AI vs. the Code: A $6 Million Reality Check
By: Michael Bosma, Managing Principal
Cody and I were on a call with a client staring down the barrel of $6 million in tax. The IRS had denied a charitable deduction and, in the process, triggered a massive gain. Our client—smart and resourceful—ran our appeal through an AI tool and applied a deep-learning review. The output? “Great start, but you missed a key point.”
AI (and the IRS position it echoed) claimed that pre-contribution gain on property contributed to a partnership must always be allocated to the original contributing partner—full stop. Reading it, you could believe we’d overlooked something big.
The Rule—In Plain English
We didn’t miss it. In fact, this is well-settled law:
- IRC §704(c)(1)(A) requires that tax items tied to contributed property reflect the difference between tax basis and fair market value when the property enters the partnership.
- Treas. Reg. §1.704-3(a)(1) prevents shifting built-in gain or loss away from where it belongs.
- Treas. Reg. §1.704-3(a)(7) goes further: if a partner transfers part (or all) of their partnership interest, the transferee steps into the transferor’s §704(c) shoes to that extent. In other words, the built-in gain allocations follow the interest, not the person who used to own it.
- Authorities like Rev. Rul. 99-5 and Rev. Rul. 99-6 (different contexts) reinforce that a transferee generally inherits the transferor’s tax posture on partnership items, and CCA 200648019 aligns with the Service’s own view that §704(c) allocations carry over to transferees.
Translation: If you contribute appreciated property to a partnership and later gift a fraction of your partnership interest—say to a charity—the charity succeeds to its proportionate share of the §704(c) allocations. The built-in gain doesn’t magically stick 100% to the original contributor forever; it tracks the interest that was transferred.
Why This Matters
That nuance changed the outcome. The “always the contributor” mantra was too simplistic. The code, the regs, and the Service’s own guidance say otherwise. In this case, discipline beat fear, and the rulebook beat the black box.
Nuggets of Wisdom From the Field
- Use AI for speed, not truth.
AI is a force multiplier for drafting and cross-checking. But it’s not an authority. Treat it like a sharp intern—fast, helpful, occasionally wrong. - Know the rules, and you rule the outcome.
Our world is rules-based. When the stakes are high, cite before you decide. Let the Internal Revenue Code and regulations—not a narrative—drive the answer. - Never make big decisions from fear.
Fear is a poor strategist. The worst client outcomes I’ve seen were rushed. Slow down, get the facts, model the options. Logic and reason win over panic. - Document the ‘why,’ not just the ‘what.’
In exams and appeals, your reasoned pathway is as important as your conclusion. Show your work—authorities, assumptions, and alternatives considered. - Surround yourself with complementary experts.
The best outcomes happen when tax, legal, valuation, and deal teams collaborate early. That’s “Better Together” in action.
Closing Thought
Technology is changing how we work, but depth of understanding still determines outcomes. Use the tools. Lead with the law.
#BetterTogether