Tax Fairness Act of 2018

To amend the Internal Revenue Code of 1986 to treat certain income with respect to partnership interests held in connection with the performance of services as ordinary income. 1. Short title This Act may be cited as the Tax Fairness Act of 2018 2. Ordinary income treatment in the case of partnership interests held in connection with performance of services (a) In general Section 1061 1061. Partnership interests held in connection with performance of services (a) In general If one or more applicable partnership interests are held by a taxpayer at any time during the taxable year, so much of— (1) the taxpayer’s net capital gain with respect to such interests for such taxable year, as does not exceed (2) the taxpayer’s recharacterization account balance for such taxable year, shall be treated as ordinary income. (b) Net capital gain (1) In general For purposes of subsection (a)(1), net capital gain shall be determined under section 1222, except that such section shall be applied— (A) without regard to the recharacterization of any item as ordinary income under this section, (B) by only taking into account items of gain and loss— (i) taken into account by the taxpayer under section 702 with respect to any applicable partnership interest, (ii) recognized by the taxpayer on the disposition of any such interest, or (iii) recognized by the taxpayer under paragraph (4) on a distribution of property with respect to such interest, and (C) in the case of a taxable year for which section 1231 gains (as defined in section 1231(a)(3)(A)) exceed section 1231 losses (as defined in section 1231(a)(3)(B)), by treating property which is taken into account in determining such gains and losses as capital assets held for more than 1 year. (2) Allocation to items of gain The amount treated as ordinary income under subsection (a) shall be allocated ratably among the items of long-term capital gain taken into account in determining net capital gain under paragraph (1). (3) Recognition of gain on disposition of applicable partnership interests Any gain on the disposition of any applicable partnership interest shall be recognized notwithstanding any other provision of this title. (4) Recognition of gain on distributions of partnership property (A) In general In the case of any distribution of property by a partnership with respect to any applicable partnership interest, the partner receiving such property shall recognize gain equal to the excess (if any) of— (i) the fair market value of such property at the time of such distribution, over (ii) the adjusted basis of such property in the hands of such partner (determined without regard to subparagraph (B)). (B) Adjustment of basis In the case of a distribution to which subparagraph (A) applies, the basis of the distributed property in the hands of the distributee partner shall be the amount determined under subparagraph (A)(i). (c) Recharacterization account balance (1) In general For purposes of this section, the term recharacterization account balance (A) the sum of— (i) the taxpayer’s aggregate annual recharacterization amounts with respect to applicable partnership interests for such taxable year, plus (ii) the taxpayer’s recharacterization account balance for the taxable year preceding such taxable year, over (B) the sum of— (i) the taxpayer’s net ordinary income with respect to applicable partnership interests for such taxable year (determined without regard to this section), plus (ii) the amount treated as ordinary income of the taxpayer under this section for the taxable year preceding such taxable year. (2) Annual recharacterization amount For purposes of this subsection— (A) In general The term annual recharacterization amount (i) the specified rate determined under subparagraph (B) for the calendar year in which such taxable year begins, multiplied by (ii) the excess (if any) of— (I) an amount equal to the applicable percentage of the partnership’s aggregate invested capital for such taxable year, over (II) the specified capital contribution of the partner with respect to the applicable partnership interest for such taxable year. If a taxpayer holds an applicable partnership interest for less than the entire taxable year, the amount determined under the preceding sentence shall be ratably reduced. (B) Specified rate For purposes of subparagraph (A), the term specified rate (i) the Federal long-term rate determined under section 1274(d)(1) for the last month of the calendar year, plus (ii) 10 percentage points. (C) Applicable percentage (i) In general The term applicable percentage (ii) Secretarial authority The Secretary shall prescribe rules for the determination of the applicable percentage in cases in which the percentage of profits of a partnership that are to be allocated with respect to an applicable partnership interest varies on the basis of the aggregate amount of such profits. Such rules may provide a percentage which may be used in lieu of the highest percentage determined under clause (i) in cases where such other percentage is consistent with the purposes of this section. (D) Aggregate invested capital (i) In general The term aggregate invested capital (ii) Invested capital The term invested capital (iii) Reduction for liquidation of partnership interests The invested capital of a partnership shall be reduced by the aggregate amount distributed in liquidation of interests in the partnership. (iv) Treatment of certain indebtedness as invested capital The following amounts shall be treated as invested capital: (I) Partner loans The aggregate value (determined as of the time of the loan) of money or other property which a partner loans to the partnership. (II) Indebtedness