Tax Fairness Act of 2021

I 117TH CONGRESS 1ST SESSION H. R. 3903 To amend the Internal Revenue Code of 1986 to treat certain income with respect to partnership interests held in connection with the performance of services as ordinary income. IN THE HOUSE OF REPRESENTATIVES JUNE 15, 2021 Mr. GROTHMAN introduced the following bill; which was referred to the Committee on Ways and Means A BILL To amend the Internal Revenue Code of 1986 to treat cer- tain income with respect to partnership interests held in connection with the performance of services as ordi- nary income. Be it enacted by the Senate and House of Representa- 1 tives of the United States of America in Congress assembled, 2 SECTION 1. SHORT TITLE. 3 This Act may be cited as the ‘‘Tax Fairness Act of 4 2021’’. 5 VerDate Sep 11 2014 00:48 Jul 02, 2021 Jkt 019200 PO 00000 Frm 00001 Fmt 6652 Sfmt 6201 E:\BILLS\H3903.IH H3903 kjohnson on DSK79L0C42PROD with BILLS 2 •HR 3903 IH SEC. 2. ORDINARY INCOME TREATMENT IN THE CASE OF 1 PARTNERSHIP INTERESTS HELD IN CONNEC- 2 TION WITH PERFORMANCE OF SERVICES. 3 (a) IN GENERAL.—Section 1061 of the Internal Rev- 4 enue Code of 1986 is amended to read as follows: 5 ‘‘SEC. 1061. PARTNERSHIP INTERESTS HELD IN CONNEC- 6 TION WITH PERFORMANCE OF SERVICES. 7 ‘‘(a) IN GENERAL.—If one or more applicable part- 8 nership interests are held by a taxpayer at any time during 9 the taxable year, so much of— 10 ‘‘(1) the taxpayer’s net capital gain with respect 11 to such interests for such taxable year, as does not 12 exceed 13 ‘‘(2) the taxpayer’s recharacterization account 14 balance for such taxable year, 15 shall be treated as ordinary income. 16 ‘‘(b) NET CAPITAL GAIN.— 17 ‘‘(1) IN GENERAL.—For purposes of subsection 18 (a)(1), net capital gain shall be determined under 19 section 1222, except that such section shall be ap- 20 plied— 21 ‘‘(A) without regard to the recharacteriza- 22 tion of any item as ordinary income under this 23 section, 24 ‘‘(B) by only taking into account items of 25 gain and loss— 26 VerDate Sep 11 2014 00:48 Jul 02, 2021 Jkt 019200 PO 00000 Frm 00002 Fmt 6652 Sfmt 6201 E:\BILLS\H3903.IH H3903 kjohnson on DSK79L0C42PROD with BILLS 3 •HR 3903 IH ‘‘(i) taken into account by the tax- 1 payer under section 702 with respect to 2 any applicable partnership interest, 3 ‘‘(ii) recognized by the taxpayer on 4 the disposition of any such interest, or 5 ‘‘(iii) recognized by the taxpayer 6 under paragraph (4) on a distribution of 7 property with respect to such interest, and 8 ‘‘(C) in the case of a taxable year for 9 which section 1231 gains (as defined in section 10 1231(a)(3)(A)) exceed section 1231 losses (as 11 defined in section 1231(a)(3)(B)), by treating 12 property which is taken into account in deter- 13 mining such gains and losses as capital assets 14 held for more than 1 year. 15 ‘‘(2) ALLOCATION TO ITEMS OF GAIN.—The 16 amount treated as ordinary income under subsection 17 (a) shall be allocated ratably among the items of 18 long-term capital gain taken into account in deter- 19 mining net capital gain under paragraph (1). 20 ‘‘(3) RECOGNITION OF GAIN ON DISPOSITION 21 OF APPLICABLE PARTNERSHIP INTERESTS.—Any 22 gain on the disposition of any applicable partnership 23 interest shall be recognized notwithstanding any 24 other provision of this title. 25 VerDate Sep 11 2014 00:48 Jul 02, 2021 Jkt 019200 PO 00000 Frm 00003 Fmt 6652 Sfmt 6201 E:\BILLS\H3903.IH H3903 kjohnson on DSK79L0C42PROD with BILLS 4 •HR 3903 IH ‘‘(4) RECOGNITION OF GAIN ON DISTRIBUTIONS 1 OF PARTNERSHIP PROPERTY.— 2 ‘‘(A) IN GENERAL.