The Next Government Shutdown: A Legal Perspective

We welcome back guest blogger Stuart J. Bassin who writes about a topic recently on everyone’s mind, the government shutdown. Whether you are a government employee who must spend endless hours at the water cooler discussing whether you will come to work or someone impacted by the shutdown or threat of a shutdown because of your work or your vacation or other activity, lots of time gets wasted over something that should never happen in the first place. We have written about different aspects of the government shutdown before, focusing on the Tax Court here and here, and on the special circumstance of the National Taxpayer Advocate here when she sued the government because the Commissioner deemed her non-essential. The NTA lost her legal battle over the authority to declare her non-essential but may have won the war. In the most recent shutdown, Local Taxpayer Advocates were deemed at least partially essential and directed to work parts of the shutdown days checking and processing the mail, and particularly any payments, coming into their office. While we all enjoy talking about how dysfunctional the federal government is and how appreciative we are that the Newt Gingrich strategy to use what was previously the routine vote to increase the debt ceiling to force votes on other issues, a greater understanding of the process and the consequences can help. Stuart seeks to help us understand the consequences of a shutdown. The consequences can be scary. Keith

Many years ago, I was working as a Justice Department attorney during one of the longer Government shutdowns. Having been designated “essential” during the shutdown (but only on some days), I was supposed to continue representing the United States in ongoing civil litigation. During those happy days, I started wondering about the actual law underlying my activities and the shutdown.   Here is what I learned and some speculation about what that means for our near future.

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The Shutdown is Mandated by the Constitution and Statutory Law.

English law has limited the authority of the executive to spend money without the consent of the legislature ever since the Middle Ages. By taking the unregulated “power of the purse” from the monarchy, the English required the executive and legislative branches to come to agreement on taxation and spending, thereby providing the foundation for a parliamentary or representative form of government (as opposed to a monarchy or autocracy). Absent agreement, the system would grind to a halt.

The English tradition is carried forward by the “separation of powers” principles embodied in the United States Constitution. Spending and taxation authority reside in Congress under Article I, Section 8 of the Constitution; the Executive has no independent taxation or spending power. Separately, Article I Section 9 prevents unauthorized spending, providing that “No Money shall be drawn from the Treasury, but in consequence of appropriations made by law.” When a lapse in appropriations occurs, the government necessarily shuts down. Neither the President nor Congress decides to shut down the Government; it happens automatically under the Constitution.

Statutory law develops the constitutional prohibitions and invokes the criminal law to enforce the prohibition. Under Section 1341(a) to Title 31 of the U.S., federal employees “may not make or authorize an expenditure or obligation” or involve the “government in a contract or obligation” absent a lawful appropriation. Similarly, under Section 1342, federal employees “may not accept voluntary services for the government … except for emergencies involving the safety of human life or the protection of property.”   The “emergency” exception is narrowly defined to exclude “ongoing, regular functions of government the suspension of which would not imminently threaten the safety of human life or the protection of property.” Section 1350 makes a knowing violation of either provision a felony punishable by up to two years in prison.

Setting aside some nuances, four basic prohibitions emerge. Absent an appropriation, Federal employees can go to jail if they—

–                 obligate the government to pay for goods or services,

–                 require another government employee to perform his or her job with or without pay,

–                 allow their subordinates to perform their duties as “volunteers” with an understanding that the employees will be paid after the shutdown, or

–                 allow their subordinates to perform their duties as true volunteers if their duties are not required to prevent an imminent threat to the safety of human life.

Even if Congress and the President informally agree that some governmental function is “essential” and should continue absent an appropriation, designation of an employee or their functions as “essential” makes no difference under the statutes; that vague terminology has no basis in the Constitution or the statutory law.

Government operations during the coming shutdown.

