Free Reply to Response to Motion - District Court of Federal Claims - federal

Case 1:06-cv-00407-ECH

Document 122-6

Filed 08/21/2008

Page 1 of 36

./,JJ_

IRSA

241

APP-B-000086

Case 1:06-cv-00407-ECH

Document 122-6

Filed 08/21/2008

Page 2 of 36

Boston University
Boston, Massachusetts 02215 \_._-_ \

·

DUL

-TY

June

30,

1994

_J_'_''-

j';'lbu'SJ

.....

Internal

Revenue

Service

CC:DOM:CORP:T:R (PS-27-94) Room 5228 Post Office Box 7604 Ben Franklin Station Washington, Re: D.C. 20044 Notice of Public Rule --- Proposed Hearing Treasury (PS-27-94),

Proposed Subchapter Comments Regulation

Rulemaking and K Anti-Abuse

i Ladies

Section

1.701-2

and

Gentlemen:

I submit the following comments on Prop. Treas. Reg. S 1.701-2 proposed on May 12, 1994 to set partnership anti-abuse standards. This proposed regulation was discussed widely at the most recent meeting of the American Bar Association Tax Section in Washington where it was much criticized both as to its authority and its scope. I am commenting to try to put these issues in perspective in order to help define the approach to this regulation. The Department of the Treasury is an executive

administrative agency. It is specifically charged under Code § 7805(a) with interpreting the Internal Revenue Code: "[T]he Secretary shall prescribe all needful rules and regulations for the enforcement of this title, including all rules and regulations as may be necessary by reason of any alteration of the law in relation to internal revenue." The Supreme Court has recognized, as in the leading case of Chevron U.S.A,, Inc. v. Natural Resources Defense Counsel , Inc., 467 U.S. 837 (1984), the right of agencies to adopt reasonable interpretations of the statutes they administer provided the administrative constructions are not contrary to clear congressional intent.*

*The scope of Chevron and the deference to pay to administrative interpretations is the subject of both academic and judicial debate. See, e.q., Farina, Statutory Interpretation _nd the Balance o_ power in the Administrative State, 89 Colum. L. Rev. 452 (1989); Anthony, Which Agency Interpretations Should

d

IRSA

323

APP-B-000087

Case 1:06-cv-00407-ECH

Document 122-6

Filed 08/21/2008

Page 3 of 36

This delegation of authority does not require a general delegation in the specific code provision in addition to the general delegation of power under Code § 7805(a). Nonetheless, regulation adopted based on a general grant of rulemaking authority must follow the origin and purpose of the statute to constitute a reasonable interpretation to which the courts will defer. Se___ee National Muffler Dealers Association, Inc. v. United States, 440 U.S. 472, 476-77 (1979). The proposed partnership regulation raises a fundamental question of statutory interpretation. Under the approach of regulation drafting in the 1980's, particularly illustrated by the detailed partnership tax regulations under § 704(b) and the passive activity regulations under § 469, impact regulations other wereCode written with extreme specificity. Where on sections was anticipated, guidance was often not given unless a regulation was issued under that particular section. This extremely tight form of drafting has obscured the broader regulatory mandate of Treasury to provide general interpretations of the tax law and to use all methods of statutory interpretation J

a

purposive view of statutory one of legislative is purpose. interpretation discussed The the in including the fundamental classic book on the subject by F. Reed Dickerson, The Interpretation and Application of Statutes (1975). "[L]awyers tend to identify the immediate legislative purpose with ·legislative intent' and to reserve the term 'legislative purpose' for any broader or remote ("ulterior") legislative purpose." Id. at 88. In interpreting a statute, an agency or court looks both to the specific language of the statute and its internal context (the surrounding text of the statute) and its external context (the reasons that prompted the legislation, legislative history in committee reports and other documents, the broader purpose of the statute, and the general social, political, and legal tradition). As I view it, in proposing Treas. Reg. § 1.701-2 Treasury correctly fulfilling its congressional mandate to issue regulatory guidance that fills the interstices of the statute. It coordinates the context of Subchapter K with the Code as a whole. The issue is whether it is sufficiently certain in its methodology and scope. The proposed regulation affects a number of situations in which the admitted flexibility of Subchapter K creates unintended results through interaction with other Code sections or literal application of provisions in regulations. While not mentioning all reasons behind Subchapter K, Treasury correctly points out that Subchapter K was intended by Congress to provide flexibility is

Bind Citizens and v. Cardoza-Fonseca,

the Courts?, 47 Yale J. 480 U.S. 421 (1987). 2

on

Reg.

i

(1990);

IN__SS

IRSA

324

APP-B-000088

Case 1:06-cv-00407-ECH

Document 122-6

Filed 08/21/2008

Page 4 of 36

and a flow-through conduit entity for business taxation _ and does not attempt to limit the favorable structural provisions of Subchapter K with respect to such transactions as contributions, distributions, and special allocations. See Background to Prop. Treas. Reg. § 1.701-2; see also Prop. Treas. Reg. § 1.701-2(e), example 1. Nor does Treasury challenge specific elective provisions in Subchapter K even when the absence of an election creates discontinuities. Se___ee Prop. Treas. Reg. § 1.701-2(e), example 4. It views the provisions of Subchapter K as "not intended . . . to permit taxpayers either to structure transactions using partnerships to achieve tax results that are inconsistent with the underlying economic arrangements of the parties or the substance of the transactions, or to use the existence of the partnership to avoid the purposes of other provisions of the Internal Revenue Code." Prop. Treas. Reg. § 1.701-2(a). I have a forthcoming article in which I argue for the recognition of the benefits of flexibility in Subchapter K and the economic rationale for such flexibility. See Rebecca S. Rudnick, Enforcinq the Fundamental Premises of Subchapter K, 22 Hofstra Law Rev. _ (forthcoming 1994). Thus I applaud the Treasury's recognition that the benefits of Subchapter K's flexibility are intended by Congress. At the same time, I support the attempt to put Subchapter K in a broader context within the tax law and congressional mandates with respect to other Code sections, regulations, and policies and to harmonize results under regulations interpreting Subchapter K. 3 The proposed regulation should be amended to articulate scope precisely to give comfort as to the manner in which Treasury is following a purposive view of the statute and a its

2A major reason for Subchapter K was to codify rules for partnership taxation to clarify what had been an uncertain regime under administrative and judicial interpretations. See S. Rep. No. 1622, 83d Cong., 2d Sess. 89 (1954). The fact that certainty was a goal of Subchapter K does not eliminate the need to look to specific legislative intent with respect to particular Code provisions and the interaction of Subchapter K with other principles and specific sections of the tax law. For example, leading commentators adopt a sophisticated statutory interpretation analysis to submit that a service partner's profits interest is not taxable upon receipt based on the theory that under Subchapter K it is a nonrealization event. Se_ee William S. McKee, William F. Nelson & Robert L. Whitmire, Federal Income Taxation of Partners and Partnerships _ 5.02[i][b], at 513 to 5-14 (2d ed. 1990) & _ 5.02[1][c], at $5-2 to $5-9 (Cumulative Supp. No. 2 1991). _his assignment the family parallels Congress's coordination of gift and of income rules that occurred upon the enactment partnership rules in Code § 704(e). 3

