Tax Basis Determinations, Pass-Through Entities, and Taxpayer Noncompliance

James Alm () and Jay Soled ()
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Jay Soled: Rutgers School of Business, Rutgers University

No 1407, Working Papers from Tulane University, Department of Economics

Abstract: In the United States, one of the most popular ways to conduct business is to use a pass- through entity such as a partnership, limited liability company, or S corporation. Investor taxpayers in such pass-through entities commonly hold their ownership interest for years or decades. Over this lengthy period of time, a taxpayer's tax basis in the entity is subject to constant annual adjustments, which generally have no immediate tax consequences. However, when the pass-through entity investment is later sold or liquidated, tax basis determinations are of critical importance, and these determinations enable taxpayers to calculate their concomitant gains or losses. At this pivotal juncture, accurately determining taxpayers' tax bases in these investments is highly unlikely, and the IRS's ability to detect taxpayers' tax basis reporting inaccuracies is virtually nonexistent. This analysis examines the phenomenon of taxpayers who do not know their tax basis in pass-through entity investments and the consequences associated with such ignorance. Also provided are projected revenue losses associated with taxpayers purposefully or inadvertently inflating the tax basis that they have in their pass-through entity investments. To curtail the projected revenue losses associated with tax basis misreporting, we propose several reform measures that Congress should adopt. Such measures include simplifying tax basis computations, enhancing information reporting, and limiting the ability of taxpayers to estimate the tax basis of their pass-through investments.

Keywords: tax basis; pass-through entities; information reporting (search for similar items in EconPapers)
JEL-codes: H2 H26 K34 K42 (search for similar items in EconPapers)
Date: 2014-07
New Economics Papers: this item is included in nep-acc, nep-iue, nep-law and nep-pbe
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