There are some special situations involving expenditures from government trust funds and multi-year appropriations which allow certain spending when other appropriations have lapsed.   However, setting aside those exceptions, we should consider how the plain statutory language and the Constitution apply in some commonplace situations—

Can the military pay soldiers to man the borders?   National defense surely involves situations which present an imminent threat to human life. But, that is not enough to allow military commanders to pay soldiers’ salaries. The imminent threat to human life exception would not authorize salary payments to anyone; it only applies where the soldiers “volunteer” to work without pay or promises of future pay. We can all hope that they will volunteer.

Can Veterans Affairs employees pay health care benefits to veterans? In general, government employees cannot issue checks when there is no appropriation. Even if money for the payments was available from some trust fund or unexpired appropriation, the Government cannot pay the employees responsible for issuing the checks. Indeed, even if those employees volunteer to work without pay or any expectation of future payment, their supervisors likely could not allow them to volunteer because issuing payments for veterans’ health care benefits is not required to prevent an imminent threat to the safety of human life.

Can IRS employees receive and deposit checks in the Treasury? Probably no. Even if the employees were volunteers, depositing checks is not required to prevent an imminent threat to the safety of human life.

Can the courts operate?   For civil matters, almost surely no. Even if all involved were volunteers, the conduct of virtually all civil litigation does not implicate any imminent threat to the safety of human life.   Volunteers (and only volunteers) might be able to conduct criminal litigation involving an imminent threat to the safety of human life.

Perhaps some agencies have squirreled away some portion of a prior appropriation to support their activities for a couple days. But, absent an appropriation, these functions of government cannot continue for long absent a new appropriation.

The National Train-Wreck Scenario

Of course, the scenario described above would quickly degenerate into a national train-wreck. And, no one would argue that it is good policy to leave the borders unmanned, veterans unpaid, government funds undeposited, or the courts largely closed. However, the current jury-rigged system where government operations continue (or not) based upon some vague notion of what is essential (probably protecting those functions which would trigger a public outcry) surely is not what the Constitution and the law mandate.

Perhaps the Constitutional fathers had it right. A lapse in appropriations (and a legal government shutdown) should be extremely painful for all involved. The prospect of a true government shutdown ought to hang like a Sword of Damocles over the heads of our elected officials. Regardless of party or ideology, a national train-wreck would produce enough blame to pass amongst all involved and one would hope that none of those involved would survive politically.   One thing for sure; the threat of such a train-wreck ought to focus everyone’s attention.

NTA Issues 2017 Annual Report to Congress

Earlier today, the NTA released the 2017 Annual Report to Congress. In addition to its sections on most serious problems, legislative recommendations, ten most litigated issues and a dedicated volume on research studies, this year the report contains a Purple Book, which is a new feature and is described as a “concise summary of 50 legislative recommendations that she believes will strengthen taxpayer rights and improve tax administration.”

In the next few days, we will be reviewing the report, and will flag areas of interest for our readers. I am especially interested in the Purple Book, and think setting off recommendations relating to taxpayer rights in a separate volume is an excellent way to highlight the importance of taxpayer rights and help ensure that the IRS embraces taxpayer rights as a guiding principle of tax administration.

A good place to start is the preface, where the NTA discusses the funding challenges that IRS has faced and continues to face. While noting that a lack of funding is a major challenge, she notes that should not be the end of the conversation:

At the same time, limited resources cannot be used as an all-purpose excuse for mediocrity. There is not a day that goes by inside the agency when someone proposes a good idea only to be told, “We don’t have the resources.” In the private and nonprofit sectors, saying “we don’t have the resources” is the beginning of the discussion, not the end. Yet with the IRS, lack of resources often has become a reflexive excuse for not doing something, or worse, for doing things “to save resources” that harm taxpayers, foster noncompliance, and undermine taxpayer and employee morale.

The consequences of poor taxpayer service and a defeatist attitude toward tax administration are far reaching. The preface emphasizes that the IRS can do a “better job of using creativity and innovation to provide taxpayer service, encourage compliance, and address noncompliance.”

I look forward to reading the report.

Some Tax History: Whatever Happened to the W-1?

