Delivering Your Tax Refund Is the Least of the IRS’s Problems

(Bloomberg) -- For Tax Day this year, House lawmakers are focusing on a familiar target -- the Internal Revenue Service.

Pegged to Tuesday’s tax-filing deadline, Republican leaders scheduled a floor vote later this week on a bipartisan package to retool the agency.

If the measure gains momentum, the IRS could face restructuring as it struggles to implement a once-in-a-generation overhaul of the U.S. tax code. The agency has been crippled by years of budget cuts leaving it vulnerable to fraudsters and relying on computer program languages that date back to the 1950s. And a recent agreement will require some of the IRS’s tax regulations to be vetted by the White House Budget Office for the first time in decades.

Those headaches could mean the confusion surrounding the tax law isn’t likely to be cleared up anytime soon. Various industries and tax professionals are still struggling to understand dozens of the law’s provisions and interpret lawmakers’ intentions on changes such as the special break for pass-through businesses and new international tax measures. More mundane questions exist too: Can you still deduct some of the cost of dinner with a business client?

It makes the IRS’s usual job -- processing more than 120 million tax returns that arrive by mid-April and spitting back some $300 billion in refunds -- look easy.

There’s concern among tax professionals that until there’s clear IRS guidance, they’ll just have to make “gut decisions” for 2018 returns, said Jody Padar, chief executive officer of New Vision CPA Group in Mount Prospect, Illinois.

‘Bureaucratic Twilight Zone’

Senator Ron Wyden, the top Democrat on the tax-writing Finance Committee, said at a hearing last week that small businesses are stuck in a “bureaucratic twilight zone” because they have estimated tax payments due Tuesday, but still don’t know how the new law works.

The IRS has promised to issue guidance on several priority items by June 30. But that deadline seems more and more ambitious. Even providing details by that date on who’s allowed to take the pass-through deduction has been questioned by a former top Treasury official.

House Republicans have pushed for years to streamline the agency. Last week, the Ways and Means Committee unanimously approved the package of IRS bills, which call for changes like creating a new independent office for the appeals process. It would also require the agency to send Congress a written plan for its reorganization by Sept. 30, 2020. House leaders have said the delay is in part to give the IRS time to implement the new law.

House Ways and Means Chairman Kevin Brady told reporters Monday that he’s working with the Senate on the IRS overhaul bill and trying to get it to the president’s desk this year. He said the package wouldn’t require appropriators to provide additional money.

OMB Review

The IRS will also have to contend with a new agency weighing in on its tax regulations, which could further delay guidance. Under a deal announced last week, White House Budget Director Mick Mulvaney won the right to weigh in on any new regulations written by the IRS and Treasury Department with a substantial economic impact, of at least $100 million. The Office of Management and Budget will have 45 days to review new rules, though the Treasury can designate certain regulations for an expedited review of just 10 days.

Mark Mazur, a former assistant secretary for tax policy at Treasury, told Bloomberg Tax that it was difficult to predict how the review process would happen in practice. The change is more likely to affect smaller companies, since larger firms are often in a better position to get informal guidance directly from Treasury, according to Andrew Silverman, a Bloomberg Intelligence analyst.

Even if OMB and the Treasury Department can agree on guidelines, the next challenge those rules are likely to face is in court. Ambiguity in the hastily passed law will make the IRS’s job more difficult. For example, Treasury Secretary Steven Mnuchin moved quickly to plug a loophole for hedge funds in the law, but many experts doubt the government has the legal authority to do so. That could set up a years-long court battle between the IRS and hedge fund managers trying to profit from Congress’s vague language.

‘Punier Organization’

The IRS’s lack of resources could influence how it interprets and enforces the new rules. A loose interpretation could inflate the federal deficit, already expected by the Congressional Budget Office to exceed $1 trillion per year by 2020. However, a tight interpretation could be expensive for the IRS, requiring many more audits and court fights with taxpayers.

Congress recently provided $320 million to the IRS to implement the law. But it also cut $124 million in other funding from the IRS’s $11.4 billion budget. The agency is still 18 percent below its 2010 funding after adjusting for inflation, according to the Center on Budget and Policy Priorities.

“The IRS is a much smaller and punier organization than it used to be,” said Stephen Ziobrowski of the Day Pitney law firm in Boston. “It’s difficult to imagine in the current environment that the IRS would have the resources to police a tight interpretation.”

Under the new tax code, thousands of U.S. companies could end up re-structuring or re-organizing their operations to minimize their tax burdens. Businesses could become corporations to take advantage of the new, lower corporate tax rate. Or they could re-arrange their holdings or payroll to qualify for the pass-through deduction. First, though, they’ll need a better idea of how the IRS is going to interpret the law. CPAs and lawyers are left in an awkward spot when clients ask what to do.

“All you can do is say, ‘This is what we think,’" said Bill Smith, managing director of CBIZ MHM’s national tax office. “I know you want us to know the answer,” he said he tells clients. “But this is the answer: ‘We don’t know.’”

©2018 Bloomberg L.P.

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