of

·

: r, I.-_

IRSA

_25

APP-B-000089

Case 1:06-cv-00407-ECH

Document 122-6

Filed 08/21/2008

Page 5 of 36

principal purpose requirement. 4 Attributing a global intent to Subchapter K in Prop. Treas. Reg. § 1.701-2(a) as being "to permit taxpayers to conduct business for joint economic profit through a flexible arrangement that accurately reflects the partners' economic agreement without incurring an entity-level tax . · · ," rather than looking to the intent of each of its provisions, may be criticized as vague and may be less clearly grounded in the legislative history as a standard to adopt in regulation drafting. Moreover, examples, now lacking, should be provided of transactions to be caught by the anti-abuse rule, including these discussed below, in which the interaction of Subchapter K with another Code provision produces an unintended first is where the form of the transaction is inconsistent with the substance. result. Several An illustration categories of transactions is the recent come to mind. approach with The respect to the use of partnerships to convert dividends on preferred stock into deductible interest where the risk of the creditor is essentially the risk of an equity participant. 5 A second category is situations in which the flexibility inherent in Subchapter K enables potential inconsistencies within the system to be exploited. These include issues with respect to the combination of installment sales with allocations under Subchapter K. A third area is where the'characterization rules at the partnership level nullify a rule outside of Subchapter K. Examples include transactions such as the Brown Group case, avoiding the built-in gain rules under Code § 1374 through partnerships, and forming partnerships to avoid the limitations of Code S 163(e) (5). The latter two categories encompass transactions in which Congress, in my view, did not intend a specific prohibition to be avoided by using a conduit partnership entity either through an explicit directive within Subchapter K,

_

4The touchstone for the application is forming or availing of a partnership "in connection with a transaction or series or related transactions . wi£h a principal purpose of substantially reducing the present value of the partners' federal tax liability inconsistent with the intent of Subchapter K . . . ." (The standard also should include where it is inconsistent with the intent of another Code provision.) "Principal purpose" and "substantial" are not defined but reference to such standards in judicial opinions interpreting general language would fill the interstices. To the extent that Treasury adopts a regulation to coordinate Subchapter K with other Code provisions or to coordinate provisions within Subchapter K, it should be able to adopt a standard for that coordination. This is not the case of Treasury interposing its own additional standard to overlay a statutory provision that already has a specific and detailed standard for its application. Se___ee Braunstein v. Commissioner, 374 U.S. 65, 71 (1963). 5Se__ee Notice 94-48, 1994-19 I.R.B. 4 i0.

/

IRSA

326

APP-B-000090

Case 1:06-cv-00407-ECH

Document 122-6

Filed 08/21/2008

Page 6 of 36

such as authority to prescribe regulations under Code § 702(a) (7), the general legislative intent of the Subchapter K regime on which Treasury relies with respect to the application of aggregate rather than entity principles, 6 the legislative intent of special allocations to facilitate bona fide business transactions rather than tax avoidance, v or encompassed in the legislative intent behind the particular Code provision outside of Subchapter K. A fourth category is where specific regulations under Subchapter K when literally applied reach results inconsistent with the intent of the regulation as a whole, s Se___ee, e____q=., Prop. Treas. Reg. § 1.701-2(e), example 3. There the proposed regulation merely amplifies a standard already present within the statute, "substantial economic effect," and provides a regulations. catch-all 9 for regulatory ambiguity in already issued

_he specific language of H.R. Conf. Rep. No. 2543, 83d Cong., 2d Sess. 59 (1954) that Treasury states as Congress's indication "that aggregate, rather than entity, concepts should be applied if such concepts are more appropriate in applying other provisions of the Code . . . ," is as follows: "No inference is intended, however, that a partnership is to be considered as a separate entity for the purpose of applying other provisions of the internal revenue laws if the concept of the partnership as a collection of individuals is more appropriate for such provisions. An illustration of such a provision is section 543(a)(6), which treats income from the rental of property to shareholders as personal holding company income under certain conditions." Adoption of aggregate rather than entity approaches to interpreting events is the subject of both judicial opinion, se___ee Quick Trust v. Commissioner, 54 T.C. 1336 (1970), aff'd per curiam, 444 F.2d 90 (8th Cir. 1971), and academic discussion, se___ee Fellows, Partnership Taxation: Confusion in Section 702_b), 32 Tax L. Rev. 67, 88-97 (1976). _Se___ee _nfra note 8.

SAnd the intent of the regulation as a whole was drafted to implement the congressional intent of the statute as expressed in the legislative history. For example, with respect to special allocations, Treasury notes in the background to Prop. Treas. Reg. S 1.701-2, the rationale of Congress in amending the rules with respect to special allocations to "'prevent the use of special allocations for tax avoidance purposes, while allowing their use for bona fide business purposes.' S. Rep. No. 938, 94th Cong., 2d Sess. i00 (1976)."

within _fhis same approach Subchapter K such could beinter-relationship as the used to coordinate SS 704(b) and 704(e). 5

between Code provisions

,

.2

,,

IR3A

327

APP-B-000091

Case 1:06-cv-00407-ECH

Document 122-6

Filed 08/21/2008

Page 7 of 36

On the other hand, the abusive principle should not apply to t_actions in which the partnership vehicle is chosen as an or_amizational structure and the use of a partnership structure enables participation by investors who could not participate in anmt_er form of organizational structure. For example, consider a limited partnership in which a nonresident alien is a general or limited partner and a general partner is an S corporation. Cl_ly the nonresident alien could not be a member of the S corlsoration but the nonresident alien takes on a separate ecD_mic liability as a general partner or has more limited mamagement rights as a limited partner than as an S shareholder. Con_zess has a long history of providing multiple vehicles for _. and S corporations, bus/mess and investment and has often articulated formation--C corporations, that partnerships, of the choice ent/ity is intended to be flexible. Thus, the proposed regulation sh_d not apply to such transactions. Because Treasury already has T.he power to recast suspect transactions under Greqor_v. Hel_rinq, there should be an effort to offer more safe harbors for "areas of flexibility" that the Treasury does not intend to at-Z_n_k, lo The two most difficult categories to which apparently Tr_sury seeks to apply the regulation are the second and the t_ discussed above that encompass transactions wherein Tre=_sury asserts that Congress did not intend a specific prmhibition to be avoided by using a conduit partnership entity. Thesm categories are difficult due both to the specific language of T__e regulation and underlying questions of statutory intarpretation. I will first deal with the specific language of the _egulation and then the issue of statutory interpretation. This new Prop. Treas. Reg. § 1.701-2(a) is the first attempt at a generalized anti-abuse provision in Subchapter K and the onl_ place where the purpose of provisions generally applicable to a form of business organization are held by Treasury to create u_nded results in interaction with other Code provisions. Ne_T__er the application provision, Prop. Treas. Reg. § 1.7012(b), nor the facts and circumstances test, Prop. Treas. Reg. § 1.7DI-2(o) reference the purposes of another Code provision nor

i

1°In that regard, Treasury should also clarify the import of thm language in the background note and regulation as to the in_t of Subchapter K to allow persons "to conduct business for joi_ economic profit." Is it an operative standard in the i pux_mses of Subchapter K? And if intended as an operative regulation or merely a general statement as to one of the sta_zlard, is it an accurate requirement for all partnerships, in=l_ding investment partnerships?