We welcome back guest blogger Bob Kamman who, as usual, causes us to think about something that we would easily pass by without further thought.  While it is wonderful that Bob is writing guest blogs, he continues to write comments that deserve careful reading as well.  If you have not already looked at his comment on my post regarding the link between social security benefits and filing tax returns, you should do so.  Similarly, if you were at all interested in my post last week on worker classification, you need to read his comment there.  I wrote the post before the Court entered the order in the case.  Bob picks up the link to the order that came out last week.  It is a fascinating order and those with worker classification issues might want to see the orders entered in those types of cases. Keith

Here is a word-association question. What is your first thought when you hear “January 31”?

I polled some family members and most remembered it’s my birthday. But for millions of Americans, and especially tax practitioners, the likely answer is “W-2 Form.” January 31 is the deadline for employers to distribute these “Wage and Tax Statements” to employees.

Like most taxpayers, you know about Form W-2, but did you ever wonder what happened to Form W-1? I did, and I researched it so now you won’t have to. Along the way, I came across a novel tax administration idea: What if taxpayers whose only income is shown on W-2 forms could just fill out the back of the form with the names of their dependents; add a small amount of other income, if any; sign it; and send it to IRS?

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My search for Form W-1 led me to the Code of Federal Regulations edition of 1949 (another significant date in my life) and specifically to Section 405.601, “Return and payment of income tax withheld on wages.” It provided:

“(a) Every person required, under the provisions of section 1622, I.R.C., to deduct and withhold the tax on wages shall make a return and pay such tax on or before the last day of the month following the close of each of the quarters ending March 31, June 30, September 30, and December 31. Such return is to be made on Form W-1, Return of Income Tax Withheld on Wages, and must be filed with the collector of internal revenue for the district in which is located the principal place of business or office of the employer . . .There shall be included with the return filed for the fourth quarter of the calendar year or with the employer’s final return, if filed at an earlier date, the triplicate of each withholding tax receipt (Form W-2a) furnished employees.”

So there you have it. Before there was a Form 941, Employer’s Quarterly Federal Tax Return, there was a Form W-1 filed quarterly with the Bureau of Internal Revenue. The Form W-2 dates back to those early days, as does Form W-3. Here is employment tax procedure from the same Regulations:

“(b) The triplicate Forms W-2a, when filed with the collector, must be accompanied by Form W-3 and a list (preferably in the form of an adding machine tape) of the amount shown on Form W-2. If an employer’s total payroll consists of a number of separate units or establishments, the triplicate Forms W-2a may be assembled accordingly and a separate list of tape submitted for each unit. In such case, a summary list or tape should be submitted, the total of which will agree with the corresponding entry to be made on Form W-3. Where the number of triplicate receipts is large, they may be forwarded in packages of convenient size. When this is done, the packages should be identified with the name of the employer and consecutively numbered and Form W-3 should be place in package No. 1. The number of packages should be indicated immediately after the employer’s name on Form W-3. The tax return, Form W-1, and remittance in cases of this kind should be filed in the usual manner, accompanied by a brief statement that Forms W-2a and W-3 are in separate packages.”

The word “triplicate” might bring memories of carbon paper. Anyone under 30, though, might ask “what is carbon paper?”

But these regulations for Form W-1 mention nothing about Social Security tax withholding, which nowadays is also reported on the quarterly Form 941. How did employers deal with that, in times past?

The answer is in Regulations Section 601.43, “Forms.”

“(a) Description. The forms specially applicable in connection with the employment taxes, copies of which may be secured from collectors of internal revenue, are as follows:

There was also a Form SS-9 available to employees who had paid more than the maximum FICA tax because they earned more than $3,000 combined from more than one employer. They had to claim this refund with a Form 843, filed no more than two years after the year the excess FICA was paid.

It was not until 1950 that the separate Forms W-1 and SS-1a were combined into the single Form 941. At the same time, employers with a combined payroll tax liability of more than $100 each month were required to pay taxes at a member bank of the Federal Reserve system with a “Federal Depositary Receipt.”

