Don’t Let Capital Accounts go Negative

13 Pages Posted: 16 Nov 2010

See all articles by Calvin H. Johnson

Calvin H. Johnson

University of Texas at Austin - School of Law

Date Written: November 16, 2010

Abstract

Calvin H. Johnson is a professor of law at the University of Texas. The author wishes to thank Deborah Geier, Adam Rosensweig, John Steines, and Patrick O’Daniel for helpful comments on a prior draft without binding them to conclusions with which they disagree.

A negative capital account is a partnership tax concept describing the situation in which adjusted basis in partnership assets is less than the outstanding debt of the partnership. When the capital account is negative, the partnership is a tax shelter, worth more after tax than in the absence of tax. The shelter subsidy distorts the use of capital and induces investment into projects that are not justified by their real pretax economic merits. The term "negative capital account" is now used only in the partnership tax context, but the underlying concept of adjusted basis below debt applies to assets owned by a single corporation or individual.

This proposal would prohibit deductions that would reduce a taxpayer’s capital account below zero. Subsidies resulting in negative tax should be given only when justified by the federal budget process. Real business activity that does not depend on the negative tax would be unaffected by the proposal.

Deductions suspended by the tax limitation would be allowed when the capital account is positive by enough to allow the deduction because the debt is paid off or income or contributions come into the activity. The adjusted basis side of the capital account would include all assets that could be reached by the liability.

The proposal is made as a part of the Shelf Project, a collaboration among tax professionals to develop proposals to raise revenue. The Shelf Project is intended to raise revenue without a VAT or a rate hike in ways that will improve the fairness, efficiency, and rationality of the tax system. Now is the time for congressional staff work to be done to prevent the impending revenue crisis. An overview of the Shelf Project is found in "How to Raise $1 Trillion Without a VAT or a Rate Hike," Tax Notes, July 5, 2010, p. 101, Doc 2010-13081, or 2010 TNT 129-4. Congress adopted its first Shelf Project in March 2010. New section 871(1), enacted in the Hiring Incentives to Restore Employment Act, is based on the Shelf Project proposal by Reuven S. Avi-Yonah, "Enforcing Dividend Withholding on Derivatives," Tax Notes, Nov. 10, 2008, p. 747, Doc 2008-22806, or 2008 TNT 219-34.

Shelf Project proposals follow the format of a congressional tax committee report in explaining current law, what is wrong with it, and how to fix it.

Suggested Citation

Johnson, Calvin Harsha, Don’t Let Capital Accounts go Negative (November 16, 2010). Tax Notes, 2010, U of Texas Law, Law and Econ Research Paper No. 191, The Shelf Project, Available at SSRN: https://ssrn.com/abstract=1710160

Calvin Harsha Johnson (Contact Author)

University of Texas at Austin - School of Law ( email )

727 East Dean Keeton Street
Austin, TX 78705
United States
512-232-1306 (Phone)
512-232-2399 (Fax)

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