AICPA to Congress: Do Not Combine Partnership and S Corporation Regimes

September 5, 2013

As part of a larger tax reform effort, House Ways and Means Committee Chairman Dave Camp (R-Mich.) developed a discussion draft, commonly referred to as Option 2, which outlined several proposals to change the small business tax regime.  One of the proposals would provide a single passthrough regime.

In a letter to Camp and Ranking Member Sander Levin, the American Institute of CPAs (AICPA) acknowledged that the goal of the proposal was to simplify reporting for taxpayers, but noted that taxpayers already have options for a simpler taxing regime.  They “can choose to form a simple partnership with pro rata allocations, or they can opt to be taxed as an S corporation and forego basis and ownership flexibility,” the letter stated.  While the AICPA is in favor of simplifying the tax system, the new system, as proposed, would result in significant complexity.

“Taxpayers need the simplicity of operating as S Corporations and the flexibilities allowed by partnerships with the ability to make allocations depending on their various and differing circumstances,” the AICPA told the lawmakers.  “They benefit by having the choice of subjecting themselves to Subchapter K or Subchapter S.  The Code should continue to include both forms as viable options for the business and investment communities.”

The AICPA also offered comments on other concepts within the draft and existing regulations impacting passthrough entities.  The comments include proposals related to tax-free distributions under section 731 and existing section 707, which provide that a partner may act in a capacity other than partner (e.g., as a creditor, customer, or vendor).  “Current IRS policy is to reject the notion that a partner may also act in an employee capacity,” AICPA Tax Executive Committee Chair Jeffrey A. Porter wrote.  “Since the withholding of income tax aids in compliance with the IRC [Internal Revenue Code], partners should be encouraged, rather than prohibited, to treat themselves as employees if they desire.”