Every Friday, we feature Tax Law & Policy Perspectives from Monte A. Jackel, UBalt Law’s graduate tax program scholar-in-residence. The posts reflect the views of the author and do not reflect the views of the University of Baltimore. Although we strive to be accurate in our posts, they do not constitute legal advice. Independent advice should therefore be sought if it is deemed advisable.
When I was high-level official at the IRS during 1994-1995, the IRS and Treasury first proposed and then finalized regulation §1.701-2, known as the “partnership antiabuse rule.” Much fanfare was made about how the regulation would change the partnership tax law landscape, for both good and ill, and there were many complaints that the regulation exceeded the IRS’s regulatory authority. Over two decades then went by with very little, if any, tangible results on how this antiabuse regulation had changed the world of partnership tax and stopped the abusive use of partnership tax law.
I have written a series of articles on the need for partnership tax reform that illustrates this point quite clearly. (See “Partnership Tax Reform: Combined Tax Notes Material”, Jackel SSRN, Feb. 7, 2023; they are not behind any paywall.) I also co-authored two related articles (the “antiabuse articles”) on the history of this antiabuse rule. They are published on SSRN. (See Jackel SSRN, “Time to Revoke the Partnership Antiabuse Regulation”, Oct. 6, 2023; they are not behind any paywall).
The proven thesis of those articles is that the promulgation of this antiabuse rule and its application by taxpayers, their advisers, the IRS and the Department of Justice (DOJ) did not add anything to the ability to curb partnership tax abuse beyond what the already existing common law doctrines (meaning judicial doctrines such as the economic substance doctrine, substance versus form, business purpose, sham, and step transaction) had and have done. It was argued that if the partnership antiabuse rule would only be useful in cases where the common law doctrines would otherwise have applied, it should be revoked because it is not adding anything new to the ability to curb abuse.
The rule seemingly only made the Internal Revenue Code rules for partnerships more complex. It was argued that there was no Congressional mandate, either by statute or legislative history, to promulgate such a rule after forty years of silence since the Internal Revenue Code was enacted in 1954. (See Judge Halpern’s statement in DTDV LLC v. Comm’r (T.C. Memo 2018-32) that the regulation would likely be invalid if applied to cases where the common law doctrines would not also apply).
Thus, it was argued, statutory support for the antiabuse regulation should be added to the Internal Revenue Code. Some opponents of adding such statutory support argue that adding a statutory antiabuse rule in only one subchapter of the Internal Revenue Code could lead to an inference that there is no antiabuse issue outside of partnership tax law. I do not share such a view.
The partnership antiabuse rule was at the leading edge of regulatory antiabuse rules; meaning following the issuance of that rule and up until the present time it is now common practice to add an antiabuse rule to a regulation stating that if the taxpayer acts “with a principal purpose” of violating that regulatory section, the IRS could attack that arguable abuse. (See Jackel, “A Principal Purpose: 194 Entries and Counting”, 169 Tax Notes Federal 813, Nov. 2, 2020; and Jackel, “Small Business Tax Shelters Under the Business Interest Expense Limitation”, 165 Tax Notes Federal 607, Oct. 28, 2019). That is the same standard of behavior that the partnership antiabuse rule uses today to tackle the problem.
The disconnect with that regulatory approach is that “a principal purpose” or “a significant purpose” are much lower standards of behavior than “the principal purpose”. The latter is taken to mean the most important purpose or the predominant purpose, while the former has been taken to mean a meaningful purpose which need not be the most important purpose.
The problem inherent in “a principal purpose or a significant purpose” anti abuse rules is that those terms have not yet been addressed in the regulations. Given that these types of regulatory anti abuse regulations could apply to almost any kind of tax motivated behavior, it is difficult and perhaps even impossible to apply such a rule in the real world because almost every business transaction has some tax motivation. (See Jackel, “A Look at Regulatory Rules Under the TCJA”, 167 Tax Notes Federal 2289, June 29, 2020.)
As a matter of tax policy, I do not favor “a principal purpose” or “a significant purpose” regulatory antiabuse rules. They are too vague. It is argued that such rules eliminate the need for regulations to be very lengthy and mechanical in application and even then, someone could forget to add a rule to block a supposed loophole. The problem with that assertion is that regulations are still mostly long and mechanical despite those rules, and no one really knows how to apply these ambiguous antiabuse regulations.
This goes to show that partnership tax law itself must be statutorily amended and reformed by the Congress because regulatory Antabuse rules of questionable authority will not win over the day. If, however, the partnership antiabuse regulation was supported by a congressional grant of regulatory authority, the rule would be a very useful addition to tax administration regardless of the ultimate fate of partnership tax law reform.
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