eligible to share in equity of the partnership The face amount of any convertible debt of the partnership or any debt obligation providing equity participation in the partnership. (E) Specified capital contribution (i) In general The term specified capital contribution (ii) Contributed capital The term contributed capital (I) the total cumulative value, determined at the time of contribution, of all money or other property contributed by the partner to the partnership with respect to such interest as of such day, over (II) the total cumulative value, determined at the time of distribution, of all money or other property distributed by the partnership to the partner with respect to such interest as of such day. (iii) Treatment of related party borrowings Any amount borrowed directly or indirectly from the partnership or any other partner of the partnership or any person related to such other partner or such partnership shall not be taken into account under this subparagraph. For purposes of the preceding sentence, a person shall be treated as related to another person if the relationship between such persons would be described in section 267(b) or 707(b) if such sections and section 267(f) were applied by substituting 10 percent 50 percent (F) Multiple interests If at any time during a taxable year a taxpayer holds directly or indirectly more than 1 applicable partnership interest in a single partnership, such interests shall be treated as 1 applicable partnership interest for purposes of applying this paragraph. (3) Net ordinary income For purposes of this subsection, the net ordinary income with respect to applicable partnership interests for any taxable year is the excess (if any) of— (A) the taxpayer’s distributive share of items of income and gain under section 702 with respect to applicable partnership interests for such taxable year (determined without regard to any items of gain taken into account in determining net capital gain under subsection (b)(1)), over (B) the taxpayer’s distributive share of items of deduction and loss under section 702 with respect to such interests for such taxable year (determined without regard to any items of loss taken into account in determining net capital gain under subsection (b)(1)). (d) Applicable partnership interest For purposes of this section— (1) In general The term applicable partnership interest (2) Applicable trade or business (A) In general The term applicable trade or business (i) raising or returning capital, (ii) investing in (or disposing of) trades or businesses (or identifying trades or businesses for such investing or disposition), and (iii) developing such trades or businesses. (B) Treatment of research and experimentation activities Any activity involving research or experimentation (within the meaning of section 469(c)(4)) shall be treated as a trade or business for purposes of clauses (ii) and (iii) of subparagraph (A). (e) Transfer of applicable partnership interest to related person (1) In general If a taxpayer transfers any applicable partnership interest, directly or indirectly, to a person related to the taxpayer, the taxpayer shall include in gross income (as ordinary income) so much of the taxpayer’s recharacterization account balance for such taxable year as is allocable to such interest (determined in such manner as the Secretary may provide and reduced by any amount treated as ordinary income under subsection (a) with respect to the transfer of such interest). (2) Related person For purposes of this paragraph, a person is related to the taxpayer if— (A) the person is a member of the taxpayer’s family within the meaning of section 318(a)(1), or (B) the person performed a service within the current calendar year or the preceding three calendar years in any applicable trade or business in which or for which the taxpayer performed a service. (f) Reporting by entity of taxpayer’s annual recharacterization amount A partnership shall report to the Secretary, and include with the information required to be furnished under section 6031(b) to each partner, the amount of the partner’s annual recharacterization amount for the taxable year, if any. A similar rule applies to any entity that receives a report of an annual recharacterization amount for the taxable year. (g) Regulations The Secretary shall issue such regulations or other guidance as necessary to carry out this section, including regulations— (1) to prevent the abuse of the purposes of this section, including through— (A) the allocation of income to tax indifferent parties, or (B) a reduction in the invested capital of the partnership (including attempts to undervalue contributed or loaned property), (2) which provide that partnership interests shall not fail to be treated as transferred or held in connection with the performance of services merely because the taxpayer also made contributions to the partnership, (3) which provide for the application of this section in cases where the taxpayer has more than 1 applicable interest in a partnership, and (4) which provide for the application of this section in cases of tiered structures of entities. . (b) Coordination with section 83 Subsection (e) of section 83 is amended by striking or , or (6) a transfer of a partnership interest to which section 1061 applies. . (c) Effective date The amendments made by this section shall apply to taxable years beginning after December 31, 2017.

Summary: Tax Fairness Act of 2018 This bill amends the Internal Revenue Code to modify the tax treatment of partnership interests held in connection with the performance of services. The bill requires certain income from the partnerships to be treated as ordinary income rather than as capital gains.