Tax reform and the IRS: Five takeaways for tax practitioners

Editor: Mary Van Leuven, J.D., LL.M.

Tax collectors have never won popularity contests. Indeed, railing against the perceived unfairness and inefficiency of the tax system — and imputed incompetence and bad faith of the tax collectors charged with administering it — has long been a staple of modern public debate, manifesting itself in everything from Beatles songs to U.S. presidential campaigns.

Thus, two years ago, the Republican Party adopted a platform that proclaimed that the Internal Revenue Code (not for the first time) was “the object of both anger and mockery” and promised that, once tax reform was passed, the IRS would become “obsolete” and could be “abolished” (Republican National Convention, “Republican Platform 2016,” pp. 1 and 27 (July 17, 2016)). Following the 2016 election, President Donald Trump and the Republican leaders of the House and Senate made tax reform a top priority, and the enactment of P.L. 115-97 in December 2017, known as the Tax Cuts and Jobs Act (TCJA), became the signal achievement of Trump’s first year in office.

That said, few in Washington are writing the IRS’s obituary, and while some members of Congress continue to voice support for reforming, restructuring, or even abolishing the agency, no consensus exists on what a post-reform IRS will look like. Even so, the activities and priorities of the IRS in 2018 (and onward) are by no means the same as they were in 2017 (and before). Tax administration, post-tax reform, is markedly different than before, for several reasons. Here are five quick takeaways.

Takeaway No. 1: Tax reform means more work for the IRS

Anytime Congress enacts major legislation, the agency charged with enforcing the new law has the challenge of juggling its new responsibilities with its extant ones, and that truism clearly applies to the TCJA. What makes the 2017 tax law unique, however, is the speed and opacity with which the legislative language was developed, considered, and passed into law. Compared with its 1986 counterpart, which was first released in bill form in May 1985 and not finally approved by Congress until late October 1986, the 2017 law moved quickly. The House version of the 2017 bill was not released until Nov. 1, and the final legislation was approved by Congress on Dec. 20 and signed by the president two days later. Members of Congress, the IRS, taxpayers and their representatives, the media, and the public at large scarcely had time to skim, let alone comprehend and offer comments on, the nearly 200-page bill (and over 700-page conference report) before the legislative process was complete.

One important consequence of last year’s truncated legislative schedule is that the final legislation contains myriad glitches, gaps, errors, and ambiguities — as well as inconsistencies between congressional intent (as set forth in the meager legislative history) and what the words of the statute mandate. Significantly, since the final bill introduces several brand-new concepts into the Internal Revenue Code — such as the intricate regimes for taxing foreign-source income passthrough entities — the not-always-clear legislative language virtually begs for exposition, line-drawing, and interpretation.

The net result of the process used and the breadth and magnitude of changes made is that the IRS’s overall task in implementing the new law is far from ordinary or mundane. Further complications flow both from the temporary status of the new law’s tax rates and the now-you-see-it, now-you-don’t nature of many of the technical provisions. Even the mundane tasks associated with the new law — such as revising the withholding tables to reflect lower tax rates and changes to the rules relating to dependents and exemptions — can be,>

Treasury and the IRS’s 2017-2018 priority guidance plan, as updated in February 2018, which contains 29 new projects, 18 of them related to the 2017 tax reform law, is only the first tranche of guidance projects engendered by the legislation. Among the scores of interpretative duties spawned by the new law are the following:

• Determining how foreign subsidiaries and other controlled foreign corporations should calculate their earnings and profits for purposes of the repatriation tax, which is due with most U.S. corporate parents’ or U.S. shareholders’ 2017 returns (and subject to estimated tax payments beginning early in 2018);
• Implementing the new withholding obligation under Sec. 1446(f) for transfers of certain partnership interests;
• Explaining the scope and operation of the new deduction for qualified business income under Sec. 199A, including the crafting of anti-abuse rules;
• Determining the contours of the law’s limitations on the deductibility of business interest under Sec. 163(j); and
• Determining how to calculate income subject to the global intangible low-taxed income and foreign-derived intangible income provisions.

Even assuming the meaning and operation of the new provisions are either clear-cut or easily determined, the implementation of the rules is not something that can be done by a click of a mouse or the flip of a switch. Earlier this year, National Taxpayer Advocate Nina Olson reported that the 2017 tax reform law implicates 131 filing season systems with an astounding number of programming and systems updates and requires new and revised forms and instructions; employee training; and new systems to verify compliance, eligibility, and documentation. She also said the IRS needs an additional $495 million in 2018 and 2019 to perform these tasks, plus answer taxpayer phone calls and issue new guidance.

