Suggestions to Get Up to Speed on (Some) Issues With the New Tax Law

Tax professionals have a stocking full of tax law to read, digest and apply.

Here are some of the articles and posts I read yesterday that I think readers may enjoy as well:

  • Professor Dan Shaviro, in a post in his insightful blog Start Making Sense, foreshadows a follow up paper to the Tax Games article we flagged the other day and critiques the passthrough deduction giveaway;
  • Smart and perceptive post in the Medium by Professor Dan Hemel (one of the Tax Games authors) and Professor Ellen Aprill on the Byrd Rule’s impact on the legislation;
  • A post from Victor Thuronyi over at the Surly Subgroup discussing the need and precedent for a technical corrections bill that this time may do quite a bit more than just fixing some glitches; and
  • Nice summaries in the WSJ [$] and NYT [$]discussing the fate of individual deductions and the general impact of the legislation on individuals.

UPDATE: We will keep adding helpful links to this post and invite you to post sources in the comments that you have found to be helpful

  • Tax Foundation summary of differences between Conference Report and current law, with nice clean visuals highlighting the differences
  • Professor Shaviro’s latest post, predicting a new day for shelter type transactions that will generate pre tax losses and after tax benefits to take advantage of the passthrough rules.
  • NYT [$} discussing the challenges IRS faces in light of the sweeping changes
  • Davis Polk’s helpful hyperlinked guide to the language in the  tax bill
  • KPMG summary and observations of the bill
  • Twitter thread from NYU Law Prof David Kamin (and Tax Games co-author) talking about the tax somersaults people will soon be engaging in to fall within the “sloppily written” provisions that are hard to justify
  • Sam Brunson at Surly Subgroup talks about the differences between the bill’s elimination of the dependency exemption and the heightened CTC, and how families with children over 16 who would have qualified as dependents under current law may be getting a lump of coal next year

Final Version of Tax Bill Released

The text of the bill’s language, as well as the Conference explanation starting at page 507, can be found here.

 

Paper Highlights How Taxpayers Can Game Proposed Tax Legislation

A group of mostly law school academics and one partner at a large law firm has written an important article highlighting some major problems with the current tax legislation. Here is the abstract from The Games They Will Play: Tax Games, Roadblocks, and Glitches Under the New Legislation

This report describes various tax games, roadblocks, and glitches in the tax legislation currently before Congress. The complex rules proposed in the House and Senate bills will allow new tax games and planning opportunities for well-advised taxpayers, which will result in unanticipated consequences and costs. These costs may not currently be fully reflected in official estimates already showing the bills adding over $1 trillion to the deficit in the coming decade. Other proposed changes will encounter legal roadblocks that will jeopardize critical elements of the legislation. Finally, in other cases, technical glitches in the legislation may improperly and haphazardly penalize or benefit individual and corporate taxpayers. This report highlights particular areas of concern that have been identified by a number of leading tax academics, practitioners, and analysts.

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We have previously posted on the House and Senate versions of tax legislation, though have noted that for the most part the proposed legislation does not have many provisions that directly address tax procedure or tax administration.

I recommend this paper to our readers. It invariably follows that whenever there is tax legislation some very smart people consider ways to exploit the legislation’s ambiguities. For years, Congress, the IRS/Treasury and the courts are left to legislate, administer and adjudicate around the uncertainty.

Yet as the authors describe in this paper, the proposed Senate and House legislation presents gaming opportunities of a different scale. Consider two of the key domestic provisions, the lowering of rates on C Corps and the preferential treatment of passthrough entities. As the paper discusses, in the absence of major changes, or broad anti-abuse provisions that require an engaged and funded IRS, there are likely to be gaming and planning opportunities spinning off this that will keep the tax advice business fully employed.

For those who do not have the time to read the paper take a look at the Twitter feed of Tax Notes regular Martin Sullivan, who neatly summarizes the paper in a series of tweets (I list the first seven of these; his twitter feed has a bunch more):

