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In 2017, Congress drastically reduced the corporate tax rate and provided an unprecedented deduction under section 199A for qualifying passthrough business income. Although purportedly necessary to maintain tax parity between income earned in corporate and noncorporate form, section 199A encourages active high-income passthrough owners to misclassify labor income as business profit, thereby reducing both income and employment taxes. This Article considers how section 199A is likely to affect choice of entity among different passthrough forms. Prior to the 2017 legislation, S corporations had an advantage over other passthroughs because of their ability to convert owner compensation into S corporation income not subject to employment taxes (or the section 1411 tax). Under the 2017 legislation, it is unclear whether S corporations will continue to represent the superior choice of passthrough entity. Section 199A provides a perverse incentive for S corporations to understate or overstate owner compensation depending on which technique minimizes combined income and employment taxes. The Treasury’s decision to limit the reasonable compensation guardrail to S corporations highlights the anachronistic employment-tax treatment of passthrough entities, as well as the lack of any coherent rationale for preferential treatment of passthrough income. The Article concludes that section 199A offers a fertile field for income-shifting and potentially undermines the rationale for maintaining Subchapter S.

Section 1411 imposes a 3.8% surtax on investment income of high earners that mirrors Medicare taxes on earned income. The enactment of the net investment income tax highlights gaps in the employment tax rules for passthrough entities—particularly limited partnerships, S corporations, and limited liability companies. This Article considers how businesses can be structured to allow active high-income owner-employees of passthrough entities to avoid all three of the 3.8% Medicare taxes (SECA, FICA and section 1411). Part I considers the anachronistic limited partner exception to the SECA tax and the well-known S corporation loophole under the FICA tax, as well as the failure of section 1411 to reach active business income that avoids these employment taxes. Part II considers the recent Renkemeyer case, which has reignited the employment tax debate and threatens to upend structures used in investment and real estate funds to shelter management fees from all of the 3.8% taxes. Although repeal of section 1411 remains high on the Republican tax-cutting agenda, Part III suggests the need to reform (not repeal) section 1411 to backstop the employment tax rules for active passthrough businesses, regardless of organizational form. The proposed approach would curtail opportunities to avoid the 3.8% taxes, raise substantial revenue, and promote the goal of parity in the taxation of earned and unearned income. By contrast, tax legislation enacted in 2017 leaves intact planning to avoid employment taxes and section 1411, while dramatically lowering the income tax rate on business income. As a result, business taxation has grown increasingly incoherent, regressive, and unstable.

Long-awaited proposed regulations would revise the operation of section 751(b) to reflect modern concepts of partnership taxation. The Treasury should be commended for exercising its regulatory authority to thoroughly overhaul the section 751(b) regulations to achieve the goals of the statute — preventing shifts in unrealized ordinary income — in a more sensible manner. The novel approach under the proposed regulations relies on section 704(c) principles to measure a partner’s interest in hot asset gain before and after a distribution of partnership property. Ordinary income tax would be imposed only to the extent a partner’s interest in hot asset gain cannot be fully preserved through mandatory revaluations. When a disproportionate distribution reduces (but does not eliminate) a partner’s interest in the partnership, revaluations and reverse section 704(c) allocations would permit considerable flexibility to avoid section 751(b) and thus obtain continued deferral. This Article illustrates the hypothetical sale construct and reasonable approaches to determine the existence and consequences of a section 751(b) distribution, as well as the role of mandatory (or elective) capital gain recognition to prevent basis adjustments under sections 732 and 734(b). The Article suggests alternative approaches for reconciling the operation of sections 704(c) and 734(b), including enhanced capital gain recognition and exchanges of reverse section 704(c) hot asset gain. The Article also considers fixes to prevent basis-shifting to depreciable assets and the need to curtail deferral when no longer consistent with the purpose of section 751(b). The Article concludes that the proposed regulations could be significantly improved by mandating the deemed gain approach and requiring enhanced gain recognition to allow basis adjustments to function sensibly. Despite their daunting complexity, the proposed regulations should hopefully improve compliance with section 751(b).

This article considers recent proposals to replace subchapters K and S with a unified passthrough system. It argues that resistance to a unified approach may pave the way for further expansion of subchapter S and discusses proposed fixes to the section 1374 tax on built-in gains. The article suggests that proposed mandatory basis adjustments under subchapter K, unless coupled with partial liquidation treatment, would introduce needless complexity. Finally, the article considers the possibility of eliminating subchapter K and expanding subchapter S to include as many privately held businesses as possible.

Arthur Andersen LLP v. Carlisle is the first investor suit involving a failed Son-of-BOSS tax shelter to reach the Supreme Court. Although the Court rests its decision on procedural grounds under the Federal Arbitration Act, the case offers a tantalizing glimpse into the structure of the shelter transaction and the relationships between the various participants. This comment argues that the primary impact of the Court’s decision will be to invite tactical maneuvers by litigants seeking to delay litigation and avoid discovery.

In Countryside Limited Partnership v. Commissioner, T.C. Memo 2008-3, the government challenged a purportedly tax-free distribution of nonmarketable securities to partners who wished to withdraw from a real estate partnership shortly before sale of the partnership's depreciated real property. By manipulating the partnership basis adjustment provisions, the Countryside transaction sought to shift and duplicate basis, while potentially deferring indefinitely the withdrawing partners' gain from the real property. Surprisingly, without addressing the larger Countryside transaction, The Tax Court held that the withdrawing partners recognized no gain on the deemed distribution of securities; in granting partial summary judgment on the issue of gain recognition under I.R.C. § 731, the court found that the transaction was imbued with economic substance and was not inconsistent with the intent of Subchapter K. This article discusses the transaction in a manner that is (hopefully) accessible to readers who are not steeped in Subchapter K. It suggests several alternative ways in which the transaction could be recharacterized to clearly reflect income under traditional judicial doctrines and, specifically, the partnership anti-abuse rule. Unfortunately, the Tax Court failed to send a clear message that such transactions do not work, thereby undermining the effectiveness of the partnership anti-abuse rule. The article suggests that the Countryside decision facilitates massive avoidance of the statutory 25% rate on gain from depreciated real property, and proposes that Congress amend the partnership distribution rules to prevent shifting of basis from capital assets to depreciable real property.

Professor Karen C. Burke explains the operation of the section 1(h)(6)(B) limitation on gain taxed at 25 percent when a partner's only capital gain for the year consists of unrecaptured section 1250 gain on sale of a partnership interest.