New PARTNERSHIPS Act Tightens Tax Rules on Large Firms, Expands 3.8% Tax on High Earners' Business Income

The Preventing Abusive Routine Tax Nonsense Enabled by Rip-offs Shelters and Havens and Instead Promoting Simplicity Act—mercifully shortened to the PARTNERSHIPS Act—is anything but simple. This bill rewrites major parts of the tax code governing partnerships (Subchapter K), focusing heavily on closing loopholes, increasing IRS oversight, and making life more complicated for large, related-party businesses. For high earners, the most immediate hit is the expansion of the 3.8% Net Investment Income Tax (NIIT) to cover certain business income, starting in the first tax year after the bill becomes law (SEC. 13).

The End of the Seven-Year Clock and Basis Adjustments

If you contribute property that has appreciated in value to a partnership, the old tax rules gave you a seven-year countdown for when the built-in gain had to be recognized if the property was later distributed to another partner. This bill repeals that seven-year limit entirely (SEC. 5). Now, that potential tax liability sticks with the property indefinitely. Furthermore, the bill makes it mandatory to use the “remedial method”—a specific accounting technique—to allocate any built-in gains or losses on contributed property (SEC. 3).

Perhaps the biggest change for many medium-to-large partnerships is the severe restriction on basis adjustments (SEC. 12). Basis adjustments are a technical tool (often called a Section 754 election) that allow a partnership to adjust the value of its internal assets when a partner sells their stake or property is distributed. This is crucial for making sure the new partner’s tax basis matches what they actually paid. The PARTNERSHIPS Act now limits the ability to make this election almost exclusively to a “qualified small business partnership”—meaning those that meet certain gross receipts tests. If your partnership doesn't qualify as a small business, this change could mean significantly more complex tax calculations and potentially higher tax bills for incoming partners, as they lose the ability to step up the basis of their share of the partnership’s assets.

Retirement Payouts Get a Tax Rewrite

For anyone planning a business exit or managing an estate, the rules for payments to a retiring partner or a deceased partner’s estate are changing dramatically. The bill repeals Section 736 (SEC. 6), which used to govern how these payments were taxed. Going forward, the retiring partner or their successor (like an estate) will be treated as if they are still a partner until every last dollar owed for their interest is paid out. This removes a well-established set of rules and replaces it with a new default treatment, which could complicate estate planning and the final tax filing for those leaving a partnership.

Expanding the 3.8% High-Earner Tax

For individuals with Modified Adjusted Gross Income (MAGI) above $400,000 (or $500,000 for married couples filing jointly), the bill expands the reach of the 3.8% Net Investment Income Tax (NIIT) (SEC. 13). Currently, this tax mostly hits passive investment income. Under the PARTNERSHIPS Act, the 3.8% tax will now apply to the greater of your net investment income or your “specified net income,” which includes income from certain active trades or businesses that was previously exempt. Essentially, if you’re a high earner running a business, some of your active business income that currently avoids the NIIT might soon be subject to the extra 3.8% tax.

The IRS Gets a New Anti-Abuse Hammer

Finally, the bill codifies a broad anti-abuse rule (SEC. 16) that gives the Treasury Secretary significant authority to challenge partnership transactions. The Secretary can now effectively ignore, recharacterize, or change a transaction if it fails one of three tests: the tax results don’t match the economic agreement, the deal's structure doesn't match its substance, or—most importantly—the transaction lacks a substantial purpose. This means that if the IRS decides the primary reason for a partnership transaction was tax avoidance, they have explicit power to rewrite the tax outcome, adding a layer of subjective risk to complex business arrangements.