  • “Tax Games” Paper warning to Congress #1: Malpractice for advisors not to advise clients to use of C corps as shelter so interest otherwise taxed at up to 43.4% will be taxed at 20% under new bill
  • “Tax Games” Paper warning to Congress #2: Malpractice for advisors not to advise clients to use of C corps as shelter so tax on dividends otherwise taxed at up to 23.8% will be taxed at 10% under new bill
  • “Tax Games” Paper warning to Congress #3: Employees (presumably wealthy, who do not need immediate cash) can become C corps and instead of getting salaries taxed at regular rates can pay 20% tax now and defer or completely eliminate tax on distribution
  • “Tax Games” Paper warning to Congress #4: Active business owners of C Corps can minimize taxes by paying themselves low salaries. Determining “reasonable compensation” is a judgment call fraught with controversy.
  • “Tax Games” Paper warning to Congress #5: Taxpayer can put C corp in Roth IRA and, if payouts delayed to retirement, only pay total of 20% tax on C corp income.
  • “Tax Games” Paper warning to Congress #6: Employees at service firms can form own partnerships and charge for services in lieu of salary. Then they receive 23 percent deduction (in Senate bill) on fees for service instead of paying full freight on wages.
  • “Tax Games” Paper warning to Congress #7: Limits on doctors and lawyers and such qualifying for passthrough benefits can be avoided by splitting business into unqualified professional business and qualified business that provides services

Many of the House and Senate provisions will likely allow the well-advised to game the system. Less sophisticated employee/taxpayers will be left behind. The result will be more pressure on IRS/Treasury and the courts to police abuses and attempt to figure out who is on the right side of Congress’ largesse. So, while the proposed legislation may not have in the traditional sense many tax procedure and administration provisions it will, if enacted, be the most significant legislative development relating to tax administration for decades to come.

UPDATE: To see Martins Sullivan’s summary of the paper see here

Authors of Tax Games paper:

Reuven S. Avi-Yonah  University of Michigan Law School

Lily L. Batchelder New York University School of Law

J. Clifton Fleming Jr. Brigham Young University – J. Reuben Clark Law School

David Gamage  Indiana University Maurer School of Law

Ari D. Glogower Ohio State University (OSU) – Michael E. Moritz College of Law

Daniel Jacob Hemel  University of Chicago – Law School

David Kamin  New York University School of Law

Mitchell Kane  New York University

Rebecca M. Kysar  Brooklyn Law School; Fordham University School of Law

David S. Miller  Proskauer Rose LLP

Darien Shanske  University of California, Davis – School of Law

Daniel Shaviro  New York University School of Law

Manoj Viswanathan  University of California Hastings College of the Law

 

 

 

 

 

 

 

Republican Tax Bill Passes Senate

The Senate passed sweeping tax legislation last night. There is lots to digest in the bill, and there still is a reconciliation process to clear up differences between the House and Senate versions. As with the House legislation, there is not much procedure in the bill, though some of the substantive changes have major administrative implications.

While not the main focus, the Senate bill has some procedural provisions, which I highlight below:

  • Changes the due diligence rules to include due diligence requirements associated with Head of Household filing status as well as CTC, EITC and AOTC;
  • Extends time to return property subject to levy under Section 6343 from nine months to two years;
  • Extends time to bring a wrongful levy suit under Section 6532 from nine months to two years;
  • Caps user fees for installment agreements and explicitly waive fees for taxpayers at or under 250% of federal poverty guidelines;
  • Defines proceeds under the whistleblower provisions to include interest and penalties under internal revenue laws and proceeds from laws IRS investigates, administers or enforces including criminal fines, civil forfeitures and violations of reporting requirements; and
  • Modifies rules relating to property exempt from levy due to the elimination of the dependency exemption deduction and the increase in the standard deduction; the Senate bill provides that the amount that escapes levy is the sum of the standard deduction and $4,150 times the number of dependents in the taxpayer’s household. Given the increase in the standard deduction this amounts I believe to an additional amount of income that will be free of IRS levy; however absent submission of a verified statement the IRS is to treat a taxpayer as a MFS taxpayer with no dependents.

This is a moving target, and what comes out of the sausage factory is still up for grabs.

 

 

Delinquency Penalties: Boyle in the Age of E-Filing

The issue of when a taxpayer can be insulated from the imposition of civil penalties when the taxpayer depends and relies on the advice of a tax professional is an issue that we have discussed many times on PT and which fills many pages in the Saltzman Book treatise IRS Practice and Procedure. This month the American College of Tax Counsel (ACTC) filed an amicus brief in the Fifth Circuit case Haynes v US, which looks at the issue with a modern twist: can a taxpayer who uses an authorized e-filer expecting that the return be timely filed avoid a delinquency penalty if in fact there was an error in the processing of the e-filed return but the IRS or the preparer did not notify the taxpayer of the error until a couple of years passed and penalties accrued?