And it was not until 1978 that quarterly lists of employees and their wages were not required by Social Security. Today, benefits are still based on “quarters” of coverage, but a quarter is determined by income received at any time during the year. For 2018, every $1,320 of earnings results in a quarter of coverage, up to four a year.

I mentioned above the innovative proposal of using the reverse side of Form W-2 as a tax return — perhaps, the next best thing to a postcard. Suppose your only income is from wages, a situation in which millions of Americans find themselves. Why not just sign the form, mail it to IRS, and let them figure the tax?

Well, actually, that’s the way it could be done until 1948. The back of the W-2 had lines to list exemptions. If more than one W-2 was received, there was a box to show how many others were attached. If the spouse had more than $500 income, that W-2 could be attached also. Another line allowed reporting of interest, dividends, and other income if those sources added up to less than $100. The taxpayer signed the back — there was also a signature line for a spouse with income — and the return was mailed to Internal Revenue, which would compute and assess the tax, with refund or balance due. A Tax Table was published for those curious to know what those amounts would be, or to check the collector’s math.

A page of history is worth a volume of logic, as Justice Oliver Wendell Holmes Jr. noted in New York Trust Co. v. Eisner, 256 U.S. 345, 349 (1921). Those seeking a logical reason for the current lack of a Form W-1 may find this page of history helpful.

 

Some More Reading on The Tax Legislation that Was Formerly Known as the Tax Cuts and Job Act/Twitter and Tax

As we have over the past few weeks, we will occasionally be linking interesting articles, blog posts, tweets, etc on the recently-signed tax legislation. While many of the provisions do not directly address tax administration, they will have a major impact on taxpayers, advisors and the way IRS administers the law (let alone my soon to start classes at Villanova on Business Tax and Individual Income Tax!)

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Professor Brian Galle has a post in Medium on a charitable contribution strategy that states may employ as a workaround to the 10,000 S&L deduction limit

What I’ve called the “charity at home” plan would grant a 100% credit against state income taxes for any charitable contribution to the state government (or perhaps a subdivision of donor’s choice)

Professor Andy Grewal in Notice & Comment on why the charitable contribution strategy may not work

Whether the charitable contribution strategy works will depend on the details of a given state’s plans, but there are unquestionably some serious legal and practical obstacles.

Ed Zollars in Current Federal Tax Developments describes the workings of of the passthrough income deduction regime and especially the ambiguity around the term “specified trade or business.”

Professors Lily Batchelder and David Kamin in an LA Times op-ed on the passthrough loophole, including major problems for taxpayers and IRS that has to administer the boondoggle

It could take the IRS and Treasury Department many years to clarify exactly how the pass-through loophole works. By then, the new deduction will be on the verge of expiring, creating further uncertainty and risks for regular employees.

Professor Francine Lipman over at Surly discussing changes to the CTC and the requirement that families with children who do not have a Social Security number can no longer qualify for any amount of CTC.

On a somewhat unrelated point, above I have linked to the twitter accounts. I am a recent convert to Twitter; in addition to its being a usefuld distraction when I had about 125 exams to grade, it is increasingly a great way to get real time information on a host of tax developments.

Kelly Phillips Erb (Tax Girl) also has a piece at Forbes on the top 100 tax twitter accounts to follow for 2018.

Procedurally Taxing has had a twitter feed for a long time; you can follow that here. I have recently dipped my toes in Twitter as well; I encourage readers to follow me here

Happy reading (now back to my exams, or more likely some time wasting on Twitter).

The End of Alimony

Today we welcome first-time guest poster Phyllis Horn Epstein, who writes about the recently-enacted tax law’s changes to the treatment of alimony and the elimination of the deduction for personal exemptions.

