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Last year, Congress proved it can act quickly—enacting the massive Tax Cuts and Jobs Act (TCJA) just six weeks after the first version was introduced. But without hearings and time for careful drafting and analysis, the enacted statute is riddled with glitches and loopholes, which the Treasury and IRS now are scrambling to address.
However, they face a serious problem: While the executive branch may fill gaps in legislation, it cannot rewrite it. If regulators overstep their bounds, the legislative and judicial branches can and often will object. And key congressional leaders are already raising red flags. At a hearing last week, Senate Finance Committee Chairman Orrin Hatch (R-UT) reminded the Treasury Secretary that Congress—and not the administration—writes tax law. He added: “The best place to get an explanation of Congress’s intent is Congress itself.” In a separate letter to the IRS, Minority leader Chuck Schumer (D-NY) questioned whether the agency’s Dec., 2017 guidance on prepaid property taxes strayed too far from the law.
At the Finance Committee hearing, Treasury Secretary Steven Mnuchin acknowledged a loophole in the new legislation that allows private equity managers to hold their carried interest through S corporations—and thus continue to pay the low capital gains tax rate on what is essentially their compensation, without the longer three-year holding period contemplated by the new law. Mnuchin promised to close this loophole within two weeks, but can he do so lawfully?
The courts generally apply a two-step test to executive branch regulations, including tax regulations. The first is whether the statute is clear, in which case an agency cannot pursue a contrary course. At least for the carried interest provision and the ability to prepay certain property taxes, the statutes appear clear, in favor of taxpayers. Thus, Treasury’s authority to reinterpret the law seems limited.
The statutory language of the TCJA excludes from its new carried interest curbs holdings by “corporations” which, on its face, includes S corporations. And thousands of private equity managers quickly exploited the language and presumably will defend their interpretation of the statute if challenged by the IRS.
Similarly, last year’s IRS advisory warned taxpayers that they could not deduct 2018 property taxes they prepaid in 2017 unless their property already had been “assessed” for this year. However, the IRS did not define “assessed,” and did not offer any legal authority for imposing this requirement. In the TCJA, Congress prohibited taxpayers from prepaying state income taxes, but not property taxes (which would continue to receive the same treatment provided under prior law). If the IRS challenges some of the thousands of individuals who did prepay property taxes last December, the taxpayers may well prevail.
Of course, there are plenty of other areas where the statutes are ambiguous, or conflicting. The new 20 percent deduction for pass through businesses is rife with questions that Treasury will have to answer. But the agency cannot simply ignore the statute and rewrite the tax law.
Congress may try to clean up some of these issues through a technical corrections bill later this year. Perhaps it will muster the votes to do so, or perhaps not. But either way, Chairman Hatch is right, Congress holds the pen.
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