Tax Fairness Act of 2021
Bill: H.R.3903 | Sponsor: Rep. Grothman, Glenn (R-WI)
Policy area: Taxation

Summary:
Tax Fairness Act of 2021
This bill modifies 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.

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.

    Be it enacted by the Senate and House of Representatives of the 
United States of America in Congress assembled,

SECTION 1. SHORT TITLE.

    This Act may be cited as the ``Tax Fairness Act of 2021''.

SEC. 2. ORDINARY INCOME TREATMENT IN THE CASE OF PARTNERSHIP INTERESTS 
              HELD IN CONNECTION WITH PERFORMANCE OF SERVICES.

    (a) In General.--Section 1061 of the Internal Revenue Code of 1986 
is amended to read as follows:

``SEC. 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' means, with respect to any 
        taxpayer for any taxable year, the excess (if any) of--
                    ``(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' means, with respect to any 
                applicable partnership interest for any partnership 
                taxable year, an amount equal to the product of--
                            ``(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' means, with respect to 
                any calendar year, a percentage equal to--
                            ``(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' means, with respect to any 
                        applicable partnership interest, the highest 
                        percentage of profits of the partnership that 
                        could be allocated with respect to such 
                        interest for the taxable year (consistent with 
                        the partnership agreement and assuming such 
                        facts and circumstances with respect to such 
                        taxable year as would result in such highest 
                        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' means, with respect to any 
                        taxable year, the average daily amount of 
                        invested capital of the partnership for such 
                        taxable year.
                            ``(ii) Invested capital.--The term 
                        `invested capital' means, with respect to any 
                        partnership as of any day, the total cumulative 
                        value, determined at the time of contribution, 
                        of all money or other property contributed to 
                        the partnership on or before such day.
                            ``(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' means, with respect to 
                        any applicable partnership interest for any 
                        taxable year, the average daily amount of 
                        contributed capital with respect to such 
                        interest for such year.
                            ``(ii) Contributed capital.--The term 
                        `contributed capital' means, with respect to 
                        any applicable partnership interest as of any 
                        day, the excess (if any) of--
                                    ``(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' for `50 percent' each 
                        place it appears.
                    ``(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' means any interest in a partnership which, directly 
        or indirectly, is transferred to (or is held by) the taxpayer 
        in connection with the performance of services by the taxpayer, 
        or any other person, in any applicable trade or business.
            ``(2) Applicable trade or business.--
                    ``(A) In general.--The term `applicable trade or 
                business' means any trade or business conducted on a 
                regular, continuous, and substantial basis which, 
                regardless of whether the activities are conducted in 
                one or more entities, consists, in whole or in part, 
                of--
                            ``(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'' at the end of paragraph (4), by striking the 
period at the end of paragraph (5) and inserting ``, or'', and by 
adding at the end the following new paragraph:
            ``(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, 2021.
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