Phyllis is a partner with Epstein, Shapiro & Epstein in Philadelphia. She is a frequent speaker and writer on many tax and corporate issues and has been in leadership positions in the Pennslylvania Bar Association and the ABA Tax Section, including as the immediate past Chair of the Individual and Family Tax Committee. Les

Presently, or at least until January 1, 2019, alimony can be taken as an income tax deduction by the payor of alimony under Internal Revenue Code (IRC) § 215(a) and should be reported as income by the recipient under IRC § 61(a)(8). In order to be deductible, payments have to be made in cash and as a result of a divorce or by a separation agreement. The parties have to live separate and apart and the obligation has to terminate after the death of the recipient. The terms of payment cannot provide for any substituted transfers in the event of non-payment.

Section 11051 of the Tax Cuts and Jobs Act of 2017 upends this long standing tax approach by removing the alimony tax deduction and at the same time no longer requiring alimony to be reported as income when received. Nothing happens in a vacuum and the result of this simple declaration has ripple effects for a large body of tax law in place.

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Rush To Sign By December 31, 2018.

The change in the law will not impact anyone with an agreement in place by the end of next year, December 31, 2018. This will undoubtedly have a profound impact upon negotiations with a rush to complete final agreements by year end 2018. In addition, the IRS will be faced with the mighty task of determining which tax returns should be reporting alimony under the old scheme – income to recipient and deduction for payor – or under the new scheme – no income reporting and no deduction. Under the new law the payment will be a non-event from a tax point of view so that only those agreements under the old law will be showing up on tax returns. But only a tax audit will elicit proof that a taxpayer is entitled to a claimed deduction with the taxpayer providing evidence of a qualified pre-2019 agreement. Perhaps new revised tax reporting on Form 1040 (the standard individual tax return) will compel attachment of such agreements for every return claiming the deduction. Could this be problematic for payment recipients? Possibly at least because the taxation symmetry requires them to report alimony as income and at least on Form 1040 to date the payor of alimony is required to supply the tax identification number of his or her spouse who receives income.

Is it Alimony or Property Division? Alimony Recapture No Longer Recalculated.

The IRS devised a set of rules to prevent front-loading of payments and calling them alimony when in reality they are non-deductible property transfers.  The recapture laws found at IRC § 71(f) would result in the reversal of an alimony deduction. Because there is no longer an alimony deduction, there is no longer an incentive to disguise property division as alimony. It would seem then that the entire set of alimony recapture laws are no longer operative for agreements entered into after December 31, 2018. The way the recapture law worked was through a computation that was done post-facto. The amount of the recapture which was realized in the third year after alimony had begun was calculated by taking the excess of alimony payments in the second year over the sum of payments in the third year plus $15,000, PLUS the excess of the payments in the first year over the sum of the average payments in the second year and third year plus $15,000. A complicated calculation that will not be necessary going forward and for some a welcome relief.

Will We Even Need An Agreement Going Forward?

In order for alimony to be deductible, the payments (in addition to other things) had to be made pursuant to a written divorce or separation agreement or court order. IRC § 71(b)(2) There are many cases dealing with the question of whether something is or is not a written separation agreement. One such case Mudrich, TC Memo 2017-101 held that a husband’s promise to split his bonus with his ex-wife was not made pursuant to a satisfactory agreement and therefore denied him the alimony deduction. The agreement called for the separation of an item of property but never mentioned that the payment was for spousal support.

There have been other opportunities for drafting mishaps. The Code also requires payments to cease upon the death of payor in order to be considered alimony. There is disagreement between the IRS and the Tax Court regarding whether the amount of alimony must be a definite amount (the IRS view) or an ascertainable amount (the Tax Court view).

It seems that all of these issues requiring careful drafting are going to be a thing of the past.