I,

IRSA

328

I
APP-B-000092

Case 1:06-cv-00407-ECH

Document 122-6

Filed 08/21/2008

Page 8 of 36

are examples provided of unintended benefit Iz or of how the analysis under the Treasury regulation would be undertaken. The present proposal should be substantially augmented with reference to other Code sections, analysis and methodology and by examples to delineate the scope of the regulation to cure the present vagueness. The regulation will then give guidance to taxpayers, field agents, and the courts as to the reasonable manner in which Code provisions should be interpreted and will present a standard somewhat like an overriding standard of Greqory v. Helverinq or the tax benefit rule. On the one hand, Subchapter K itself could be said to be neutral with respect to the results obtained through it by application of other Code provisions. On the other I literal other Code that in combination language hand, provisions may have with provisionswith in specific been drafted Subchapter K causes results that are inconsistent with the intent of Congress in adopting that provision. To the extent that the an aggregate intent under Subchapter legislative rather than entity concept supports K if such an intent concepts are more to apply appropriate in applying other provisions of the Code n or the purpose of Congress to allow special allocations for bona fide purposes business for preventing but not for tax avoidance, a stronger basis exists inconsistencies in the application of another Code section in combination with one or more provisions the Subchapter regulation contrary proposed intends to impact upon results section. seemingly As in K absent intent in that other mandated by the literal language of other sections, it should reference the lack of congressional intent for the purpose of the other Code provisions to be avoided through partnership or a transaction or arrangement This is the same consideration that applies rule which is discussed below. Categories two and three applying the literal language the use partnerships. of a within under the tax benefit

I

I

I

I

I

raise the interpretative problem of the statute notwithstanding

of

I

hAs an illustration, Subchapter K in allowing

Example i deals with one level of taxation

the intent of in a limited

I

I

partnership deals consistentbenefit Example 2 as with a with the intent in of Subchapter provided another Code K. section, Code § 42, that is magnified by the use of a partnership to extend its benefits to multiple parties. It is presumed that entirely this extension of the benefit is consistent with the intent of Congress in providing the benefit but the example does not specifically reference that legislative intent. It merely benefit that "[t]he not derived low-income from the notes example should be amended to Code § 42. use of Thus, the housing the partnership." credit is a statutory reference congressional intent under

I

! |

-

nSee

supr_

note

6.

,

IRSA

_29

I
APP-B-000093

Case 1:06-cv-00407-ECH

Document 122-6

Filed 08/21/2008

Page 9 of 36

congressional intent. It would appear that cases such as Brown Grou_ or arrangements to avoid the literal application of Code sections such as § 1374 should result in a judicial finding that the inconsistent result was not intended by Congress under this form of analysis which looks to the intent of the other provisions in combination with Subchapter K and the proposed regulation merely announces that Treasury is applying this form of analysis. When Treasury attempts to use its reading of the generalized intent underlying Subchapter K to reach transactions that create seeming inconsistencies within the statute, it may go beyond a reasonable interpretation of the statute to the extent that it does not take into account the intent and legislative the rationale for allowing special allocations or the aggregate versus entity choice as a flexible congressionally sanctioned history of thoseof specific or more v. strongly interpretation Subchapterprovisions K. Se___ee, articulate e.u., Braunstein Commissioner, 374 U.S. 65, 71 (1963) (rejecting Commissioner's interpretation of collapsible corporation provision contrary to explicit language); United California Bank v. United States, 439 achieve evenhanded administration of our tax laws is to adhere closely to the language used by Congress to define taxpayers' responsibilities. Occasionally there will be the best way to clear U.S. 180, 211 (1978) ("I firmly believe that manifestations of contrary intent that justify a nonliteral reading . . .") (Justice Stevens, dissenting); Dobson v. Commissioner, 320 U.S. 489, 505-06 (1943) (provision dealing with bad debt recoveries because of absence of mention of recovery for other losses did not preclude finding that other loss recoveries were embraced by tax benefit rule). Categories two and three are not codifications of Gregory v. Helverinq as such absent clear articulation of the relationship of Subchapter K with the intent of another Code provision. No substance versus form premise of statutory interpretation underlies the authority of Treasury to deviate from the literal language of other Code provisions as they interact with the language of Subchapter K. After all, _reqory v. Helverinq interpreted literal provisions within one area of the Code, namely Subchapter C and implemented its overall policy. The leap to affect policies within other Code provisions must be undertaken with an analysis of those provisions and the extent that a flexible interpretation of aggregate and entity principles within Subchapter K (or with respect to characterization issues, in Code S 702(a)(7) and the regulations thereunder), allowance of special allocations for bona fide business purposes rather than a tax avoidance purpose, or implementation of other purposes of Subchapter K is grounded firmly in its legislative intent. To the extent that the regulation does this, it announces a reasonable method of interpretation in addition to the step transaction and substance over form analysis of current law that goes beyond literal language.

8

IRSA

3

APP-B-000094

Case 1:06-cv-00407-ECH

Document 122-6

Filed 08/21/2008

Page 10 of 36

A criticism of the proposed regulation is that it provides limited guidance and has an in terrorem effect because the fringes of the rule are unclear. The tax law is not merely a chess board in which highly technical combinations are mapped out and executed with infinite standards. The correct working of the tax system involves interpretation of legislative purpose in the calculation of a particular tax liability. That requirement is inherent in the system and is nowhere better illustrated than in the tax benefit rule. Under the tax benefit rule, and most specifically its articulation in Hillsboro National Bank v, Commissioner, 460 U.S. 370 (1983) where a subsequent event is fundamentally inconsistent with a prior deduction that produced a tax benefit, absent an applicable nonrecognition rule, a taxpayer is required to recognize income. In determining a fundamentally inconsistent event one must look to the premise of the previous deduction and the nature of the event, and necessarily to legislative history and congressional intent. Analysis of any tax benefit rule question involves a purposive look at legislative intent, and the scope of the rule is unclear at its margins. Thus, the proposed regulation should be applauded for bringing tax law back to its roots but should be fleshed out to substantiate the scope of and methodology for Treasury's purposive interpretation of the operation of Subchapter K in connection with other statutory provisions in order to provide a reasonable basis for upholding the regulation under the Chevron standard.

Very

truly

yours,

Rebecca S. Rudnick Visiting Associate Professor of Law

IRSA

331

APP-B-000095

+.

Case 1:06-cv-00407-ECH
-

Document 122-6
j

Filed 08/21/2008

Page 11 of 36

pNI.a_KLPNIA NI_W _.¢Am'* P_IMCCTON IBRt, J_I[ _. _ YOmK

CGUhSCLORS |800 H 5TRI[;I['r, O.¢.

$LT LAW N.W. 20036

W_MINOTON.

YCL£1_I_mlr (*_OZJ MORGAN, LEWIS 4_?-_POO0 K BOCKIU$ WAX q_l 4gY-?r'/41

SHCLDON S. COH£N
QIA. 9,a¢¢1 (ZOZ! 467-y_

January

4,

1995

The Honorable Leslie B. Samuels Assistant Secretary for Tax Policy
Depa_--_ment of the 1500 Pennsylva_nla Room 3120 Treasury Avenue, N.W.

Dear

Lee:
DC 20220 anti-abuse rules are very constructive. well I hope Archer and Packwood auree The partncrship you hazldled this

Washington, I think,

Have

a great

year. Best r_gards,

Sheldon

S. Cohen

|
t TgT_IL P.

