S. 2095 — PARTNERSHIPS Act

This section establishes the short title of the Act as the “Preventing Abusive Routine Tax Nonsense Enabled by Rip-offs Shelters and Havens and Instead Promoting Simplicity Act” or the “PARTNERSHIPS Act”; specifies that amendments are made to the Internal Revenue Code of 1986; and sets forth the table of contents.

This section revises the rules under Section 704(b) for determining a partner's distributive share of partnership income, gain, loss, deduction, or credit. In general, such distributive shares are determined in accordance with the partner's interest in the partnership (considering all facts and circumstances) if the partnership agreement is silent or the allocation lacks substantial economic effect (as under prior law). The revision further requires any "covered partner" in a "covered partnership" to determine its distributive share of "applicable items" (i.e., any item of income, gain, deduction, loss, or credit) using the "consistent percentage method," under which (1) the partner's share of each applicable item bears the same ratio to the aggregate shares of all covered partners as the partner's "net equity" bears to the aggregate net equity of all covered partners, and (2) the partner receives the same percentage share of each applicable item. A covered partnership is one in which, at any time during the taxable year, (1) two or more members of a controlled group (under Section 267(f)) own 50% or more of the capital or profits interests, or (2) the partnership is specified by the Secretary in regulations to prevent avoidance; a covered partner includes controlled group members and certain other non-de minimis owners (or as specified by the Secretary). Net equity equals contributed equity (i.e., net value of contributions and assumed liabilities minus distributions and partnership-assumed liabilities, including from predecessors under Section 707(d)(1)(A)), adjusted for specified revaluation events. Covered partnerships must report their status and related information to the Secretary. This section also adds Section 707(d), under which a covered partner with an "excess share" in a covered partnership is treated as receiving a partnership interest in a non-partner capacity transaction, with the value includible in the partner's gross income and no deduction or loss allowed to the transferor. (Thus, the rules limit special allocations lacking substantial economic effect in controlled or specified partnerships, requiring pro rata allocations based on economic investment to curb tax avoidance.)

This section revises partnership allocation rules under IRC §704(c)(1)(A) for income, gain, loss, and deduction (including notional items) attributable to contributed property from any reasonable method to the remedial method prescribed by the Secretary, to fully account for the variation between the property's basis to the partnership and its fair market value at contribution. (As background, §704(c) addresses built-in gain or loss on contributed property by requiring special allocations that prevent shifting tax consequences among partners.) The amendment applies to property contributed after the date of enactment.

This section establishes new IRC §704(f) requiring partnerships to apply rules similar to the built-in gain and loss allocation rules of §704(c)(1)(A) and (C)—which generally require tax allocations to reflect differences between a property’s fair market value (book value) and tax basis—to any property held at the time of a revaluation event (i.e., a disproportionate non-de minimis contribution or distribution of money or property; non-de minimis grant of a partnership interest for services; issuance of a non-compensatory option for a non-de minimis interest; non-de minimis agreement to change partners’ sharing of income, gain, loss, deduction, or credit items; or other events prescribed by Treasury). The rules do not apply to revaluation events in a taxable year when the partnership satisfies the gross receipts test of §448(c) (generally, for entities with average annual gross receipts of $25 million or less, adjusted for inflation) unless the partnership elects otherwise; the rules also apply to lower-tier partnerships if an upper-tier partnership that owns more than 50% of its capital or profits interests experiences a revaluation event. (Thus, the provision prevents partners from shifting tax consequences arising from book-tax disparities created by common partnership “book-up” events.) The section makes conforming amendments to IRC §§168(h)(6), 514(c)(9)(E)(i), 613A(c)(7)(D), 743(b), and 897(k)(4)(C) to reference new §704(f) alongside §704(c). The amendments apply to revaluation events after the date of enactment.

This section repeals the 7-year time limitation on taxing precontribution gain for appreciated property contributed to a partnership—previously applicable to (1) distributions of other partnership property to the contributing partner and (2) distributions taken into account in determining a partner's net precontribution gain. (Thus, partners must now recognize such gain on qualifying distributions occurring any time after contribution.) The amendments apply to property contributed after the date of enactment.

This section repeals IRC §736, which classified liquidating payments to a retiring partner or a deceased partner's successor in interest as either guaranteed payments (ordinary income to recipient, deductible by partnership) or distributive shares (capital gain treatment). It treats such retired partners and successors as partners under subchapter K until complete liquidation of their interests (new IRC §761(d)) and makes conforming amendments to §§357(c), 731(d), 751(b), 753, and 691, including simplifying the §751(b)(2) exception for contributed property and replacing §753 with a cross-reference to income in respect of a decedent rules under §691. The changes apply to partners retiring or dying after enactment.

This section revises the rules under IRC §707(a)(2) governing when payments from a partnership to a partner for property or services are treated as occurring between the partnership and a non-partner by replacing the requirement for regulations prescribed by the Secretary with authority for the Secretary to provide exceptions. The revision applies to services performed or property transferred after the date of enactment and specifies that it creates no inference as to the treatment of prior transactions.

This section eliminates the preformation expenditure exception to the disguised sale rules under IRC §707(a)(2)(B) by requiring partnership-partner transfers to reimburse capital account expenditures (determined without regard to elections under the IRC) to be treated as part of a sale or exchange of property. (Thus, such reimbursements—previously excluded—may trigger taxable gain recognition for partners.) The amendment applies to property transferred after the date of enactment, except for transfers pursuant to a written binding contract in effect on the enactment date and at all times thereafter.