Takeaway No. 2: It is unclear whether the IRS will receive sufficient funds to implement the 2017 tax reform law while doing its ‘regular job’

Even before the TCJA was passed, the IRS faced a daunting task. Since 2010, the agency has seen its budget cut by $900 million (or 20% in inflation-adjusted terms) and endured a concomitant reduction in staffing of 21,000, or 23% (a 20-year low). Beginning that same year, the agency became responsible for implementing significant portions of two major laws — the Patient Protection and Affordable Care Act, P.L. 111-148, and the Foreign Account Tax Compliance Act, P.L. 111-147 — plus numerous other new provisions — while having to cope with the workload associated with nearly 10 million additional individual returns (owing to population growth).

These budget reductions — attributable in part to congressional concerns about the IRS’s handling of requests for tax-exempt status by “Tea Party” organizations — have had very real consequences. For example, individual audit coverage in 2017 was a bit over 0.6% — the lowest since 2002 and the sixth year in a row that the audit rate declined. What’s more, substantially more audits are being conducted via correspondence (71% of the total) rather than face to face. Fewer corporate returns were audited during FY2016 than any year since FY2004, and in FY2017, the IRS audited just under 935,000 individual income tax returns — the lowest number in 14 years.The correlation between the IRS budget and tax collections led Treasury Secretary Steven Mnuchin to testify at his confirmation hearing in early 2017 that “the IRS is under-resourced to perform its duties” and that additional funding was necessary to help close the tax gap.

Although Mnuchin’s views did not carry the day in terms of the Trump administration’s fiscal 2018 and 2019 budget proposals — which both proposed reducing the IRS’s overall funding — they confirmed the nexus between budget dollars and tax administration. (Mnuchin has acknowledged the IRS needs at least a $400 million budget increase to implement the TCJA (“Statement of Steven T. Mnuchin, Secretary, United States Department of the Treasury Before the Committee on Appropriations Subcommittee on Financial Services & General Government” (March 6, 2018)). In the Consolidated Appropriations Act, 2018, P.L. 115-141, the IRS received $320 million for FY 2018 to carry out changes made by the TCJA.

Furthermore, during the debate on the TCJA, the Senate Finance Committee approved a “sense of the Senate” statement that politically motivated budget cuts are counterproductive to deficit reduction, diminish the IRS’s ability to adequately serve taxpayers and protect taxpayer information, and reduce the IRS’s ability to enforce the law. This language, however, was not included in either the final legislation or the conference report, and while both tax-writing committees have acknowledged, post-enactment, that they would “listen” to requests for more funding, they seemingly remain skeptical. Thus, Kevin Brady, R-Texas, the chairman of the House Ways and Means Committee, has said that “the assumption is not that we’re opening up the pocketbook.” This reality leads to the following takeaway.

Takeaway No. 3: Tax reform means that the IRS’s ability to do its ‘normal’ work will likely be affected

While “doing more with less” is a familiar refrain in some management and government circles, a more apt expression when it comes to tax administration — one that was used by former IRS Commissioner John Koskinen — is “doing less with less.” The challenge, of course, is achieving consensus on what not to do. History teaches that consensus will likely be difficult if not impossible to achieve.

Hence, members of Congress; professional associations such as the AICPA, the National Association of Enrolled Agents, and the American Bar Association; taxpayer groups; the media; and the Taxpayer Advocate Service have all in recent times lamented the reduced quality (and volume) of taxpayer service, insufficient IRS personnel and training, and a lack of investment in new and better tax administration technologies (including those related to cybersecurity and online access to accounts by taxpayers and their representatives). And nearly all stakeholders acknowledge the link between reduced funding and less-than-optimal results.

More to the point, the shortcomings of the pre-tax reform “do less with less” outlook will only grow more pronounced as the IRS moves with urgency to address the mandatory tasks related to the TCJA. For example, the IRS has already detailed staff away from their normal jobs to address needed changes to hundreds of tax forms, withholding tables, and the like. For the IRS to be ready for next year’s filing season, the programming needs to be done now. These trade-offs will not end soon.

Takeaway No. 4: While the need for guidance under the TCJA is compelling, guidance may be delayed because of several ‘structural’ constraints

Even in the best of circumstances, developing and issuing guidance takes time. Consider a few of the questions that must be answered when transforming legislative language into administrable rules, regulations, etc.:

• What is the question prompted by the statute (and how it relates to other provisions of the Code)?
• Did Congress anticipate and express a view on how the question should be answered?
• What is the best answer to the question?
• Does the statute permit that answer; i.e., does the IRS have authority to answer the question, or is a technical correction or other legislation required to answer the question in an acceptable fashion?
• How large is the constituency for the guidance, how pressing is the need, and is it likely (or possible) that Congress might enact either a technical correction or other legislation affecting the statute?

