Partnership Distributions: Options for Reform

Abstract

The rise of new forms of limited liability business entities, coupled with changes in the federal tax rules for classifying such entities, has precipitated an influx of businesses that are treated as partnerships for federal tax purposes. Some commentators welcome what they perceive as a process of de facto integration that promises eventually to make an elective regime of pass-through taxation available for all nonpublicly-traded businesses. To the extent that the partnership model, as currently embodied in Subchapter K, represents a coherent and well-functioning body of law, such a sanguine view may be justified. However, as the preliminary work of the American Law Institute (ALI) project on pass-through entities suggests, the intricate provisions of Subchapter K may be "dysfunctional" in important respects.Indeed, Subchapter K may have reached an important turning point. The 1954 Code drafters stressed simplicity and flexibility while allowing partners considerable latitude in allocating tax benefits and burdens among themselves. With the benefit of hindsight, this tolerant attitude toward shifting tax consequences among partners appears to undermine broader tax policy goals. Concern about the flexibility of partnership taxation-particularly the ease of entry and exit-has led some partnership reformers to veer in the opposite direction. Recent legislative attempts to confine the broad nonrecognition policy of section 72 1-especially with respect to contributions of property with built-in gain or loss, disguised sales, and distributions of previously contributed property-signal Congressional ambivalence about Subchapter K's unrivaled flexibility.