—In the case of any dis- 3 tribution of property by a partnership with re- 4 spect to any applicable partnership interest, the 5 partner receiving such property shall recognize 6 gain equal to the excess (if any) of— 7 ‘‘(i) the fair market value of such 8 property at the time of such distribution, 9 over 10 ‘‘(ii) the adjusted basis of such prop- 11 erty in the hands of such partner (deter- 12 mined without regard to subparagraph 13 (B)). 14 ‘‘(B) ADJUSTMENT OF BASIS.—In the case 15 of a distribution to which subparagraph (A) ap- 16 plies, the basis of the distributed property in 17 the hands of the distributee partner shall be the 18 amount determined under subparagraph (A)(i). 19 ‘‘(c) RECHARACTERIZATION ACCOUNT BALANCE.— 20 ‘‘(1) IN GENERAL.—For purposes of this sec- 21 tion, the term ‘recharacterization account balance’ 22 means, with respect to any taxpayer for any taxable 23 year, the excess (if any) of— 24 ‘‘(A) the sum of— 25 VerDate Sep 11 2014 00:48 Jul 02, 2021 Jkt 019200 PO 00000 Frm 00004 Fmt 6652 Sfmt 6201 E:\BILLS\H3903.IH H3903 kjohnson on DSK79L0C42PROD with BILLS 5 •HR 3903 IH ‘‘(i) the taxpayer’s aggregate annual 1 recharacterization amounts with respect to 2 applicable partnership interests for such 3 taxable year, plus 4 ‘‘(ii) the taxpayer’s recharacterization 5 account balance for the taxable year pre- 6 ceding such taxable year, over 7 ‘‘(B) the sum of— 8 ‘‘(i) the taxpayer’s net ordinary in- 9 come with respect to applicable partnership 10 interests for such taxable year (determined 11 without regard to this section), plus 12 ‘‘(ii) the amount treated as ordinary 13 income of the taxpayer under this section 14 for the taxable year preceding such taxable 15 year. 16 ‘‘(2) ANNUAL RECHARACTERIZATION 17 AMOUNT.—For purposes of this subsection— 18 ‘‘(A) IN GENERAL.—The term ‘annual re- 19 characterization amount’ means, with respect to 20 any applicable partnership interest for any 21 partnership taxable year, an amount equal to 22 the product of— 23 ‘‘(i) the specified rate determined 24 under subparagraph (B) for the calendar 25 VerDate Sep 11 2014 00:48 Jul 02, 2021 Jkt 019200 PO 00000 Frm 00005 Fmt 6652 Sfmt 6201 E:\BILLS\H3903.IH H3903 kjohnson on DSK79L0C42PROD with BILLS 6 •HR 3903 IH year in which such taxable year begins, 1 multiplied by 2 ‘‘(ii) the excess (if any) of— 3 ‘‘(I) an amount equal to the ap- 4 plicable percentage of the partner- 5 ship’s aggregate invested capital for 6 such taxable year, over 7 ‘‘(II) the specified capital con- 8 tribution of the partner with respect 9 to the applicable partnership interest 10 for such taxable year. 11 If a taxpayer holds an applicable partnership 12 interest for less than the entire taxable year, 13 the amount determined under the preceding 14 sentence shall be ratably reduced. 15 ‘‘(B) SPECIFIED RATE.—For purposes of 16 subparagraph (A), the term ‘specified rate’ 17 means, with respect to any calendar year, a per- 18 centage equal to— 19 ‘‘(i) the Federal long-term rate deter- 20 mined under section 1274(d)(1) for the 21 last month of the calendar year, plus 22 ‘‘(ii) 10 percentage points. 23 ‘‘(C) APPLICABLE PERCENTAGE.— 24 VerDate Sep 11 2014 00:48 Jul 02, 2021 Jkt 019200 PO 00000 Frm 00006 Fmt 6652 Sfmt 6201 E:\BILLS\H3903.IH H3903 kjohnson on DSK79L0C42PROD with BILLS 7 •HR 3903 IH ‘‘(i) IN GENERAL.—The term ‘applica- 1 ble percentage’ means, with respect to any 2 applicable partnership interest, the highest 3 percentage of profits of the partnership 4 that could be allocated with respect to such 5 interest for the taxable year (consistent 6 with the partnership agreement and as- 7 suming such facts and circumstances with 8 respect to such taxable year as would re- 9 sult in such highest percentage). 10 ‘‘(ii) SECRETARIAL AUTHORITY.