After the substantive questions are tentatively answered (tentatively, since the answers may change and the process continues), the timing of when answers are released depends on several procedural issues.

• Form of guidance: What form should the guidance take (e.g., regulations, notices, revenue procedures, forms and instructions, frequently asked questions, or perhaps something as informal as a press release, speech, or other statement)?

Who approves? Who needs to approve the answer (at the IRS or Treasury)? Does the absence of “permanent” leadership at the IRS — i.e., a confirmed commissioner or chief counsel — affect the timing of when guidance can be issued (or the priorities for which questions are considered first)?

 

Does the answer need to be approved by the White House Office of Information and Regulatory Affairs (OIRA) (part of the Office of Management and Budget) under the 1980 Paperwork Reduction Act? (Historically, most tax rules were exempt from OIRA review, but that policy was changed in April 2018.)

• Is there a need for public input?

Does the answer need to be released in proposed or temporary form, subject to the notice-and-comment provisions of the Administrative Procedure Act and, regardless, does the recent decision in Altera Corp., 145 T.C. 91 (2015), appeal pending (holding that the IRS must examine relevant data, such as taxpayer comments on the proposed rule, and demonstrate that its final rule was the product of “reasoned decisionmaking”), have any relevance?

If the answer is provided via temporary regulations, does Sec. 7805(e)(2), relating to how long temporary regulations can be outstanding, have any relevance?

Takeaway No. 5: When Congress turns to ‘restructuring’ the IRS, it is unclear how dramatic the changes will be

At a congressional hearing in February on whether and how structural changes to the IRS should be adopted, Acting Commissioner David Kautter (who is also the assistant secretary of the Treasury for tax policy) testified that Congress should take care that restructuring efforts not impede the IRS’s ability to implement the new law (“Written Testimony of David J. Kautter, Acting Commissioner, Internal Revenue Service, Before the Senate Finance Committee on IRS Budget and Current Operations” (Feb. 14, 2018)). To be sure, restructuring some parts of the IRS — those relating to criminal investigations, appeals, and taxpayer assistance — could potentially be addressed without adversely affecting the TCJA’s implementation process. In the administration’s view, however, others should be postponed.

One thing is clear, though: The IRS cannot be abolished, because it is the linchpin in making the new law work (the old law, too). Thus, while changes to the IRS are likely not imminent, a bipartisan bill released in spring 2018 hints at the types of potential structural changes Congress may ultimately consider.

The so-called GOP Blueprint, from which the TCJA sprung, was released in the summer of 2016, and it is short on specifics, generally and in terms of what the “new IRS” should look like (“A Better Way: Our Vision for a Confident America” (June 24, 2016)). While pledging to deliver “world-class customer service” with a team of legal professionals dedicated to providing guidance and information, the Blueprint does not address in any detail how the revamped agency would differ in structure and operation from the old one. The Blueprint envisions an IRS consisting of three major units:

• A families and individuals unit focused on providing state-of-the-art customer service;
• A business unit focused on administering the new Code provisions for businesses of all sizes and types; and
• A “small claims court” unit, independent of the IRS, which would allow disputes to be resolved more quickly.

The document, however, is scant on details. For example, the relationship of the “small claims court” unit to the current Tax Court (or Appeals Division) is not discussed. Nor is the agency’s field structure, the role of the Office of Chief Counsel, or the IRS’s relationship with Treasury. In short, the Blueprint’s discussion about the “new IRS” was neither lengthy nor particularly sophisticated.

That may change soon, however. In January, Congress held a hearing on improving tax administration, and the witnesses focused, among other things, on improving taxpayer service, providing better support to tax practitioners (including expanded online services), and enhancing oversight of the agency. Members of the Ways and Means Committee, including Chairman Brady, have expressed interest in improving the IRS’s dispute resolution process. And in the runup to the April 15 filing deadline for individual tax returns, the top Republican and Democrat on the House Ways and Means Oversight Committee released draft legislation, the Taxpayer First Act. Although the proposed changes are scarcely dramatic, the legislation does contain numerous provisions intended to reinforce the fairness — and perceived fairness — of the tax dispute process. While it is too early to conclude how the IRS might be reorganized, prudent taxpayers and advisers ought to remain attuned to developments.

These articles represent the views of the author(s) only, and do not necessarily represent the views or professional advice of KPMG LLP. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser. 

EditorNotes

Mary Van Leuven is a director, Washington National Tax, at KPMG LLP in Washington.

For additional information about these items, contact Ms. Van Leuven at 202-533-4750 or mvanleuven@kpmg.com.

Unless otherwise noted, contributors are members of or associated with KPMG LLP.