WASHINGTON -- The Public Securities Association is concerned a provision in the pending tax simplification bill that is designed to ease tax accounting rules for large partnerships would set an alarming precedent for the municipal tax exemption, an association official said yesterday.

The Securities Industry Association warned Congress last week that the proposal would cause financial hardship for some of its member firms because it would require large investment partnerships to treat as taxable the tax-exempt interest they earn.

Micah S. Green, the executive vice president of the PSA, said the authors of the provision were well-intentioned in trying to simplify the partnership rules, "but in so doing we think the principle of tax exemption seems contradicted."

The group is "analyzing this to see. . .how this is related to the grander legislative picture," Mr. Green said. The association also is investigating whether the proposal would cause many large partnerships -- both in and out of the securities industry -- to avoid buying municipal bonds, he said.

Since 1988, when the Supreme Court denied the existence of a constitutional safeguard for the municipal bond exemption, some in the municipal market have said they were concerned Congress would begin eroding the exemption. But House Ways and Means Committee Chairman Dan Rostenkowski, D-Ill., and Senate Finance Committee Chairman Lloyd Bentsen, D-Tex., have said that would not happen.

The provision in question was designed to ease the current law, under which partnerships must include more than 40 tax-related items on tax forms distributed to their partners, who, in turn, use the information to prepare their federal income taxes.

The simplification legislation, introduced in June by Rep. Rostenkowski and Sen. Bentsen, would eliminate more than three-fourths of those items, including tax-exempt bond interest, which would be treated as taxable. The proposal would only apply to large partnerships in which tax-exempt income is less than 50% of the firm's assets.

While the partnership proposal might provide tax-accounting relief to some broker-dealers, "for others, such as dealers in municipal obligations whose partners will be required to include the partnerships' tax-exempt interest in their gross income, the large partnership rules will be quite onerous," the Securities Industry Association said last week in written comments to the House Ways and Means Committee.

The SIA has checked among its members and said it "is concerned that several of them are subject to the large partnership rules because they have 250 or more partners." The group did not say exactly how many of its members would be affected by the provision.

The provision does include a so-called personal services exemption for partnerships in which substantially all of their activities "involve the performance of personal services by individuals who directly or indirectly own interests in the partnership," the SIA said in its comments.

But that exemption does not solve the brokerages' problem, because many of them would not be eligible for it, the securities group said. "'Personal services,' as the term has been defined under the Internal Revenue Code, will not necessarily include the partnerships' activities," the association said.

As expected, the SIA proposed that broker-dealers be given the option of complying with an alternate set of rules that are now in effect for oil and gas partnerships.

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