Phantom Alimony – Gone

Payments to others on behalf of the recipient spouse may be alimony if required under a property settlement agreement. The result of this scenario is that the beneficiary of these payments had taxable income but no cash with which to pay the tax. How does it work? For example, payments that the payor spouse makes directly for rent, mortgage, tax or maintenance on a home owned by the payee spouse will qualify as deductible alimony. (The same does not hold true if the home is in the name of the payor spouse regardless of what is stated to in a property settlement agreement.) Half of what is paid for these home related expenses on a jointly owned home in which the payee spouse continues to reside may be deducted as alimony. In addition, life insurance premiums that a payor spouse was obligated to pay by reason of a property settlement agreement directly to a life insurance company were alimony so long as the policy was owned by the payee spouse. Now, none of these payments are income and none are deductible by the paying spouse. Phantom income is gone.

Tax Implications Are Still a Factor For Determining Alimony Under Local Law.

Our Pennsylvania Statute 23 Pa. C.S.A. §3701 states that the “Federal, State and local tax ramifications of the alimony award” are a factor when determining whether alimony is necessary, the amount of alimony and the duration. The current automated calculations reach an amount of alimony generally based upon relative incomes and expenses. The comment to Pennsylvania Rule §1910.16-4 tells us that “the tax consequences of an order for a spouse alone or an unallocated order for the benefit of a spouse and child have already been built into the formula.” The question is whether these programs correct for the tax implications of alimony and whether going forward, the loss of the alimony deduction changes that calculation. Very simply, the loss of the deduction increases the amount paid as well as the amount received. Some adjustment seems warranted.

Currently, spouses are at liberty to alter the tax consequences of alimony by agreement so that the payor no longer receives the deduction and the recipient no longer includes payments in income. An overall savings may be the motivation.

Illustration: Husband pays $20,000 a year for support. Husband is in the 28% tax bracket, and W is in the 15% tax bracket. If the payments are alimony then Husband saves $5,600 in taxes. Wife includes the entire amount as alimony and pays a tax of $3,000. The savings of $2,600 represented by the difference in tax reporting can be incorporated into the final divorce agreement.

These adjustments will no longer be available however the cost of support/alimony to the payor will vary from person to person depending on their own individual tax status. Will this be considered as part of the settlement process or the alimony calculation? We don’t know.

Allocation Headaches Over?

When support for children is required in addition to alimony or spousal support, it has been the best practice to clearly identify each payment since child support, unlike alimony, is neither deductible by the payor or included in the income of the recipient. In those cases where it was unclear how much of a payment was deductible alimony and how much was non-deductible child support litigation often ensued. When IRS was involved, the Service would conduct a facts and circumstances analysis to apportion a single payment between deductible and nondeductible support. For example, the Service might consider whether there was an agreement to reduce payments upon the occurrence of certain events like a child’s graduation from High School. The reduction would imply an amount designated as nondeductible child support.

If the taxpayer owed a combination of child support and alimony and during the year paid less than obligated, then the payments were first allocated to child support regardless of whether the parties agree otherwise. See IRC § 71 (c)(3); Haubrich, TC Memo 2008-299

By way of illustration:

Husband is obligated to pay to Wife $20,000 for alimony and $12,000 for child support and pays only $8,000 for the year, then the entire amount is treated as non-deductible child support and none of the payments are allocated to alimony.

None of this tax planning is required now that alimony is no longer deductible or income. There is no tax difference between the payment of child support or alimony. At least that will be the law for agreements entered into starting in 2019.

Personal Exemptions Eliminated

Under the law as we knew it before 2017 tax reform, taxpayers adjusted their gross income by taking personal exemptions for themselves, their spouse and dependents. For 2018 that exemption was going to be $4,150 for each person subject to a phase out based upon income. Under the new law, for tax years 2018 through 2025, the personal exemption is zero.

The personal exemption was a subject for negotiation in divorce settlements. A husband and wife could not both claim an income tax exemption for the same child. Presently, under Section 152(e)(4)(A) in the absence of agreement, the exemption belongs to the custodial parent defined by the Code as “the parent having custody for a greater portion of the calendar year.” IRC §152(e)(4)(A) (If days are equal, the exemption belongs to the parent with the highest adjusted gross income.)