This section expands the partnership termination rule under Section 708(b)(1) of the Internal Revenue Code—under which a partnership terminates if 50% or more of the total interest in partnership capital and profits is sold or exchanged within a 12-month period—to include such sales or exchanges by historic partners or related persons (defined by reference to loss disallowance rules under Sections 267 and 707(b)), for taxable years beginning after enactment (from sales by current partners only). (As background, partnership termination ends the existing partnership for tax purposes, requiring a new partnership tax return and potential acceleration of tax liabilities for partners.) It further provides that the amendment creates no inference as to the treatment of related-party activities in prior taxable years.

This section eliminates the requirement that partnership inventory be substantially appreciated in value (i.e., fair market value at least 120% of adjusted basis) for disproportionate distributions to be treated as a sale or exchange under IRC §751(b)(1)(A)(ii). It also strikes the conforming definition in §751(b)(3). The amendments apply to distributions after enactment.

This section revises the allocation of partnership liabilities under Section 752 of the Internal Revenue Code by adding a new subsection (e) generally requiring liabilities to be allocated among partners according to their shares of partnership profits (instead of prior-law recourse and nonrecourse rules based on economic risk of loss), effective for taxable years beginning after December 31, 2025. The allocation rule does not apply to bona fide indebtedness of the partnership to a partner or related person (i.e., related if losses disallowed under §§267 or 707(b)) or to guarantees or similar arrangements, and directs the Secretary to issue related regulations. This section further permits a taxpayer recognizing gain from the new allocation rule in its first taxable year beginning after December 31, 2025 to elect to pay the resulting net tax liability increase (i.e., excess of net income tax for that year over net income tax computed without the gain inclusion) in six equal annual installments. (Thus, the provision provides transition relief for basis reductions triggered by reallocating liabilities away from prior disproportionate shares, with installment payments due on tax return due dates, acceleration upon specified events such as business cessation, proration of deficiencies, and special rules preserving overpayment credits and estimated tax treatment.)

This section revises partnership basis adjustment rules to make them generally mandatory—with exceptions for qualified small business partnerships (i.e., partnerships meeting the gross receipts test of IRC §448(c), as modified to include certain passive activities and excluding prior failures of the test or certain tax shelters)—and limits the optional §754 election to such partnerships. Specifically, with respect to transfers of partnership interests (IRC §743), it requires basis adjustments except for qualified small business partnerships lacking a §754 election and without a substantial built-in loss immediately after the transfer. (Thus, basis adjustments reflect the transferee's outside basis in partnership property, preventing income allocation mismatches.) With respect to distributions (IRC §734), it requires basis adjustments except for qualified small business partnerships lacking a §754 election or substantial basis reduction from the distribution, and it establishes a new general adjustment method preserving each remaining partner's net liquidation amount immediately before and after the distribution (accounting for certain prior adjustments). It also expands reporting requirements under §6050K and makes conforming amendments.

This section amends the net investment income tax (NIIT) under IRC §1411—currently a 3.8% tax on net investment income (e.g., interest, dividends, capital gains, and passive rental income) for individuals with modified adjusted gross income over $200,000 ($250,000 joint filers), estates, and trusts—to instead tax the greater of net investment income or specified net income for individuals whose modified adjusted gross income exceeds $400,000 ($500,000 joint or surviving spouse filers; $250,000 married filing separately) and for undistributed income of trusts and estates. (Specified net income includes trade or business income previously excluded from NIIT as active and not from financial trading or commodities; the additional tax above regular NIIT is phased in over excess modified adjusted gross income of $100,000 ($50,000 married filing separately).) The section further amends NIIT computation rules by (1) excluding self-employment income taxed under §1401(b), certain U.S. wages taxed under §§3101(b) or 3201(a), and foreign wages from foreign employers; (2) disallowing net operating losses under §172; (3) including amounts includible in gross income under §§951, 951A (GILTI), 1293, or 1296; and (4) directing the Secretary of the Treasury to issue regulations on previously taxed income (e.g., certain Subpart F or §962 distributions). The amendments apply to taxable years beginning after enactment, with transition rules for coordination of foreign income inclusions across taxable years.

This section revises the nonrecognition-of-gain rules under IRC §351 for transfers to corporations by (1) expanding the definition of stock in clause (vi) of §351(e)(1)(B) to include limited and preferred return interests and interests in entities holding such assets (subject to regulations) and (2) deeming transfers of marketable securities to registered investment companies, certain private funds exempt from registration under section 3(c)(7) of the Investment Company Act of 1940 (i.e., those offered to qualified purchasers), or entities allowing diversification of blocks of marketable securities with significant unrealized appreciation as transfers to investment companies. It amends IRC §721(b) to apply parallel rules to partnership transfers (i.e., nonrecognition unavailable if the partnership would qualify as an investment company or trigger §351(e)(3) if incorporated). The amendments apply to transfers after the date of enactment.

This section modifies the tax treatment of certain losses under IRC §165(g), including worthless securities and capital assets, to recognize losses at the time of the identifiable event establishing worthlessness (from the last day of the taxable year); extends such treatment to indebtedness by a partnership; treats abandonment as an identifiable event establishing worthlessness; and establishes a new rule treating a worthless partnership interest as a capital loss from its sale or exchange at the time of the identifiable event. (Thus, these changes allow taxpayers to claim capital losses earlier rather than deferring recognition to year-end.) The amendments apply to losses arising in taxable years beginning after the date of enactment.

This section codifies an anti-abuse rule as new IRC §701(b), authorizing the Secretary—under regulations—to recast, disregard, or otherwise modify a partnership transaction unless (1) the tax consequences to each partner and the partnership reflect the partners' economic agreement and clearly reflect income, (2) the form of the transaction is consistent with its substance, and (3) there is a substantial purpose (apart from federal income tax effects) for the transaction. The provision states that it creates no inference limiting the Secretary's existing authority to regulate such transactions.