The Future Of Partnership Taxation

I. INTRODUCTIONThe year 1986 was a landmark point in the history of United States income taxation. The Tax Reform Act of 1986(1) changed the topography as drastically as an earthquake.(2) Today's tax adviser is still sorting out many of the subtle changes in an attempt to properly advise clients.Among the more prominent changes wrought by the 1986 Act were the following: a drastic lowering of the tax rates;(3) an inversion of the individual and corporate tax rates;(4) repeal of the tax break for long-term capital gains;(5) revision of the alternative minimum tax,(6) which, when coupled with decreased regular tax rates, resulted in expanded applicability; a frontal attack on tax shelters and losses;(7) and repeal of the Genera) Utilities doctrine.(8) In effect the law broadened the tax base, reduced rates and assured the double taxation of corporate income. The short-term effect was to encourage the conversion of corporations into non-corporate, pass-through entities as well as a search for new sheltering opportunities.(9) The old rules and plans were either abandoned or drastically modified.With the arrival of a new administration, 1993 is shaping up to be another monumental year for tax policy. Congress is currently debating President Clinton's budget and tax bills, which are likely to once again redesign the tax landscape. Among the more interesting proposals are the following: resurrection of the investment credit;(10) a significant increase tax rates;(11) potential inversion of the corporate and individual rates;(12) adoption of a substantial long-term capital gain benefit;(13) and severe restriction of certain business deductions.(14) These changes will almost certainly be exacerbated by the tax law changes necessary to fund health care reform.The long-term direction of tax policy may be greatly affected by the potential adoption of two radical proposals. The first is the adoption of a value added tax (VAT). A VAT would operate, in all likelihood, as a national sales tax. The second proposal is the integration of the corporate and individual tax systems. This would eliminate the classical double taxation that we are currently operating under and put the United States in line with the rest of its major trading partners. Adoption of either or both proposals would lead the United States into uncharted territory.Given the magnitude of the prior tax law changes and the almost certain adoption of significant future changes, it is almost impossible to predict the future of partnership taxation. That does not mean there will not be changes; it means that the scope and direction are unpredictable. This Essay discusses various aspects of partnership taxation that Congress should address and offers suggestions for improving the operation of Subchapter K. Specifically, this Essay addresses the need for congressional examination of the definition of partnerships, the dichotomy between the aggregate and entity theories of viewing partnerships, and several specific types of partnership transactions.II. DEFINITION(15)Code section 761 defines a partnership as "...a syndicate group, pool, joint venture or other unincorporated organization ...."(16) This is not so much a definition as the statement of an antonym. A partnership is not a corporation. Given this approach, it is no wonder that the majority of the cases and rulings concentrate on the definition and classification of a corporation.The Internal Revenue Code of 1986, as amended (Code), defines a corporation as including associations, joint-stock companies, and insurance companies.(17) The regulations focus on the term "association" and define this word based on the six corporate characteristics enumerated by the Supreme Court in Morrissey v Commissioner.(18) The six characteristics are: associates, profit motive, continuity of life, centralized management, limited liability, and free transferability of interest. To be classified as a corporation the entity must contain over one-half the corporate attributes. …