Tax practitioners are closely watching how the Treasury Department will navigate the complexities of new partnership tax regulations in light of the Supreme Court’s Loper Bright Enterprises v. Raimondo decision. This ruling collectively dispensed with the precedent set by Chevron v. NRDC, making it tougher for the Treasury and IRS to promulgate regulations without judicial setbacks.
The Treasury plans to focus on two longstanding issues: defining a “limited partner in a limited partnership” under Section 469(h)(2) to limit passive losses, and the application of the “disguised sale of a partnership interest” rule under Section 707(a)(2)(B). These efforts have historically been fraught with taxpayer challenges, and they may encounter even more obstacles post-Loper Bright.
The end of Chevron deference implies that courts, rather than agencies, will have the ultimate say in interpreting ambiguous laws. Without this deference, the Treasury’s ability to impose new regulations in contentious areas becomes uncertain. It plans to finalize regulations proposed as far back as 2011, which aimed to resolve material participation issues for partners, a measure that originally would have benefited from Chevron deference.
Notably, past judicial decisions, such as Gregg v. United States and Thompson v. United States, have seen taxpayers successfully challenge the IRS by leveraging similar arguments that may be used again post-Loper Bright. In Thompson, for example, the court posited that the Treasury should not have expanded Congress’s language to restrict the definition of a “limited partner.”
In addition, the Treasury’s proposed regulations on disguised sales—meant to clarify contributions and distributions among partners as sales—have had mixed results historically. After the IRS faced multiple defeats in court, regulations issued in 2004 were withdrawn in 2009 due to significant criticism (pdf).
An April report by the Congressional Research Service pointed out that a significant percentage of agency rule drafters believed Chevron deference allowed them to pursue aggressive interpretations (report). Moving forward, the Treasury might adopt a more conservative strategy in issuing new regulations, as the lack of Chevron deference means it will need to win over courts without the fallback of regulatory deference.
Given the combined impact of the Loper Bright ruling and historical judicial resistance, the Treasury’s path to finalizing these partnership tax regulations could prove arduous, inviting further litigation and court scrutiny.
For further details and updates, visit the original article on Bloomberg Tax.