I
i IRSA 532

APP-B-000096

Case 1:06-cv-00407-ECH

Document 122-6

Filed 08/21/2008
I

"

Page 12 of 36
"J / I /

_ : _

July

25,

1994

STATEMENT OF RICHARD G. COHEN NEW YORK, NEW YORK

My as Reporter

name for

is Richard American

Cohen. Law

From

1976 study

to

1984 of the

I served federal

the

Institute

income tax for changes in 1984;

treatment of partnerships. The ALI recommendations in partnership tax law were published in final form many The of those proposals expressed American have here Law to already been been

a great into law.

enacted I "_ support deter

views by the

have

neither

considered

nor

endorsed

the

Institute. today It Many the will of in usefully

I appreciate of the many proposed

opportunity

testify

anti-abuse

regulation.

abusive are of these

partnership marketed as

transactions. a way to avoid

these tax a limited can be

transactions consequences number large. of

normal Even if

large

corporate

transactions. place, the

transactions

take

revenue

loss

In the to curtail

past,

the

Internal

Revenue by

Service on

has

attempted law

tax-motivated or,

partnerships by seeking

relying the

common of

authority legislation partnership i wholly

alternatively, would

enactment abusive attack has

that

specifically Neither

discourage means of

transactions.

been

effective.

i

Specific

Legislatlon Enactment

is a Limited of legislation

and to

Temporary target many

Solution partnership partnerships,

specific abusive

ii

transactions,

while

effective

to deter

I
|
IRSA 535

APP-B-000097

Case 1:06-cv-00407-ECH

Document 122-6

Filed 08/21/2008

Page 13 of 36

is

a limited

and

Sisyphean

remedy,

requiring avoid Unless new the

constant legislation Service's under and law

renewal by power to

as

abusive mutating attack

partnership into

transactions guises.

different

questionable of to tax ask

partnership law

transactions the Service

general Treasury in a manner will

principles be forced

is enhanced, to than rewrite

Congress (rather thereby

existing covers the

abusive implicitly) increases complexity of

that

explicitly and and

transactions existing law

further

regulations. the -effectiveness of specific attacks is

Moreover, I questionable, · at

best

Writing new tax laws is a lengthy process. The prospective effective date of new legislation may give taxpayers time to take advantage of what soon may be a prohibited transaction. Delays in the legislative in a large and unjustified process may result loss of revenue. affect One of only the a

·

·

Legislative changes necessarily limited class of transactions.

great virtues of partnership tax law is its inherent flexibility. But that flexibility makes it impossible to adopt specific rules to prohibit all types of abusive partnership transactions. Anti-abuse i partnership · i · j area -low audit rate for partnerships means that rules are particularly useful in the

The

expertiseare to handle agents not able The complexity of

partnership to develop

matters. the necessary transactions can

partnership

making it difficult cloud the economic occurring.

to see substance that of

an abuse is a transaction,

|

IRSA

536

|
APP-B-000098

/

Case 1:06-cv-00407-ECH

Document 122-6

Filed 08/21/2008

Page 14 of 36

0

An

Important The

Alternative proposed anti-abuse action rule aimed which is presents at an important abusive by the to block

alternative transactions. existing Internal

to

legislative This law

specific

regulation, principles

amply

supported enhance

common Revenue

of taxation, to use

will that

Service's

ability

authority

abusive transactions. Adoption of these rules may need for further complex partnership legislation. Some uncertain tax suggest that the for proposed legitimate Service misuse of regulation partnership has

reduce

the

may

lead

to

consequences The Internal step

transactions. important The recent

Revenue to limit a team any the

already

taken

an

procedural announcement will to

this IRS by

regulation. national an office

that review

including action

representatives agent who seeks

proposed

individual

invoke the

anti-abuse "rogue" and should

regulation agent. be

should the adding and

adequately scope more those of

control this

feared can

Furthermore, clarified tax by abuse

regulation of

examples that do This

transactions

that

demonstrate

not. regulation offered the will permit practitioners partnership prepared to tax to advise

clients that

who

are

questionable Service are

strategies such

Treasury

and

challenge

transactions. While it may regulation will strike fear

be in

unrealistic the hearts

to assume of creative

that tax

this

g

planners, the regulation will, at the very least, conservative taxpayers to proceed with caution.

prompt

|
I -3l IRSA 537 X_j __zz.....e...._

|
APP-B-000099

Case 1:06-cv-00407-ECH

Document 122-6

Filed 08/21/2008

Page 15 of 36

Hon. Margaret M. Richardson Commissioner Internal Revenue Service I I 11 Constitution Avenue, NW Washington, D.C. 20224 Dear Commissioner Richardson:

I

I am writing to express my strong support for proposed regulation §1.701-2, the say partnership anti-abuse rule. Much of what I would has been expressed in the Report on the proposed regulation you have received from the New York State Bar Association and in the letter commenting on the regulations from Professor Joseph Bankman of the Stanford Law School, and I wish to express my agreement with the essential thrust of both comments. In particular, I agree with these commentators that the Treasury and the IRS have the legal authority to issue the proposed regulation. Some have objected to the proposed regulations by quoting Learned Hand to the effect that it is not sinister to arrange one's affairs to keep taxes as low as possible -- "nobody owes any public duty to pay more than the law demands." True enough, but it is entirely inappropriate to draw from this the suggestion the idea that the tax law amounts to no more than a set of rules entirely devoid of any plan or purpose. As Judge Hand put it in the Gregory opinion, "the meaning of a sentence may be more than that of the separate words, as a melody is more than the notes, and no degree of particularity can ever obviate recourse to the setting in which all appear" (Helvering v. Gregory, 69 F. 2d 809, 810-11 (2d Cir. 1934), aff'd 293 U.S. 465 (1935)). In any event, is worthwhile to examine in what way the regulation would change anyone's tax liability. Some suggest that it would not do so at all since the Internal Revenue Service already has ample authority under the common law doctrines of substance over form, sham transactions, clear reflection of income, and the like to require that taxpayers report income according to the economic substance of the transaction. If so, what would be gained by the regulation? Perhaps, it would mitigate the ability of taxpayers to avoid penalties by claiming they were following the literal language of the Code and had no notice this was not acceptable. It breeds disrespect for the law if taxpayers feel free to adopt positions which the), do not expect to prevail in the hope they will not be detected, or even if they arc, the only cog will be interest on the amount of tax otherwise due. Certainly an effort to minimize these opportunities should be applauded.

600 Nt'uJt'ruy

Avt'n_ NW W,z_ingto. f,MZlt_.pt_l

DC _k_v-zozz

IRSA

568

APP-B-000100

Case 1:06-cv-00407-ECH

Document 122-6

Filed 08/21/2008

Page 16 of 36

_: ,_ ,,

New York State Bar Association July, 26, 1994 Page 2

-

It may perhaps be true that the courts, which might not always be willing to insist on substance over form, would be more likely to do so in the presence of an anti-abuse regulation. If this is the case, the proposed regulation might change the result in particular cases. Again, this seems unobjectionable. It is eminently sensible and well within the IRS's power to make use of available doctrines to cause income tax consequences to be as consistent as possible with the underlying arrangement. The fact that a transaction might have a business purpose does not excuse a departure from this principle. But says the opposition, the scope of the regulation is unclear. It would be better and lead to less uncertainty if the IRS more specifically described those transactions which are objectionable. We need to be clear as to what is at stake here. If the IRS does not have the power to affect certain transactions, perhaps, because the results sought are consistent with the substance, then the regulations will not change the ultimate result. Nevertheless, it is argued taxpayers will be deterred by uncertainty from entering into legitimate transactions or will be subject to additional costs when issues are improperly raised on audit. The IRS has attempted to minimize these difficulties through the procedures set forth in Announcement 94-87. As the New York State Bar Association suggests, other steps along these lines are possible without adversely affecting the purpose of the regulation. Nevertheless, I acknowledge a certain amount of uncertainty and unwarranted challenge is unavoidable at least in the initial stages. However, this cannot be determinative. It is as the New York State Bar Association states, "inherently impossible to adopt specific rules that will prohibit all types of abusive partnership transactions." Those who claim otherwise are at best disingenuous. First, the Treasury and the IRS are frequently unaware of abusive transactions until they have been carried out for some time. Practitioners do their best to conceal their plans. Some who might be willing to inform the Treasury would be deterred by their duty of loyalty to their client. Second, specific ad hoe responses take time to devise, often are prospective only, and add clutter and complexity to the tax law. Finally, more specific rules will invite taxpayers and advisors to devise approaches that will dodge the specific inhibitions. This kind of gaming should be stopped if at all possible. Moreover, I believe the degree of uncertainty is overstated. Practitioners are undoubtedly aware when a transaction might appear to achieve a tax result inconsistent with its economic substance. In fact, it seems to me that at least some of the "legitimate" transactions which it is claimed should not be affected by the proposed regulations are raising concerns precisely because they may appear to achieve that kind of result.