—The 11 Secretary shall prescribe rules for the de- 12 termination of the applicable percentage in 13 cases in which the percentage of profits of 14 a partnership that are to be allocated with 15 respect to an applicable partnership inter- 16 est varies on the basis of the aggregate 17 amount of such profits. Such rules may 18 provide a percentage which may be used in 19 lieu of the highest percentage determined 20 under clause (i) in cases where such other 21 percentage is consistent with the purposes 22 of this section. 23 ‘‘(D) AGGREGATE INVESTED CAPITAL.— 24 VerDate Sep 11 2014 00:48 Jul 02, 2021 Jkt 019200 PO 00000 Frm 00007 Fmt 6652 Sfmt 6201 E:\BILLS\H3903.IH H3903 kjohnson on DSK79L0C42PROD with BILLS 8 •HR 3903 IH ‘‘(i) IN GENERAL.—The term ‘aggre- 1 gate invested capital’ means, with respect 2 to any taxable year, the average daily 3 amount of invested capital of the partner- 4 ship for such taxable year. 5 ‘‘(ii) INVESTED CAPITAL.—The term 6 ‘invested capital’ means, with respect to 7 any partnership as of any day, the total 8 cumulative value, determined at the time 9 of contribution, of all money or other prop- 10 erty contributed to the partnership on or 11 before such day. 12 ‘‘(iii) REDUCTION FOR LIQUIDATION 13 OF PARTNERSHIP INTERESTS.—The in- 14 vested capital of a partnership shall be re- 15 duced by the aggregate amount distributed 16 in liquidation of interests in the partner- 17 ship. 18 ‘‘(iv) TREATMENT OF CERTAIN IN- 19 DEBTEDNESS AS INVESTED CAPITAL.—The 20 following amounts shall be treated as in- 21 vested capital: 22 ‘‘(I) PARTNER LOANS.—The ag- 23 gregate value (determined as of the 24 time of the loan) of money or other 25 VerDate Sep 11 2014 00:48 Jul 02, 2021 Jkt 019200 PO 00000 Frm 00008 Fmt 6652 Sfmt 6201 E:\BILLS\H3903.IH H3903 kjohnson on DSK79L0C42PROD with BILLS 9 •HR 3903 IH property which a partner loans to the 1 partnership. 2 ‘‘(II) INDEBTEDNESS ELIGIBLE 3 TO SHARE IN EQUITY OF THE PART- 4 NERSHIP.—The face amount of any 5 convertible debt of the partnership or 6 any debt obligation providing equity 7 participation in the partnership. 8 ‘‘(E) SPECIFIED CAPITAL CONTRIBU- 9 TION.— 10 ‘‘(i) IN GENERAL.—The term ‘speci- 11 fied capital contribution’ means, with re- 12 spect to any applicable partnership interest 13 for any taxable year, the average daily 14 amount of contributed capital with respect 15 to such interest for such year. 16 ‘‘(ii) CONTRIBUTED CAPITAL.—The 17 term ‘contributed capital’ means, with re- 18 spect to any applicable partnership interest 19 as of any day, the excess (if any) of— 20 ‘‘(I) the total cumulative value, 21 determined at the time of contribu- 22 tion, of all money or other property 23 contributed by the partner to the 24 VerDate Sep 11 2014 00:48 Jul 02, 2021 Jkt 019200 PO 00000 Frm 00009 Fmt 6652 Sfmt 6201 E:\BILLS\H3903.IH H3903 kjohnson on DSK79L0C42PROD with BILLS 10 •HR 3903 IH partnership with respect to such inter- 1 est as of such day, over 2 ‘‘(II) the total cumulative value, 3 determined at the time of distribution, 4 of all money or other property distrib- 5 uted by the partnership to the partner 6 with respect to such interest as of 7 such day. 8 ‘‘(iii) TREATMENT OF RELATED 9 PARTY BORROWINGS.—Any amount bor- 10 rowed directly or indirectly from the part- 11 nership or any other partner of the part- 12 nership or any person related to such other 13 partner or such partnership shall not be 14 taken into account under this subpara- 15 graph. For purposes of the preceding sen- 16 tence, a person shall be treated as related 17 to another person if the relationship be- 18 tween such persons would be described in 19 section 267(b) or 707(b) if such sections 20 and section 267(f) were applied by sub- 21 stituting ‘10 percent’ for ‘50 percent’ each 22 place it appears. 