current tax law, the corporation pays tax on its income and the individual shareholder pays tax on any dividends. Is the Treasury Department moving in the direction of integrating the two schemes with these rules? If so, Congress will certainly want its share of the credit and will want to see that integration is achieved fairly.

Question 3: If the "check the box" regulations go into effect, should attention be given to modifying or repealing other statutory flow-through regimes, such as the one-level-of-tax regime for S corporations?

This question reflects an assumption that if the check-the-box regulations go into effect many businesses will switch to partnerships.

Fixing the various tax rules to accommodate the check-the-box regime, or to prevent abuse, implies this is an academic investigation. Is this inquiry then really a technical corrections or simplification project? (A simplification project is an attempt to simplify the tax code. A technical corrections project is an attempt to fix something in the law that is either a mistake, that produced unintended consequences, or that turned out to be more trouble for taxpayers than it’s worth. Theoretically, it is revenue-neutral, which means it costs the government less than $100 million.)

Question 4: Is there legal authority for making this change through regulations (as opposed to legislation)?

This is a legal question, a question about power. Does only Congress -- through the House Ways and Means and Senate Finance Committees -- have the right and power to make this kind of change to the tax system? Is the IRS exceeding its authority with the check-the-box regulations?

Question 5: What are the implications of this change for international competitiveness?

At face value, this question is hard to deal with. The committee may be more concerned about the effect of these regulations on multinational companies than domestic entities. Could the convoluted international tax rules, many of which depend on how businesses are set up, inadvertently be rewritten under check-the-box? Alternatively, this might simply be restating the integration question, as well as the other questions on tax reform and simplification, in the context of international taxes.

Question 6: What are the implications of this change for fundamental tax reform? For example, does this change suggest that a tax on all business operations, regardless of form, would become appropriate?

To me, this may be the most interesting question of the six. In one of his first post-election letters, Kies asks about the prospects for tax reform. Perhaps the staff of the Joint Committee on Taxation still is struggling to come up with a fundamental tax reform proposal or strategy for House Ways and Means Committee Chairman Bill Archer, R-Texas, and Senate Finance Committee Chairman Bill Roth, R-Del.

Is this investigation really a strategy to subvert the check-the-box regulations -- which have the support of the Clinton administration -- into a discussion of tax reform, which the administration has tried to avoid?

This question also resembles question 1. Both essentially ask who has the power and responsibility to attempt to simplify the tax system. The Internal Revenue Service, by issuing regulations, or Congress and its tax-writing committees, by changing the tax law?

It is little wonder that tax practitioners are having a hard time digesting this letter. Judging from Kies’s letter, the Joint Committee is investigating the level of future revenues, or the possibility of corporate integration, or the need for technical refinements to the partnership rules, or international competitiveness, or the allocation of power between the executive and legislative branches, or the outlook for fundamental tax reform.

The Joint Committee on Taxation staff either is up to different things, some of which are mutually exclusive, with these different questions, or is off on an investigation that the staff itself doesn’t understand. No matter what, as the comment that prompted this piece suggests, many people are uncomfortable with these questions.