! IRSA 569

APP-B-000101

Case 1:06-cv-00407-ECH

Document 122-6

Filed 08/21/2008

Page 17 of 36

New York State Bar Association July 26, 1994 Page 3 In these circumstances, I do not find it objectionable to place the burdenof uncertainty on those who seek this advantage. The integrity of the tax system is undermined when certain, mostly well-to-do, individuals and large corporations are able to manipulate their affairs to avoid taxes. It should not be troublesome, particularly in light of the real difficulties of attempting to directly target each abuse, to place some risk on those who seek dlis opportunity. If taxpayers really want to avoid such risk, they could disclose the proposed transactionsand seek private rulings or other forms of assurance that they will achieve the intended result. This is ail to the good. People should recognize the inconsistency, if not the downright hypocrisy, of the assertion that the desired result is "unassailable"but still we rather the IRS did not know about the transaction. Taxation is not a football game, but rather an effort to see to it thatall of us pay our fair share, no more and no less. I The proposed regulation moves us in this direction. The IRS and Treasury should be supported in these efforts. Sincerely,

I

Daniel Halperin

il | II
IRSA 570

|

APP-B-000102

Case 1:06-cv-00407-ECH

Document 122-6
° -

Filed 08/21/2008

Page 18 of 36

Sutherland,
7[L '_,Oau 8_-80o0 999

Asbill
PKACHTR£K 5TRKET.

& Brennan
N _

_Ax ,4=_ ssa-aaoe
N.JEi_OU3COHCN

ATLANTA. G[ORGtA aoaog-a99s

-_'snx NEw Yom_
_HINGTON

,_'J"L._T._

July

i,

1994

F

The Honorable Leslie Assistant Secretary, Room 3120 MT 1500 Pennsylvania Department of the

B. Samuels Tax Policy

Avenue, Treasury

N.W.

RE: Washington, Dear Les:

DC

Proposed 20220

Reg.

§ 1.701-2

I wanted to tell you that I am among the group that feels that the Treasury was not off the reservation in issuing Proposed Reg. § 1.701-2. I have had the experience of reviewing on behalf of clients some of the questionable partnership tax strategies that are being marketed and that probably prompted the regulation. While the strategies often have flaws, there is enough technical plausibility in some of them to lead some clients to believethat the implausible tax results can be achieved. Some of these schemes are coupled with opinions that merely describe the hoped for results, rather than opining on them. Thi_ scenario has a look which is very reminiscent of the tax shelter days. In advising clients in this area, it is comforting to be able to point to a proposed regulation that at prepared to challenge these transactions.

As I mentioned the very least indicates regulation does call for

to you, the broad phrasing of the that the Treasury and the Service are the addition of more examples when the

its parameters. I think that your recent ruling concerning the formation regulation of S finalized is corporation or a series partnerships, point of and rulings your statements outlining direction. The cry that should have been silenced concerning the Service the intention is continuing that to agents in Many the of field the the regulation would prevent UPREITS by your speeches and by the fact that of the regulation in to issue favorable are steps withthis rulings respect will apply the regulation also have in unwarranted complained

them.

regulation's

critics

IRSA

651

APP-B-000103

Case 1:06-cv-00407-ECH
s ?

Document 122-6
2"

Filed 08/21/2008

Page 19 of 36

The July Page

Honorable i, 2 1994

Leslie

B. Samuels

situations. Your decision to have all calls with respect to this regulation made out of the National Office -- at least for a time -- should help with this problem and should be much appreciated by the Tax Bar. Best regards. Sincerely,

N.J__ohen NJC:jkp

IRSA

652

APP-B-000104

Case 1:06-cv-00407-ECH

Document 122-6

Filed 08/21/2008

Page 20 of 36 COPY YOUR FOR

:
FABER ABUSE ADVISES RULE. ' TREASURY TO 'STICK TO YOUR GUNS' ON 'SUBCHAPTER

INFORMATIOH
K ANTI-

June Mr. David L. Jordan Acting Chief Counsel Room 3026 Internal Revenue Service 1111 Constitution Avenue, Washington, DC 20224

1,

1994

NW

Dave: Stick to your guns on the proposed regulations under section 701. Transactions in which partnerships are formed for no business purpose but for use solely as a means of shiftinq basis so as to avoida_ on otherwise taxable._ales have become the tax shelters of the 1990s_._--s_u_'not-betolerated. I think that you will find support your approach. The legitimate concerns that have been that responsible and professional expressed by some practitioners practitioners can be addressed associations by including will examples of transactions that will not be challenged. Sincerely, Peter L. Faber Kaye, Scholer, Handler New York, N.Y. cc: Hon. Margaret M. Richardson

Dear

l

Fierman,

Hays

&

Electronic Microfiche

Citation: 94 TNT 111-44 Number: Doc 94-5441

IRSA

654

I
APP-B-000105

Case 1:06-cv-00407-ECH

Document 122-6

Filed 08/21/2008

Page 21 of 36

APP-B-000106

Case 1:06-cv-00407-ECH

Document 122-6

Filed 08/21/2008

Page 22 of 36

APP-B-000107

Case 1:06-cv-00407-ECH

Document 122-6

Filed 08/21/2008

Page 23 of 36

SO/_O"d

_OSS_TS_O_

±_:0_

900_-80-AUW

APP-B-000108

Case 1:06-cv-00407-ECH

Document 122-6

Filed 08/21/2008

Page 24 of 36

APP-B-000109

Case 1:06-cv-00407-ECH
t,

Document 122-6

Filed 08/21/2008

Page 25 of 36

INTERNAL

REVENUE

CODE OF 1954

J_T 26, 1954,_Ordered tobeprinted

Mr. REaD of New York,from the committee of conference, submitted the following

CONFERENCE REPORT
[To accompany H. R. 8,300]

