Tax Analysts Blog

How Congress Keeps Saving the Tax System From Treasury and the IRS

Posted on Dec 10, 2015

The conventional wisdom is that Congress passes messy laws and Treasury and the IRS have to use their regulatory authority to provide clarity and administrability. The recent changes to partnership audits are only the latest example of practitioners and observers crying out that provisions in legislation can't possibly work and that the government needs to save taxpayers and their advisers from a lawmaker-created muddle. But that conventional wisdom isn't always true. In fact, too often in the last few years, it's been Congress saving the fisc from bizarre administrative decisions from Treasury or the Service that have wounded the tax system.

House Ways and Means Chair Kevin Brady's latest extenders bill includes provisions designed to stop REITs from engaging in tax-free spinoffs. The goal of the proposals is to stop companies from dividing themselves into two new entities, one of which is a REIT. The REIT tax issue is the product of a gradual liberalization of IRS ruling policy that has allowed a lot of nontraditional REITs to spring up and use the advantageous tax rules governing these trusts. When server farms and McDonald's are considering becoming REITs, we are a long way from simply making it easier to invest in real estate. The REIT problem is entirely government created. If Treasury or the IRS had simply decided not to allow these types of conversions or had used more common sense in saying what qualified as a REIT, Brady's plan would be totally unnecessary.

Black liquor is another example of a problem entirely created by the government that Congress was forced to address. Almost no one outside the IRS or the tax departments of paper companies would have thought black liquor was eligible for a biofuel credit. After all, black liquor was a byproduct of a process that existed long before the credit was created, and it qualified for the credit only when manufacturers started adding unnecessary fossil fuels to the process simply to qualify. And everyone -- most lawmakers included -- was shocked by a June 2009 memorandum that said black liquor was eligible for the credit. Suddenly a provision expected to cost $194 million over 10 years ended up costing billions (possibly $30 billion when the dust finally settles). Congress made black liquor ineligible for the credit in 2010, but the damage had already been done (and some lawmakers fought hard for so-called son of black liquor benefits, which are too complicated to explain here, to continue). Once again, the IRS created a problem that was easily avoidable (no one would have batted an eye if the Service had never issued its 2009 memorandum), and Congress had to step in.

Perhaps the worst example of a Treasury-created problem in the last seven years was Notice 2008-83, which facilitated Wells Fargo's takeover of Wachovia in 2008. Treasury changed long-standing rules (and arguably directly contradicted a statute), allowing Wells Fargo to use Wachovia's losses from bad loans. The government claimed the decision had been in the works for weeks to help struggling banks, but it seemed to most commentators that it was targeted at this one deal. Congress, particularly Senate Finance Chair Max Baucus, was outraged at the potential costs (up to $74 billion of Wells Fargo's income might have been affected by the Wachovia losses). Congress directly overruled the Wells Fargo notice in 2009.

And even the partnership audit rules in former House Speaker John Boehner's swan song are in response to a problem the IRS might have solved on its own. As reported by Tax Analysts' Amy Elliott, the IRS has proved unable to audit large partnerships. That growing class of entities was therefore escaping scrutiny. The TEFRA regime, because of this lack of government oversight, simply wasn't working. By scrapping TEFRA and shifting many responsibilities to partners and their counsel, Congress is responding to the IRS's inability to do this oversight on its own.

In an ideal world, laws are drafted perfectly. But failing that, taxpayers should be able to rely on Treasury and the IRS to interpret them in a reasonable manner that protects the tax system and the fisc. It is far from ideal for Congress to have to step in and legislatively override administrative decisions that didn't have to be made and never even should have been considered.

Read Comments (3)

mike55Dec 11, 2015

Great article. The only part I'd quibble with is the idea that REIT spins are
abusive. I get how REIT spins look at first blush to even sophisticated tax
practitioners, but when you start crunching the numbers and diving into the
details it turns out the deal needs to make sense from a non-tax business
perspective to work. That might be one reason Treasury has been so incredibly
lax in this area: the typical REIT spin has more business purpose than just
about any other tax planning structure you'll come across. For example, I'll
betcha that even removing the impact of the tax benefit, a split McDonald's
trades at a premium relative to the legacy company.

ChuckDec 15, 2015

IIRC the revision to the black liquor tax credit was also cited by Congress as
a spending cut to facilitate added spending.

SW CPAJan 20, 2016

Can't argue that these two narrow areas are proof of your point. However,
there are literally thousands of examples where Congress consistently passes
unworkable laws which saddle IRS with impossible tasks. EG Interest
Tracing,Passive Activity rules, IRC 263 A; Tangible Property Regs. which effect
tens of millions of taxpayers.

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