Taxing Selling Partners

When a partner sells a partnership interest, the resulting gain or loss is treated as capital gain or loss, except to the extent that the partnership holds certain items whose sale would result in gain or loss that was not capital. Seemingly, the purpose of this regime is to prevent taxpayers from obtaining more favorable treatment by selling an interest in a partnership than what would result if the partnership were to sell its underlying assets. But given this legislative aim, the existing tax provisions produce results for taxpayers that are both unduly favorable (in that sale of a partnership interest sometimes receives more beneficial treatment than sale of underlying assets) and unduly unfavorable (in that, in other instances, sale of a partnership interest triggers a less beneficial outcome than the sale of underlying assets). The design of the partnership tax rules also necessitates piecemeal reform as taxpayers discover new opportunities to benefit from unduly favorable results produced by the partnership tax regime. Most recently, in December 2017, Congress adopted legislative reform to address one such instance involving the sale of a partnership interest by a non-U.S. person. In addition, the method used by the partnership tax rules requires Congress to update the statute governing sale of a partnership interest to take into account potential ripple effects of unrelated legislative changes. As a result, the design is error prone because, inevitably, Congress overlooks and fails to address these potential ripple effects. Changes enacted by Congress in December 2017 provide at least one example of this phenomenon. In particular, Congress enacted a new restriction on the deductibility of losses incurred in a trade or business. However, Congress did not provide for a corresponding modification to the tax provisions governing sale of an interest in a partnership—creating the potential for another way in which the existing statutory design is unduly favorable. Some of the problems identified by this Article existed long before the adoption of significant tax legislation in December 2017; one of the problems was partially (but incompletely) addressed by that legislation and one of the problems was created by that legislation. To address each of the failings that it identifies, this Article proposes equating the tax treatment of the sale of a partnership interest with the tax treatment of the sale of underlying assets in all cases