The committee of conference on the disagreeing votes of the two Houses on the amendments of the Senate to the bill (H. R. 8300) to revise the internal revenue laws of the Urdted States, having met after full and free conference, have agreed to recommend and do recommend to their respective Houses as follows: Thnt the Senate recede from its amendments numbered 7, lOa, 12 (4), 41a, 41b, 57a, 67a, 74a, ll0a, 129a, 141a, 154, 155, 178, 179, 180, 185a, 220a, 271b, 273a, 281a, 418a, 485a, 486 (1), 48G (2), 486 (3), 494, aTld551. Thnt the House recede from itsdisagreement o the amendments t oftheSenatenumbered I (I), (2), (I), 1 2 4,5,_,8, 9, 11, 12 (1), 12 (2), 12 (3), 12 (5), 13, 14, 15, 16, 17 (2), 18, 19, 20, 21, 22, 23 (I), (2), 23 (4), 24, 25, 26, 27, 28, 29, 31, 33, 34, 34a, 35, 36, 23 37, 38, 39, 40, 41, 42, 44, 46, 47, 48, 49j 51, 52, 53, 54, 55, 56, 58, 59, 60, f_l, 61a, 62, 63, 64_ 65, 66, 67, 67b, 68 (1); 68 (4), 69,70, 71, 72, 73 (2), 74,75, 76, 76a, 77, 78, 80,81, 84, 85 (1), 86, 87, 881 89, 90, l}l, 92, 93 (2), 94, 95, 96 (1), 97, 98, 100, 102 (2), 102a, 103, 105, lOSe, lOG, 107, 108, 110, 111, 112, 113, 114, 115, 116, 117, 118, 119, 120, 121, 122, 123, 124, 125, 126, 127, 128,129, 130, 131,132, 133, 134, 135, 13{},137, 138, 139, 140, 141,142, 143, 144, 145, 146, 147, 148, 149, 150,151,152,153,156 (1), 150 (2), 157, 1'58, 159, 100, 101,102, 163 (t), lo3 (3), 103 (4), 104,,165 (1), 166, 167, 168, 169, 170, 171, 172, 173, 174, 175, 176, 181, 182, 183, 184,, 185, 186 (2), 187, 188,, 189, 190, 191, 192, 193,194, 195, 190, 1{}7,198, 199, 200, 201,202, 203, 20'4, 205, 206,207, 208, 209, 210; 211, 212.213, 214; 215, 216, 217,, 218, 219, 220 (1), 220 (2), 220 (3), 220 (4), 221, 222, 223, 224, 225, 22(}, 227 (2), 228, 229, 230, 231, 232, 232a, 232b, 233, 234, ,235, 23{},237, 238, 239, 240, 241,242, 244, 245,, 247, 248, _t9, _50, 251, 252, 253_ 253a, 254, 255, 256, 257, 260, 261, 262, 264, 265, 266, 2{}7, 268, 269, 270, 271,272, IO 481",--._41._1

L9L_'°N

A_VNSII _00 Sn

_d_'_

900_ '_ '4_

APP-B-000110

Case 1:06-cv-00407-ECH

Document 122-6

Filed 08/21/2008

Page 26 of 36

INTERNAL

REVENUE

CODE

OF

19 5 4

_9

than that ofall prin_pal artnersf business its p ia purpose established is therefor. . , . , tiousc pmwslon weated sales_of property between a partn.e_:p and a partner naym _ an mteres.t of 50 per_nt or more as a contribution to, and a distribution from, the partne_rahip so that no gain or loss was recogmzed. In heu of the tIouse rule_, the Senate amendment a,nli_ to partnerships the rule_ Osed.in the case of similar transactio_s_t)e: tween corporations and controlling shareholdem A deduction f_r ]ossc_,is.disal_lowed if the _artner _ an "rater_eat' the partnershi_l_ in ol mo_o man ov percent. Capitol gain on the sale of depreciable property is recognized unless the partner has a partnershiu interest _¢ _norcthan 80 percent, in which case the gain is to constitute ordinary
lI1C01no,

Both the House p.rovisions and the Senate amendment provide for the use of the "entity" approach m. the treatment of the transactions l_tween a partner and a partner_htp which are described above. No inference is intended, however, that a partnershiu is to be con. stdcrcd as a separate entity for the purpose of applying other provisions of the internal revenue laws if the concept of the partnership as a collection el' individuals is.more appropriate for such provisions. An illustration of such a prowsmn is section 543 (a) (6), which treats iucomo from the rental of property ,t?.shareholders as personal holding company raceme under certain conditions, (e!, Dislr_rut_ons (sees. 781-735).--The House bill provided that in the case of distributions, whether or not in complete liquidation of a partner's interest, the distributed property was in general to have a bnsis to the distributee equal to its basis to the partnershln and that gain or loss was to be recognized on the difference between' the basis of the distributed property and that of the distributee's partnership interest. The Senate amendment retains the use of the carryover basts for nonliquidating distributions, but provides in the case of liqu!dat;ing distributions _at_the distr!butee's basis for the property reee_ve_ _s to be equal to the basis of hm partnership interest less any money received.. The basis of inventor_ items and "unrealized receivables, however, is limited to the bas_s for such property to the partnershi_ in the case of both liquidating and non]iquidating distributions. __nere the partner receives a basis for the proper_y differing _ron}its basis to the partnership, the partnership is perm_ttedto adjust me Dasis of its assets to reflect this difference. (]) Payments to a retiring l_rtner or vte._esso_,ol a deceased _artner (see. 786).--Under both the x_ouse bill and the _enate amendment, payment_ made by a partnership to a retiring 2.artner or a successor of a deceased partner in excess of the value of his capital interest are treated as income to the recipient and a deduction to the remaining partners. The recipient retired partner, estate, or _uccessor is to be treated in the same manner as a partner and, consequently, the payments, deternnned w_th respect _ a partnership taxable year, are to be treated as income to the recipient for his taxable year with,or within, which such'partnership year ends, Under the House bill, however, the treatment described above for payments other than for a capital interest was to apply only to _ayments received within 5 years after death or retirement. If received after this period, they were treated as a gift by the remaining partners

L 'd

LgL_'°N

A_V_811tOO S_

_d_'_

900_ '_ '4_

APP-B-000111

Case 1:06-cv-00407-ECH

Document 122-6

Filed 08/21/2008

Page 27 of 36

UnionCalendar No,1635
88D (_ONCSSeS_. f,dS_seton [ SENATE I R_voaT1No. 1622

INTERNAL REVENUE CODE OF 1954
-----

REPORT
OF THE

COMMITTEE
UNITED

ON FINANCE
SENATE

STATES
TO ACCOMPAHY

H. R. 8300
A BILL TO REVJ.;'._._ HE INTERlqAL'REVENUE T OF 'k,:'!E UNITED STATES LAWS

Jt_$18,
,

1954._0{dered
"-'-'T

to be printed

UNITEDSTATES,
GOVERN_IENT PRINTING OFFIOJ$ WASHINGTON t 19_4

'd

LgL_'°N

A_V_ll

POQ$n

_d_'_

900_ '_ '_

APP-B-000112

Case 1:06-cv-00407-ECH

Document 122-6

Filed 08/21/2008

Page 28 of 36

INTI4RNAI_

nEVENUI_

CODE

OF

1054

89

Under section 72 in a joint and survivor annuity_ an exclusion ra_o will be determi.ncd which will indicate the. average interest earhln_ over tlm combinBd hves of the two annmtants. ' ' The survivor will continue use this to exclusion ratio although.somewhatess.intdrest l than this will ea_edlin theloftier be yearswhileshe isrecmving axt annuityand more interes_ than thiswill earned the early b_ in y_£rs whilethey are both receivinghe_jolnt t annuity..The provj_slons contahmd in subparagraph ((2) in both paragraphs (1) and (2) of subseet, ion (e) of seotion 091 are designed to l)rovido a deduction to the survivor based upon tho estate tax attributable to a porti6n of tim survivor annuity whichrepresent8 theexcess'interest while earnc_l the annuitywas beingreceived jointly. This is, effect, in income in respectfa decedent.Thisdeductionill o w bespread ratably overthe lifexpect0a_cy o ofthosurvivor. XXIII. PAn_Z_s AND PAR'rt_RSIHPS

