Thursday Ramble: Closing a Tax Loophole

One man's important provision in the tax regulations, is another man's tax loophole. The Internal Revenue Service (IRS) the United States national income tax agency, has announced intention to change a provision in the tax regulations.  An important distinction, Congress writes the tax code or law, it authorizes the agency (IRS) to promulgate regulations.  As long as the regulations are not contrary to the law, the agency has fairly wide discretion in how they implement the law by writing regulations. Simply put, the IRS created the rule they are changing, and they most likely can change the regulation.  

If you are still awake, and still with me, let me explain what they are going to change. 

Currently the value of assets contributed to a partnership (this includes LLCs, PLCs, general and limited partnerships) is whatever value the partners agree on.   The change would require there to be a reasonable or rational basis on the value of the assets contributed.  Currently only agreement on the value by the partners is required. This change is estimated to increase tax revenues by $50,000,000,000 in the first ten years ($50-billion dollars.) 

Let me offer an example.  You have a blog and I have a blog, we agree to go into a partnership to create a blogging partnership to increase readership and advertising revenue on our new super blogs.  We agree between the two of us to contribute our blogs, all of the intellectual property, good will, and established business from our blogs. And we agree that each blog is worth $1,000,000 ($1-million dollars.) This is an in kind, contribution of capital under the current IRS accounting regulations.  The regulations will allow us to write this off as a business expense over a number of years, say ten years.  This means that each of us will be entitled to $100,000 a year expense against income, income from TravelPenguin is currently about $120 a year.  I can write the rest of the expense off against other income.  That would reduce my tax liability to zero. 

This is how rich people pay less in taxes, than you and I do. 

With a rational basis rule, even if we value travel penguin at 50 times earnings, my write off would only be $6,000, spread over ten years.  Twenty Five years ago, when I first read this rule,  I thought, this is ridiculous and needs to be changed. It is about time.