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Congress Should Define Passthrough Guardrails, Official Says

Posted on October 26, 2017 by Matthew R. Madara

Providing broad regulatory discretion to Treasury to define the guardrails necessary to prevent abuse of the lower passthrough tax rate being considered as part of tax reform could lead to extensive litigation in the future, a Treasury official said October 25. 

“My hope is that the Treasury Department will be given a lot of statutory . . . guidance on what those guardrails should look like,” said Thomas West, acting Treasury assistant secretary for tax policy. A congressional delegation of authority that establishes a passthrough rate “subject to the guardrails that Treasury puts in place” would be a “pretty broad regulatory delegation of power,” West said at the New York University School of Professional Studies Institute on Federal Taxation in New York.

unified framework for tax reform released September 27 by the Republican “Big Six” tax reform negotiators sets 25 percent as the goal for the partnership tax rate. The framework also anticipates that the taxwriting committees will “adopt measures to prevent the recharacterization of personal income into business income to prevent wealthy individuals from avoiding the top personal tax rate.”

Congressional Democrats and practitioners have raised concerns that a separate tax rate for passthrough entities could result in abuse.

“We’d all agree that some significant guardrails are probably necessary . . . assuming we do have a separate passthrough rate,” West said. Many questions remain unanswered, including what the passthrough rate will look like, the rate’s scope, and who it will apply to, he said, adding, “My hope and expectation is that a lot of that is detailed in legislative language.”

The passthrough “guardrails all involve policy choice,” according to Jason Smyczek, branch 4 senior technician reviewer, IRS Office of Associate Chief Counsel (International), who added, “You have to decide what it is you are trying to guard against, which really is a question of who you want to give the rate to.”

“I don’t think you’re going to have to wait long” to see the details of tax reform, West said, noting that the House Ways and Means Committee is planning to release its version of the legislation next week.

Regulatory Priorities

West said the government is getting back into the business of releasing guidance, and clues to the regulatory priorities can be found in Treasury’s final report on regulatory burdens and the recently released 2017-2018 priority guidance plan. Both documents follow the “policy directives we’ve been given by the new administration to focus our regulatory efforts on reducing burdens and reducing complexity where we can,” he said, adding, “I’d like to think that is always something we had in mind when we were writing regulations.”

According to West, the government is reexamining the proposed (REG-122855-15) and temporary regs (T.D. 9788) under sections 707 and 752 on the allocation of liabilities in the disguised sale context, which were included in the Treasury report among a list of guidance projects to be revoked in part. The government is “comfortable with where we landed” on the guidance on bottom-dollar guarantees and “we’re planning to leave those alone,” he said.

West said the allocation of liabilities guidance “was greeted with some consternation and surprise,” and those rules will be pulled back to give practitioners time to comment. The guidance provides a different approach to liability allocation and “the approach does have its merits,” he said.

Smyczek said there are several projects on the priority guidance plan that implement the new partnership audit rules enacted by the Bipartisan Budget Act of 2015. The general guidance project is finalizing the proposed regs (REG-136118-15) that were released in June, he said.

According to Smyczek, finalizing the proposed regs by the end of 2017 “remains the goal,” but “it may be that we don’t finalize every piece of it.” There is an ongoing conversation about items in the proposed regs that are closely tied to other projects that are included on the guidance plan and “it may be that we hold some of that back,” he said.

“The prime goal remains full finalization" of the June notice of proposed rulemaking, Smyczek said, but added that the government is interested in comments on what is the “most necessary thing to be final by the first of January, when these new audit rules take effect.”

The guidance project on how specific international provisions will operate under the Bipartisan Budget Act “is pretty far along,” Smyczek said.

2-for-1 Order

West said Treasury has kept in mind the Trump administration’s 2-for-1 executive orderrequiring the repeal of two existing regulations for any new regulation when he was asked what effect the order will have on the government’s guidance plan agenda. “We haven’t been publishing all that many regulations, and many of the regulations we have published and that we’re focused on right now I view as burden reducing, as reducing complexity, as being — in the parlance of the times — deregulatory,” he said.

“I don’t think if we’re putting out things that are deregulatory, that are helpful for taxpayers, that have been requested, I don’t necessarily think that that 2-for-1 rule would have to apply there,” West said. Treasury has been viewing deregulatory guidance as an exception to the 2-for-1 executive order and “I think we have at least tacit [Office of Management and Budget] support on that,” he said.

Smyczek said a good example of this is the proposed regs (REG-116256-17) released October 11 that eliminate the signature requirement for partnerships making a section 754 election. The signature requirement was redundant and created a trap for the unwary, he said.

“It would seem unfortunate for me if we would have to repeal two regs in order to let people not have to sign” the section 754 election, Smyczek said.