Beware of repeal of 'small partnership' exception for income tax

Beware of repeal of 'small partnership' exception for income tax

Loss of this income tax simplification provision after 2017 is a threat to farm and ranch taxpayers, and other small businesses.

In a shocking development, tucked away in the Bipartisan Budget Act of 2015, passed by Congress and signed by the President, there is a provision affecting farmers and ranchers (and other small businesses) in a highly significant way. It signals the end of a 34-year-old federal tax law that has been depended upon by thousands of taxpayers. It was a model of simplicity when enacted in 1982 and has continued to be the best example of tax simplification to this day. The late 2015 legislation repeals the “small partnership” exception after 2017.

EXCEPTION: The small partnership exception is a federal income tax provision used by many farmers and small businesses to report their income easily and in a low-cost way. After 2017, this exception is being taken away. Farmers are urged to contact their Congressmen and Senators and tell them to reinstate it.

Why the “small partnership exception” was passed in 1982
In 1967, this author was appointed by the U.S. Treasury Department to a task force to provide ideas on how to combat tax sheltering in agriculture and elsewhere. The ideas discussed were mostly enacted into law in 1969, 1976, 1982 and 1986. During the 1970s, the Congressional Committees focused in on partnerships, particularly limited partnerships, as the vehicle by which tax sheltering was taking place. The emerging draft legislation marked a “get tough” strategy with partnership taxation.

That worried a group of Senators and members of the House of Representatives enough for them to draft a “small partnership” exception to the tough rules being considered. It passed in 1982 along with major legislation cracking down on tax sheltering. The Committee reports made it that the intent was to create a simpler way for farmers and ranchers (and other small businesses) to file their tax returns.

The brief provision simply stated that if an entity had 10 or fewer members (and a husband and wife were considered one member), and the members were individuals or estates of individuals (C corporations were later added), the entity was not required to file a partnership tax return, Form 1065. The income, losses, credits and other tax items were simply passed through to the members for reporting on each individual’s tax return, Form 1040. The legislation made it clear that the entity was not liable for penalties (unless they failed to pay income tax on their share of the taxable items). Those penalties are now $195 dollars per month per partner for up to 12 months and are now adjusted for inflation.

So what happened in late 2015?
The growing number of people taking advantage of the simplification provision threatened the bottom line of some tax practitioners and the push was on to repeal it, not in the 2015 tax bill but in the Budget Bill where the repeal would be less likely to be spotted and resisted. There were no hearings and no public discussion that the most significant tax simplification in decades and decades was threatened. That clandestine effort, unfortunately, was successful.

What needs to be done? Contact members of Congress
The repeal is not effective until 2018 so the task now is to contact every House and Senate member to let them know that the best example of tax simplification in decades is under attack with a request to support reinstatement of the provision. The tax simplification did not have an impact of government revenues. It simply required far less time and effort to file the tax return. The provision is found in Section 6231(a)(1)(B) of the Internal Revenue Code.

About the author: Neil E. Harl, is Charles F. Curtiss Distinguished Professor in Agriculture and Life Sciences at Iowa State University and Emeritus Professor of Economics. He holds a law degree from the University of Iowa and a Ph.D. in Economics from Iowa State. He retired in 2004 after 40 years on the ISU faculty.

Dr. Harl has published 29 books, authored more than 800 articles and has made more than 3,400 presentations in 43 states and 17 foreign countries. He is the author of the 15-volume treatise, Agricultural Law, the two volume treatise, Farm Income Tax Manual and has published for BNA Tax Management. He served on seven federal commissions including a term as adviser to the Commissioner of the Internal Revenue Service.

Editor’s Note: Neil Harl is Charles F. Curtiss Distinguished Professor in Agriculture & Life Sciences at Iowa State University and Emeritus Professor of Economics. He holds a law degree from the University of Iowa and a Ph.D. in Economics from Iowa State.

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