Section of Taxation Publications
  VOL. 54
NO. 3
Contents | TTL Home

 Note: The following is an excerpt from the introduction to the article as published in The Tax Lawyer. Author citations have been omitted for brevity. Tax Section members may read the article in its entirety in Adobe Acrobat format.
 I Come to Bury Subchapter K, Not to Praise It
Philip E. Postlewaite*

* Professor of Law and Director of the Graduate Tax Program, Northwestern University School of Law; B.B.A. 1967, Texas Christian University; J.D. 1970, University of California at Berkeley; LL.M. in Taxation 1971, New York University.

A 1999 publication of the American Law Institute, Taxation of Private Business Enterprises—Reporters’ Study, discusses the impact on the tax law of the "Check-the-Box" Regulations, which generally permit private businesses, regardless of structure, organization, or operation, to choose among three different tax regimes—a corporation (Subchapter C), a partnership (Subchapter K), and an S corporation (Subchapter S). The Report faults the tripartite system since different tax results may arise for similarly-situated enterprises, thereby influencing taxpayer behavior and producing inefficient and unjust tax consequences. Accordingly, it advocates adopting a single tax regime by moving to a new and reformed conduit system for the taxation of private business enterprise.

Although Subchapter K is designated as the "starting point" for the development of the model tax regime, the Report ultimately favors an improved and liberalized Subchapter S regime. Because Subchapter K permits significant flexibility in allocated the partnership’s tax items among its owners, the Report asserts that such an approach tolerates allocations to partners based on their tax position and affords abusive opportunities through which to minimize individual tax liabilities. Thus, Subchapter K does not accomplish its objectives and imposes high transaction costs on both taxpayers and the Service.

The Report surprisingly deviates from its initial proposal of a single model for the taxation of private business enterprise. Instead, it ultimately offers four such models, i.e., an improved Subchapter K, a liberalized Subchapter S, a sole proprietorship for single-owner firms, and, in some instances, an elective Subchapter C. The Subchapter S regime is selected as the default classification should an enterprise fail to elect one of the others.

The Article critiques the Report. The valuable improvement in tax policy attributable to its proposal for a single tax regime for private enterprise is undercut by its subsequent advocacy of exceptions thereto. The availability of multipartite tax treatment subjects the Report’s proposals to the same criticism which it lodged against the current tripartite system. Such options are inefficient, burdensome, and inequitable. Nevertheless, the Article endorses the clarity and soundness of the Report’s initial proposal advocating the adoption of a single tax regime for all private enterprise.

The Article further advocates the exclusive adoption of Subchapter K to govern the tax treatment of all private enterprise, other than sole proprietorships, given its longevity, flexibility, and superiority to the other approaches. The Report erroneously concludes that Subchapter K is deficient in taxing income to the owners of the enterprise. The Article discusses and illustrates the Report’s faulty premises, e.g., its erroneous assumption that the paper effect of the economic effect test of section 704(b) "is a static snapshot without meaning." To the contrary, the economic effect test ensures that economic consequences ensue. If an allocation possesses economic effect, its impact by definition is long term and will continue throughout the life of the partnership. Additionally, an allocation is substantial only if there is no guarantee that offsetting allocations will be generated by the partnerships operations. If the future operations of the enterprise are sufficiently certain that the partners engage in offsetting techniques to eliminate the allocations’ economic impact, the transaction is insubstantial and the allocations will be invalidated under section 704(b)—another consequence which the Report apparently fails to grasp.


Published by
Section of Taxation, American Bar Association
With the Assistance of
Georgetown University Law Center


If you are an ABA member, you can receive The Tax Lawyer and the Section NewsQuarterly, both quarterly publications, when you join the Section of Taxation. Anyone can subscribe to The Tax Lawyer by contacting the ABA Service Center.