A custodial parent can release the dependency exemption to the non-custodial parent in a written declaration that is 1) signed by the custodial parent; 2) must state the years to which it applies; 3) must name the non-custodial parent who is the recipient of the exemption; and 4) must be unconditional. In order to claim the exemption, the noncustodial parent must file with his or her tax return this written declaration on IRS Form 8332 or a similar statement containing all of the same information. A court order is insufficient if it does not have the signature of the custodial parent attached. The Tax Court has held that the Form must actually be attached to the return and cannot be submitted at a later date. The release of the dependency exemption can be revoked under a similar process using Form 8332.

A “qualifying child” dependent as defined under Section 201 of the Working Families Tax Relief Act of 2004 (1) must be the taxpayer’s child (including adopted or foster child), stepchild, sibling, or stepsibling or a descendent of such a relative; (2) has the same principal place of abode as the taxpayer for more than one-half of that tax year;  (3) must be under age 19 at the close of the calendar year, under age 24 if a full-time student, or of any age if permanently and totally disabled; (4) hasn’t provided over one-half of his own support for the calendar year in which the taxpayer’s tax year begins; and (5) hasn’t filed a joint return (other than for a refund claim) with the individual’s spouse for the tax year beginning in the calendar year in which the taxpayer’s tax year begins. For purposes of the Child Tax Credit a qualifying child is under age 17.

Will it Matter Who Has The Dependency Exemption In The Future?

While the dependent status of a child is not significant for purposes of claiming the personal exemption on a tax return, there are other tax reasons for claiming a child as a dependent. First, while the personal exemption is temporarily zero, it may someday – after 2025 – return. Further, the legislation amends Section 24(h)(4)(A) and 24(h)(4)(C) and provides that there is still an additional $500 nonrefundable CTC for dependents over 17 or older, accomplished by giving the additional credit to those who generally would be treated as a dependent under current law. And importantly, only the parent with the dependency exemption may claim the child tax credit now $2,000 under the new law.

Even when there is a release and transfer of the dependency exemption both parents may claim the child as a dependent for purposes of excluding medical reimbursements, excluding employer-provided accident or health plan coverage, deducting medical expenses, the exclusion of health savings account distributions for qualified medical expenses and the exclusion of Archer medical savings account distributions to pay qualified medical expenses – to the extent these deductions and credits survive the 2017 reform act. So for example, in 2017 and 2018 medical expenses can still be itemized but only to the extent they exceed a floor equal to 7.5% of adjusted gross income. Most other deductions are “suspended” by the new law. Starting in 2019, medical expenses will be subject to the 10% floor for both regular tax and AMT purposes.

So, a custodial parent, even without the dependency exemption can still claim the child and dependent care credit, the exclusion for dependent care benefits, the health coverage tax credit, the earned income tax credit and head of household status. Only the parent with the dependency exemption can claim the child tax credit. For this alone it matters which parent has the dependency exemption.

Will Treasury Act to Prevent U.S. MNC Cash Distributions from Reducing Tax Rate on Deferred Foreign Income?

We welcome back guest blogger Steve Shay who writes about a provision of the new tax law that appears to have a loophole in need of closing in order to prevent a significant windfall to certain multinational corporations. Steve, a colleague at Harvard and well known expert on international issues, has written blog posts for PT before on the Altera case here, here and here. Keith

The international provisions of the Tax Cuts and Jobs Act (TCJA) are full of policy and drafting anomalies that will be explored over time. I focus on one in a brief working paper. As drafted, a U.S. multinationals whose foreign subsidiaries have a non-calendar fiscal year still have time to mitigate their exposure to the higher rate of tax on deferred foreign income that is treated as held in cash (15.5% instead of 8%) unless the Treasury uses an anti-abuse rule to neutralize this planning.