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As many PT readers know, Boyle creates a bright line that prevents taxpayers from arguing reasonable cause based on good faith reliance on an advisor when it comes to meeting tax-filing deadlines. Boyle is a Reagan era case, well before today’s e-file world. The brief, which is exceptionally well done, explains that many e-file reject returns would clearly be accepted as returns under the Beard test if they were sent in via snail mail. The current e-file regime essentially makes it easy for rejects, as IRS has required taxpayers to identify prior year’s AGI or a special PIN to verify the return (a task not all are up for).

As I have discussed previously when IRS rejects an e-filed individual income tax return that cannot be rectified taxpayers “must file the paper return by the later of the due date of the return or ten calendar days after the date the IRS gives notification that it rejected the electronic portion of the return or that the return cannot be accepted for processing.” (as per the Handbook for Authorized E-file Providers of Individual Income Tax Returns). If there is no timely notification and little way for the taxpayer to independently check whether the return was rejected, it seems unfair to apply Boyle in these circumstances.

The ACTC brief (note: Keith and I are ACTC fellows though we did not participate in the drafting of the brief; Peter Connors of Orrick and Professor Jon Forman at Univ of Oklahoma Law School led the charge for ACTC ) makes the case much more forcefully. As the brief discusses, the act of e-filing is not nearly as simple as placing a paper return in the mail. Requiring a taxpayer to independently check to ensure that the return has been accepted, absent major developments in the so-called Future State of tax account information, seems to me unfair. By requiring a taxpayer to double check with the preparer or IRS to ensure that the e-filed return has been accepted places additional burdens on taxpayers using a preparer. If anyone should have that responsibility, it is the preparer, and a preparer who fails to ensure that the IRS has accepted the return should face the penalty music, not the taxpayer.

We will watch this case with interest and keep readers posted.

“I Thought I Was Getting a Refund” is An Inadequate Excuse for Late Filing

Parekh v Commissioner  raises what I suspect to be a fairly common situation: a taxpayer believes that he is due a refund, and because of that belief may not file a tax return on time or even request an extension. Because the penalty for failing to file a timely tax return depends on the presence of a tax liability, if the taxpayer believes he is due a refund he may not feel the need to file by the April 15 deadline. (Of course, there still is a need to file a return, which serves both as an original return and as a refund claim, lest you blow the SOL on refunds, but that is another story and perhaps another blog post).

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Sometimes, as in Parekh, the taxpayer is off on the calculations, and in fact does owe taxes. Parekh tees up the issue as to whether a taxpayer can have reasonable cause for not timely filing if the reason for the late (in this case 15-months late) filing is due to the taxpayer believing that it did not really matter because he thought he was getting money back from Uncle Sam.

Here are the facts, somewhat abbreviated. Parekh and his wife filed their 2012 return about 15 months late, and did not request an extension. IRS audited the return, and proposed an approximate $8,000 deficiency due to alternative minimum tax, which the original return did not calculate, as well as a $1,666 late filing penalty under 6651(a)(1). The Parekhs conceded the tax but disputed the penalty. Appeals had found no reasonable cause for the late filing, noting also that the taxpayers had a prior history of late filing and for good measure were late on subsequent returns (important as this likely  took them out of qualifying for the first time abatement, an issue Stephen has discussed before).

The taxpayer’s argument centered on his belief that there were no consequences for late filing a return that reflected a refund:

I figured, reasonably so I thought, that since I’d be getting a refund it was OK to file late * * * . In fact, I had considered the de facto deadline for filing to be three years if one is getting a refund since after that the refund is forfeited. As I take a quick look at some tax advice websites this is pretty much what they say. For example: “if they owe you a refund, the IRS really doesn’t care when you file. In fact, you have three years to file and still get your money.”

In 2012, however, they had an AMT liability due to a job switch and the unusual occurrence of distributions from retirement accounts associated with his former employer.   At trial, and as the opinion notes only after retaining an attorney, the husband also claimed that the late filing was due to frequent travel both to Oklahoma for his new job and on numerous trips to India to care for a sick parent.

This did not amount to reasonable cause. In getting to that conclusion, the opinion notes that at trial the husband agreed that the return was not complicated, and could have been prepared “in a day or two.”

The opinion lists some (not exhaustive) examples where a taxpayer was able to demonstrate that the delinquency was due to reasonable cause and not willful neglect:

  • unavoidable postal delays,
  • the timely filing of a return with the wrong IRS office,
  • the death or serious illness of a taxpayer or a member of his immediate family,
  • a taxpayer’s unavoidable absence from the United States, or
  • reliance on erroneous advice from a competent tax adviser or IRS officer.