Tim existing tr/_tment'of tax partn'@sndpar_nershlps samong a i themost confused intheentire ncometaxfield. i The present statu-' toryprovisions wh'olly nadcqimf,& 'are i The published rb_ulations, ruh'ngs, courtdecisions and areincorn'pl_te fr_quefitly and con!,radictory. As a r_sult artnerstoday p ' cannotform,opBrkto, dmsol#e #r a partnership withany assurance to taxco'nsequences. as This confusion isparticularl3r urifortunate visw of the gre'at in number ofbusiness enterprises #enturesarriedn inp_irtnersllip and c 6 form, Itsliould be notedthattheI_artnerslnp ofo_ga/fizaalso fbrm fiouismuch more c0mmonly employed by smalIbuPinesses in and farming operat.ldns the, than corporate0rm'. f Bec0,use ofthovital eddfdrcIi_rifi'catidn'_ and ybtlr omn thd'H0use c mitteehays undertaken the first comprehensivetatutoi:y" s tre£tmctit' of partners-and partnerships tho,_ist_ix. in 6f "the income tax laws. In establishing a br'o0ki pattern appl!cab)e partnerships to gefierally, the prmclpal'ob]ectives been mmplieity, have flexibility, equity and as betweenthe'_artne_. . . In general, propgsed ths statut0_ treatment retain's existing the scheme of regarding partuership merelyan income-reiSbrfing t_o as , and not a taxablB, entity.Ihx addition,stattitory_ a p_ttem'has been established contributions a partne_hip, i_trlb'utionsa for to d by psrtn_rslfip, tr'ansfers ofpartnership interests solo on thedeath by or of a partner,erminationf partnei_hipaxabh years, t o t tratisactions betweena partner and thepartnership',thetreatment and ofpayments to a retiring partner a deceased or partner's estate heir. or .. ,4. Determin_zt_t_ o.fTaz L{ab_Kly (se, s. 701-708) (1) Hour,¢Imna,_ accepts3_ coram_#_, (_) Income oJ ioartner#.--Onder the House. and your committ_e's bill," as und6r present lay), _partners will be liable tndivld_tally, for incomb tax on their distriI_utivo shares of' partnership Income, The partngrshi p will q_t as a mere _nduit' as, tb"iheomd arid."lore items, transferri_ s_tch tbmsdire'ot.ly _ totheiti_li_dual pKrt&e_s.. . L . The items r_/_ired to"bo sA_76ga WiU #o_in '_oir on gio _ ted c,haradter in 'the Bands 'of tho'psffn_,/1% '¢h6'ugli' .th6y We_e' r_._ directly l_ini by _f/_m.ile' t skinssdii_e 'frOmwhIBli, r_MlZ_(iy'tli_ b partne_hii) and in tho sam6'niknner; After" exclt_di_: the ]texii

§ 'd

L9L_'°N

A_V_811COQS_

_d_:_

900g '_ '_

APP-B-000113

Case 1:06-cv-00407-ECH

Document 122-6

Filed 08/21/2008

Page 29 of 36

INTERNAL REVENUE CODE OF 1954

REPORT
OF THB

COMMITTEE
HOUSE OF

ON WAYS

AND MEANS

REPRESENTATIVES
TO A_OMPAN_

H. R. 8800
A BILL TO REVISE THE INTERNAL REVENUE LAWS OF THE UNITED STATES

1PIAnc_9, 19_.--Commltted to the Committee of the Whole House on the State of the Unton and ordered to be printed

UNITED STATFJ GOVERNME_-NT PRINTING OFFIOE 44140 ° WA_blING_0N ! 19_4

APP-B-000114

Case 1:06-cv-00407-ECH

Document 122-6

Filed 08/21/2008

Page 30 of 36

INTER.N'AL

REVENUE

CODE

OF

1954

65

eligible. This treatment is extended to that part of the value of a survivor's annuity included in the estate-tax base of the decedent annuitant which represents the interest accumulation for the survivor annuity since heannuity'a t purc.l_...his treatment also extended T is to thevalueof unexercmed"restricted stockoptions" included n the i gross estate fthe decedent o employeeand topai_rrnents deceased toa partner a partnershiphich are includible the income of the by w m estate beneficiary the deceasedpartner. This treatmentis or of provided forthese new formsofincomeasa partofyour committee's policy ofproviding thatall property orproperty rights ncludedn a i i decedent's gross estate for es.tate-tax purposes either receive _ new basis at the date of his death or, if subsequently to be reported as income when that event occurs receive a decluction for the estate tax paid in the decedent's estate attributable to such property.
_II, PARTNERS AND PARTNERSHIPS

tiThe existing treatment tax ofpartners and partnerships isamong xemost confused theentirencometaxfield.The present in i statu. toryprovisions wholly inadequate. are The published regulations '' ' ' '' r ulln gst and court decmmns are mcomplete and frequently contradtctory. As a result partners today cannot form, operate, or dissolve a psrtnc_'ship with any assurance as to tax consequences. This confusion is particularly un/ortunate in view of tlle great number of business enterprises and ventures carried on in partnership form. It should also be noted that the partnershil) form of organization is much more commonly employed by smelt busiuesses and in farmiug operations titan the corporate form. Because of the vital need for clarification, your committee has undertaken tlxe first comprehensive statutory treatment of partners and poxtnel_hips in the history of the income tax laws. In establishing a broad patternapplicabl_ o partnerships t generally, the principal objectives have been simplicity, flexibility, equity us and between the partners. . . In general, the proposed statutory treatment retains the exmLing scheme of regarding the partnership as merely an income-reporting_ and not a taxable, entity. Inaddition,statutoryattern a p hasbeen established contributions a partnership, for to distribution a by partnership, transfers ofpartnerslitp interests sale on thedeath by or of a partner, ermination :_ t o partnership taxable years, transactions betweena partner and thepartnership, thetreatment and ofpayments to a retiring partneror a deceased partner'sstate herr. e or A. General rules (sees. 701-707) (1) Income o] partners.--Under your committee's bill. as under present law, partners will be liable individually for incovao tax on their distributive shares of partnership income. The bill provides that the partnership will act as a mere condu!t as to income and loss items, transferring such items directly to the individual partner.. The items required to be segregated will retain their original character in thehands of the partner as though they were realized directly by him from the same source from which reahzed b$ the partner.ship and in the same manner. After excluding the 1terns requirM to be separately treated, the remaining income or loss, which

APP-B-000115

Case 1:06-cv-00407-ECH

Document 122-6

Filed 08/21/2008

Page 31 of 36

·,
/

TABLE

OF CONTENTS

"· i

Page

i
I

I. II. III.

General Revenue

Statement Effects

.................................. ....................................

4025 4026 4028 4028 4029 4029

Tax on Individuals and Corporations ................. A. Combination of normal tax and surtax (sec. 1) ..... B. Head of family (sec. 2) .......................... C. Corporate income-tax rate (sec. 11) ...............

IV.

Credits Against Tax ................................. 4030 A. Dividends received by individuals (secs. 34 and 116) 4030 B. Retirement income credit (sec. 38) ................ 4032 Deductions in Arriving at Adjusted Gross Income ....... 4033 A. Transportation expenses (sec. 62(2) (C)) ......... 4033 B. Business expenses of outside salesmen (sec. 62(2) (D)) ......................................... 4033 Special Inclusions in Gross Income ................... 4034 A. Alimony and separate maintenance payments (sec 71 ) .......................................... 4034 B Annuities (sec. 72) ............................. 4034 C. Amotlnts which are not annuity payments, but received under annuity or endowment contracts (sec 72 (e) and (h)) ................................. 4035 D. Prtzes and awards (sec. 74) ............... 4036 E. Discharge of indebtedness (secs. 76, 108, 1017) ..... 403(_ Exclusions A. I3. From Gross lncome .................. 4038 Employee death benefits (sec 101) ..... 403S Interest element tn life-insurance proceeds (sec 101 (d)) ........................ 4038 C. Payments for injury and sickness (sec_ I04, 105, and 106) ................................ 4030 D Rental value of parsonages (sec 107) ........ 4040 E. Income taxes paid by lessec corporati_n (sec 110) . 4040 F Combat pay of members of the Armed Forces (sec_ 112, 692) ............................... 4040 G. Scholarships and fellowship grants (sec. 117) ..... 4041 [-t. Contributions to the capital of a corporation (secs. I18, 355) .............................. 4042 I l_eals and Iodgtng (sec 119) ................... 4042 J. Subsistence paymer_ts to State l>Mice _t'ficcrs (sec 120) .... 40:13

V.