The TCJA’s mandatory inclusion of deferred foreign income bases the inclusion on the greater of the deferred foreign income amount at November 2, 2017 or at December 31, 2017. So far so good. Though note that this will require an interim closing for foreign subsidiaries that do not use a calendar taxable year.) But, the TCJA taxes at a higher rate (again, 15.5% instead of 8%) the portion of the inclusion equal to the aggregate foreign cash position measured by the greater of (i) the average at the end of the two taxable years ending before November 2, 2017 (the November 2 measurement date), or (ii) the end of the last tax year beginning before January 1, 2018 (the second measurement date). Most mature but foreign companies will have more cash on the second measurement date. An anti-abuse rule would allow but not require the IRS to disregard a transaction that has “a” principal purpose of reducing the aggregate foreign cash amount.

I argue in the paper that there is room for a U.S. MNC to sidestep the “greater of” test by distributing cash before the second measurement date without automatically running afoul of the anti-abuse rule. It is not clear from the text what was intended. Why even use the “greater of” rule instead of just relying on the November 2 measurement date or choosing December 31, 2017 as the second date? But, there is no prohibition on distributions and the TCJA provides that a distribution will not reduce the deferred foreign tax amount; Congress also could have said distributed cash is similarly not taken into account but did not. Or, less credibly, this formulation of the aggregate foreign cash position was intended to be a windfall for U.S. MNCs that either do not have a calendar taxable year or, even if they do, stagger their foreign subsidiaries’ tax years as permitted under Section 898 and therefore still have time for self-help.

This seemingly obscure issue can affect billions in revenue. Using public information, I estimate that Apple could reduce its U.S. tax on deferred foreign income by as much as $4 billion (before taking foreign tax credits into account). Treasury can, and I believe should, use its anti-abuse authority to include post November 2, 2017, distributions of cash in the aggregate foreign cash position to the extent they would decrease the applicability of the 15.5% rate.

Treasury will no doubt be confronted with hundreds of cases where the TCJA has policy and drafting anomalies that are within the scope of regulatory authority to adjust. Some will be pro taxpayer like this one and some would inadvertently hurt taxpayers. Given that the TCJA was rushed through the legislative process for political reasons directed at mitigating GOP losses in the 2018 elections, the same political economy calculus might cause prioritizing guidance toward assisting taxpayers over efficiency considerations and revenue protection. This is particularly the case when the Acting IRS Commissioner also is the Treasury Assistant Secretary for Tax Policy, the most senior tax advisor to the Secretary Treasury and the White House. While the IRS has never been wholly immune from taking political calculus into account, it is a remarkably apolitical institution. We can only encourage the Treasury and the IRS to continue to preserve the integrity of the tax system – in this case by denying yet another windfall for U.S. multinationals.

Follow up to Some Interesting Sources on Tax Legislation (and a Little Procedure Too)

We have previously offered some suggestions for readers wanting additional insights on the major tax legislation Congress pushed through and President Trump signed into law last week. Here are some more interesting reads:

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An update on the must read The Games They Will Play article that describes how the “final law introduces fundamental—and in our view insurmountable—structural problems to the income tax.” This is I think the most important tax article of the year and an essential read.

Tax and twitter maestro Professor Andy Grewal suggests that 2017 prepayment of 2018 property taxes may not generate a 2017 deduction;

Professor Ellen Aprill explains in a guest post on Medium why the new law imposing a 21% excise tax on highly paid University employees has a hefty technical glitch that seems to unintentionally exclude employees of public universities;

Forbes tax blogger Tony Nitti on the 20% deduction on pass through income, a major source of future game playing (and complexity). This is terrific;

Professor Sam Brunson over at Surly discussing the implications of the repeal of deductions for dependents as well as the trade offs from the law’s boosting the standard deduction and increasing the CTC. An important read for low and moderate income families—the comment exchange is also good;

A Law360 piece on another of the law’s big winners: tax professionals;

Professor Dan Shaviro offering some preliminary thoughts on the international provisions;

And finally on a completely unrelated topic, if you have had enough substance and want some procedure, Frank Agostino and his team have a new monthly tax controversy journal out, and it includes a practical and important discussion of the about to be implemented passport revocation rules.

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