The combination of past returns generating a refund and  some unexpected domestic and international travel due to job changes and family illness, especially when the current year was not complex, does not amount to reasonable cause:

Even if we were to credit petitioner husband’s testimony about his heavy travel schedule, it is inconceivable that he could not have found two days in which to fulfill petitioners’ filing obligation, as opposed to filing that return 15 months late. His response at trial–that “he didn’t think his tax return was something he had to do that very minute”–suggests that he did not take petitioners’ timely filing obligation seriously. (emphasis added). If petitioners truly intended to satisfy that obligation but were incommoded by problems suddenly arising in spring 2013 they could have requested an automatic six-month extension of time to file, as they eventually did for their 2014 taxable year. See sec. 6081. Their failure to request such an extension suggests, once again, that the real reason they filed late was their belief that the filing deadline did not matter because they were expecting a refund.

The moral of the story is that while sometimes it may not matter for penalty purposes if a taxpayer files late, the taxpayer should be sure that the return is going to generate a refund. In addition, the late filing of a return that has a liability raises the possibility that the taxes could not be discharged in bankruptcy, an issue Keith has flagged.Doing the math (or more likely plugging in the information on the software) before the fact can save a chunk of change and in some circuits preserve the potential for discharge.

 

 

Tax Court Judicial Conference Application Deadline Extended to This Friday

Readers may have heard that the Tax Court is holding a judicial conference from Monday evening March 26 to mid-day on Wednesday, March 28, 2018 at Northwestern University Law School. The Tax Court has issued a release about the conference, including information about how to apply to attend.

The Tax Court has extended the deadline to apply, from Wednesday until Friday, November 17.

The Tax Court release discusses the court’s interest in attracting a diverse conference community. The conference will be an opportunity to hear panels on issues of interest to tax litigation as well as give the court a chance to get feedback on ways to improve the tax litigation process. The panels consist of judges, academics, and practitioners from government and the private sector.

Getting together with people who share an interest in the tax litigation process sounds like a great way to spend a few days.

Court Orders Release of IRS Documents Despite Deliberative Process Privilege

Government agencies enjoy the cloak of the deliberative process privilege to protect from discovery in court or in FOIA proceedings internal deliberations that are part of their decision making process. Anadarko Petroleum v United States, a recent district court magistrate’s order, illustrates that the protection is not absolute, resulting in possible disclosure of a range of IRS documents that perhaps will shed light on how the agency apparently changed its view on a technical loss deferral regulation under Section 267.

I will summarize the issue and case below.

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Anadarko brought a $25 million refund suit; the substantive issue involved its taking a loss that arose from a liquidation of one of its subsidiaries. The precise question concerned whether a deferral of the loss ended in 2007, when Anadarko liquidated its subsidiary in a taxable liquidation. The government argued that the deferral should have continued, consistent with a regulation Treasury promulgated under Section 267 in 2012 and which Treasury claimed at the time was clarifying existing rules.

In the suit, Anadarko served interrogatories and sought a variety of documents that it felt showed that the 267 regulations did not clarify existing rules because IRS had previously taken differing views on the issue. It asked for documents relating to private letter ruling, a Chief Counsel advisory opinion and even an ABA Tax Section presentation at or around the time of finalizing the regs.

The government argued that the deliberative process privilege insulated the documents from discovery. That privilege essentially keeps from FOIA requests or court discovery agency predecisional documents, including the types that Anadarko sought.

While the privilege is a powerful cloak, it is not absolute. Courts are supposed to weigh the government’s strong interest in protecting full access to how it comes to a decision with the need of the party seeking the requested documents.

In concluding that Anadarko’s need trumped the agency’s interest the magistrate focuses on how agency changes on an issue may be relevant in a court’s legal interpretation. It did not matter, in the magistrate’s view, that the request considered documents that did not in and of themselves directly relate to precedential agency determinations.

In concluding that the government had to comply with the discovery, the court also felt that the request was proportional and reasonable, in light of the amount at issue and the costs to the government in complying. Backstopping its proportionality conclusion was its view that the nonprecedential documents had a bearing on the court’s ultimate task of sorting out the merits of the taxpayer and government’s views of  Section 267 and the regs.

Conclusion

Anadarko is an important taxpayer victory. I am not well versed with the substantive issue in this case. I suspect, however, that the court’s willingness to allow discovery has a lot to do with what the magistrate believes is at a minimum a less than complete explanation accompanying the regs. If IRS takes differing views on a technical issue, and yet when promulgating a final regulation Treasury claims that it is merely clarifying what the law had been all along, a court (and taxpayers) are justifiably curious as to how that explanation jives with what came before the final reg.