VI.

:

VII ·

40]9

APP-B-000116

Case 1:06-cv-00407-ECH

Document 122-6

Filed 08/21/2008

Page 32 of 36

HOUSE REPORT ._ Your committee's bill also extends the treatment provided for income in respect of a decedent to several forms of income not now eligible. This treatment is extended to that part of the value of a survivor's annuity included in the estate-tax base of the decedent annuitant which represents the interest accumulation for the survivor annuity since the annuity's putchase. This treatment is also extended to the value of tmexercised "restricted stock options" included in the gross estate of the decedent employee and to payments to a deceased partner by a partnership which are includible in the income of the estate or beneficiary of the deceased partner. This treatment is provided for these new forms of income as a part of your committee's policy of providing that all property or property rights included in a decedent's gross estate for estate-tax purposes etther receive a new basis at the date of his death or, if subsequently to be reported as income when that event occurs receive a deduction for the estate tax paid in the decedent's estate attributable to such property. PAE_8 AND PAET_BESHIP8

"4

., ;

I

o

The existing tax treatment of partners and partnerships is among the most confused in the entire income tax field. The present statutory provisions are wholly inadequate. The published regulations, rulings, and court decisions are incomplete and frequently contradictory. As a result , partners today cannot form, operate, or dissolve a partnership with any assurance as to tax consequences. ¢,, ,This confusion is particularly unfortunate in view of the great number _,%ff_f_business enterprises and ventures carried on in partnership form. It ,_',,_/_h6uldlso be noted that the partnership form of organization is much a _!,'.m_recommonly employed by small businesses and m farming operations i;,,_thanthe corporate form. ?_'i,. ".Because of the vttal need for clarzfication, your committee has undertaken the first comprehensive statutory treatment of partners and partnerships in the history of the income tax laws. In establishing a broad pattern app[tcable to partnerships generally, the principal object,yes have ,]_._..been simplictty, flexibthty, and equtty as between the partners. it,t, _,n general, the proposed statutory treatment retains the existing scheme i '_o_ regxrdmg the partnership as merely an income-reporting, and not a ,_,,tii_ble entity In addition, a statutory pattern has been estabhshed for _ ,contributtons to a partnership distrtbution by a partnershtp, transfers of _,_pc.rtnership interests by sale or on the death of a partner, termination of -, '_7,_ _,l_,_rtnershtp taxable ,'ears, transactions between a partner and the partnerio._] [_Y_fp, and the treatment of payments to a retzr,ng partner or a deceased _lj _"tner's estate or heir _' General rules (sees. 7111-7117) , '_']')Income of pa.rtmers.--Undev your committees bill, as under present _',partners will be habit individually for income tax on thetr distributive _res of partnershtp mcome. The bill provides that the partnershtp will _ as a mere condmt as to income and loss items, transferring such ,terns _y to the mdlv_dual partners. The items reqmred to be segregated wtll retain their original character gthe hands of the partner as though they were reahzed directly by barn

R ! B ! I g

I

4091

APP-B-000117

Case 1:06-cv-00407-ECH

Document 122-6

Filed 08/21/2008

Page 33 of 36

TABLE OF CONTENTS

PART I. II. iII. General Revenue Statement Effects

I--GENERAL

EXPLANATION Page 4629 4631 4633 4633 4633 4635

......................................... ..........................................

Tax on Individuals and Corporations ...................... A. Combination of normal tax and surtax (sec. 1) ....... B. Head of family (see. 2) .............................. C. Corporate income-tax rate (sec. 11) ..................

_IV. CreditsAgainst Tax ...................................... 4636 A. Dividends received individuals by (secs. and 116) -_ 4635 34 B. Retirement income credit(sec.37) .................. 4637 V. Deductions in Arriving at Adjusted Gross Income ..........4638 A. Transportationexpenses (sec. 62(2) (C)) ........... 4638 B. Business expenses of outside salesmen (sec. 62(2) I, (D)) ............................................. 4639

SpecialInclusions Gross Income ........................ in 4639 '. A. Alimony and separatemaintenance payments (sec.71) 4639 _;c B. Annuities (sec. 72) ........................... 4640 C. Payments other than annuitiesreceivedunder annuity 'O:_ or endowment contracts (see. 72(e) and (h)) ..... 4641 D. Prizes and awards (see. 74) ................ 4642 E Discharge of indebtedness (sees. 76 (of House bill), i08, 1017) ........................................ 4643 Exclusions From Gross Income .......................... 4643 A. Proceeds of lifeinsurancecontractspayable by reason of death (sec. 101(a)) ................ 4643 B Employees death benefits (sec. 101(b)) ............ 4644 101(d)) .......................... Accident and Life insurance health plans financedin by employers proceeds paid installments 4644 (secs (sec 4646 4646

I .',

ili_!"i '

'

D. C.

_t.t';

,|,_.

G

Rental value of parsonage (see. 107) .............. Income taxes paid by lessee corporation (see. 110) .... Combat pay of members of the Armed Forces (sees.

104nd ................................... a 105) ............................... 112, 692)

4645 4647
4647 4648 4649 4649 4650

_P'_-'"', _,,'_,

' I.H" Contributions . to fellowship of corporation Scholarships and the capital grants a (sec 117) ......(sees ]18, 362(c) ) ................................... _{ 3. Meals and lodging (see. II9) ................... K. Subsistence payments to State police officers (see. 120) Personal · . A. Exemptions ......................... ............

, l,

Definition of dependent (sec 152) Revenue effect ..................................

4650 4651 4650

4623
Earnings test for del'Jendent (sec 151) ......

APP-B-000118

Case 1:06-cv-00407-ECH

Document 122-6

Filed 08/21/2008

Page 34 of 36

INTERNAL partners and partnerships

REVENUE

CODE

OF 1954 In estab-

in the history of the income tax laws.

lishing a broad pattern applicable to partnerships generally, the principal objectaves have been simphcity, flexibdity, and equity am between the partnel'8. In general, the proposed statutory treatment retains the existing scheme of regarding the partnership as merely an income-reporting, and not a taxable, entity. In addition, a statutory pattern has been established for contributions to a partnership, distributions by a partnership, transfers of partnership interests by sale or on the death of a partner, termination of partnershlp taxable years, transactions between a partner and the partnership, and the treatment of payments to a retiring partner or a deceased partner's estate or heir. A. Determination (1) of Tax IAability (secs. 701-708)

-"

House changes accepted by committee

(a) Income of partners.--Under the House and your committee's bill, as under present law, partners will be hable ind,vidually for income tax on their distributive shares of partnership income. The partnership will act as a mere conduit as to income and loss items, transferring such items directly to the individual partners. The items required to be segregated will retain their original character in the hands of the partner as though they were realized directly by him from the same source from which realized by the partnership and in the same manner. After excluding the items required to be separately treated, the remaining income or loss, which corresponds to the ordinary income or loss of the partnership under present law, is attributed to the partners. The computatzon of partnership income is generally on the same basis as existing law. The partnership is allowed the usual business deductions, but is denied the deductions peculiar to individuals. Both versions of the bill prov,de that all elections with respect to income dertved from a partnershtp (other than the etechon to claim a credit for foreign taxes) are to be made at the partnership level and not by the indwidual partners This rule recognizes the partnersh,p as an enhty f