Congress is debating the biggest rewrite of U.S. partnership rules in 60 years, which may lead to higher taxes for real estate and finance businesses or prompt them to restructure operations to avoid new costs.

The more dramatic of two options from Dave Camp, the top Republican tax writer in Congress, would remove some of the flexibility that has made partnerships attractive legal structures for real estate investors and hedge funds. He also offered an alternative with lesser changes to simplify some rules and leave the core of the current system in place.

The broader proposal surprised tax law specialists, who hadn’t anticipated a major policy shift for the 3.2 million U.S. partnerships. The plan may alter existing arrangements by making it more difficult to allocate income and property among partners without triggering tax consequences. Lawyers said they have spent the past week scouring Representative Camp’s draft bill, especially his new second option.

“Option 2 is radical,” said Blake Rubin, global vice chair of the U.S. and international tax practice at McDermott Will & Emery in Washington. “It would be the most significant changes to the partnership tax rules since their enactment in 1954.”

Economic Results

Real estate investors and hedge fund managers may restructure partnerships to achieve the economic results they get in the current system, perhaps by creating contractual arrangements to replicate what the tax law would prevent.

When he released the proposal, Camp said he was seeking to simplify the tax system and make the U.S. tax code more fair. The proposal would change the rules governing what are known as pass-through entities -- businesses such as partnerships that don’t pay taxes at the corporate level and instead pass their income through to their owners’ individual tax returns.

Camp’s proposal is a “significant step in the right direction,” said Victor Fleischer, a partnership tax law professor at the University of Colorado in Boulder who has criticized tax maneuvers by private equity funds and other pass- through entities.

“Pass-through entities have, increasingly, been used to facilitate aggressive tax gamesmanship,” Fleischer said in an e-mail. “Taxing pass-throughs should be about taxing all income once and only once, not shifting income around to avoid paying any tax at all.”

Structural Changes

Camp, the chairman of the House Ways and Means Committee, released the draft as part of a plan to overhaul the U.S. tax code. The proposals affecting partnerships are the third in a series of drafts that would make structural changes to long- standing features of the tax code.

The first two drafts, if turned into law, would be the most significant rewrite of international tax rules since 1962 and the most fundamental rethinking of taxation of financial products since the modern income tax began in 1913.

Camp, a Michigan Republican, hasn’t unveiled the rest of his plan, which he wants to advance through his committee this year. He has asked industry groups and others affected by the potential changes to offer comments.

“It’s potentially a very positive step forward, and it’s potentially a very negative step forward depending on how this section would fit in the larger tax reform mosaic of provisions dealing with real estate,” said Jeff DeBoer, president and chief executive officer at the Real Estate Roundtable. The Washington group’s board of directors includes executives of Dune Real Estate Partners LP and Hutensky Capital Partners.

Partnerships and other pass-through entities have become a popular way to organize businesses in the past 30 years, because of tax-rate reductions for individuals, a double tax on corporate profits and interaction with state legal structures.