Partnerships may be subject to new tax rules in the future.

The staff of the House tax-writing committee released a discussion draft in March of a complete rewrite of the US tax rules for partnerships.

The draft is the third in a series of discussion drafts that the staff has been releasing for comment as it works out possible elements of a major corporate tax overhaul. The other two discussion drafts released earlier dealt with tax treatment of US multinational corporations on income earned outside the United States and the tax treatment of derivatives, like futures and forward contracts, swaps and options.

The rewrite of the partnership tax rules would apply starting next year, assuming Congress finds time to take up major tax reform in 2013. However, most lobbyists think any tax overhaul is unlikely to be enacted before next year at the earliest.

The new rules could affect some existing tax equity transactions structured as partnerships.

There are no transition rules in the draft. These are usually not added until a bill starts moving through the tax-writing committees and to the House and Senate floors.

The discussion draft would eliminate any distinction between partnerships and S corporations (a form of passthrough entity used by small businesses). Instead, an entity would either be a “passthrough” or a “corporation” for tax purposes. Taxpayers could elect to treat corporations as passthroughs, but this election would not be available for any publicly-traded corporation, bank or insurance company. “Publicly-traded” is broadly defined.

Passthroughs would have to withhold taxes on the income allocated to partners. The rate has been left blank.

The partners would have refundable income tax credits for the withheld taxes.

Partnerships would not be able to make special allocations of depreciation or other elements that go into the calculation of ordinary income. However, tax credits could be allocated in a different ratio than other partnership items. Allocations to each partner would have to be consistent with the partner’s “economic interest.” The term is not defined.

The draft is unclear about whether master limited partnerships would be able to continue operating as passthroughs. However, the staff director of the House tax subcommittee said in an email that the issue was simply beyond the scope of the draft. “Changes to the tax rules governing those specific regimes (in the context of tax reform) are a discussion for another day.”

The draft is one of two options the committee is considering for partnerships. The other option is a list of incremental changes rather than a wholesale rewrite.