23 ‘‘(F) MULTIPLE INTERESTS.—If at any 24 time during a taxable year a taxpayer holds di- 25 VerDate Sep 11 2014 00:48 Jul 02, 2021 Jkt 019200 PO 00000 Frm 00010 Fmt 6652 Sfmt 6201 E:\BILLS\H3903.IH H3903 kjohnson on DSK79L0C42PROD with BILLS 11 •HR 3903 IH rectly or indirectly more than 1 applicable part- 1 nership interest in a single partnership, such in- 2 terests shall be treated as 1 applicable partner- 3 ship interest for purposes of applying this para- 4 graph. 5 ‘‘(3) NET ORDINARY INCOME.—For purposes of 6 this subsection, the net ordinary income with respect 7 to applicable partnership interests for any taxable 8 year is the excess (if any) of— 9 ‘‘(A) the taxpayer’s distributive share of 10 items of income and gain under section 702 11 with respect to applicable partnership interests 12 for such taxable year (determined without re- 13 gard to any items of gain taken into account in 14 determining net capital gain under subsection 15 (b)(1)), over 16 ‘‘(B) the taxpayer’s distributive share of 17 items of deduction and loss under section 702 18 with respect to such interests for such taxable 19 year (determined without regard to any items of 20 loss taken into account in determining net cap- 21 ital gain under subsection (b)(1)). 22 ‘‘(d) APPLICABLE PARTNERSHIP INTEREST.—For 23 purposes of this section— 24 VerDate Sep 11 2014 00:48 Jul 02, 2021 Jkt 019200 PO 00000 Frm 00011 Fmt 6652 Sfmt 6201 E:\BILLS\H3903.IH H3903 kjohnson on DSK79L0C42PROD with BILLS 12 •HR 3903 IH ‘‘(1) IN GENERAL.—The term ‘applicable part- 1 nership interest’ means any interest in a partnership 2 which, directly or indirectly, is transferred to (or is 3 held by) the taxpayer in connection with the per- 4 formance of services by the taxpayer, or any other 5 person, in any applicable trade or business. 6 ‘‘(2) APPLICABLE TRADE OR BUSINESS.— 7 ‘‘(A) IN GENERAL.—The term ‘applicable 8 trade or business’ means any trade or business 9 conducted on a regular, continuous, and sub- 10 stantial basis which, regardless of whether the 11 activities are conducted in one or more entities, 12 consists, in whole or in part, of— 13 ‘‘(i) raising or returning capital, 14 ‘‘(ii) investing in (or disposing of) 15 trades or businesses (or identifying trades 16 or businesses for such investing or disposi- 17 tion), and 18 ‘‘(iii) developing such trades or busi- 19 nesses. 20 ‘‘(B) TREATMENT OF RESEARCH AND EX- 21 PERIMENTATION ACTIVITIES.—Any activity in- 22 volving research or experimentation (within the 23 meaning of section 469(c)(4)) shall be treated 24 VerDate Sep 11 2014 00:48 Jul 02, 2021 Jkt 019200 PO 00000 Frm 00012 Fmt 6652 Sfmt 6201 E:\BILLS\H3903.IH H3903 kjohnson on DSK79L0C42PROD with BILLS 13 •HR 3903 IH as a trade or business for purposes of clauses 1 (ii) and (iii) of subparagraph (A). 2 ‘‘(e) TRANSFER OF APPLICABLE PARTNERSHIP IN- 3 TEREST TO RELATED PERSON.— 4 ‘‘(1) IN GENERAL.—If a taxpayer transfers any 5 applicable partnership interest, directly or indirectly, 6 to a person related to the taxpayer, the taxpayer 7 shall include in gross income (as ordinary income) so 8 much of the taxpayer’s recharacterization account 9 balance for such taxable year as is allocable to such 10 interest (determined in such manner as the Sec- 11 retary may provide and reduced by any amount 12 treated as ordinary income under subsection (a) with 13 respect to the transfer of such interest). 14 ‘‘(2) RELATED PERSON.—For purposes of this 15 paragraph, a person is related to the taxpayer if— 16 ‘‘(A) the person is a member of the tax- 17 payer’s family within the [Text truncated for display. 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