If and when President Trump signs the GOP tax bill, he will also be setting up the IRS for a major test.
Almost immediately, the tax-collecting agency would be tasked with changing the withholding tables for taxes in preparation for the tax rates changing on Jan. 1. Then, it would have the space of just a year to organize on the fly for raising trillions of dollars using a largely revamped code.
It would have to do so even though it is already struggling to carry out its existing job and having gone through years of losing funding and personnel.
To add to all of that, Republicans are still weighing the possibility of a major reform of the IRS next year, House Ways and Means Committee Chairman Kevin Brady, R-Texas, said Monday.
Brady said he was aiming to sit down with acting IRS Commissioner David Kautter, who is also a Trump Treasury official, to discuss implementation of the tax bill and the agency’s needs. He already began that conversation last week with Treasury Secretary Steve Mnuchin, he said.
Brady did not rule out the possibility of greater funding for the IRS, although he made it clear that the first option would be to redirect money that the agency already has.
“What are the needs? We’ll start from there,” he said of the conversation about IRS funding. “And then: Are [funds for implementation] available if they set the priority within their own agency and budget?”
Mark W. Everson, the commissioner of the IRS under former President George W. Bush, said he hoped Congress would increase funding for the agency to undertake implementation of the tax overhaul, predicting there would be a “full court press at the service” from businesses and individuals trying to sort out their taxes next year.
Of particular difficulty will be writing the rules for the new regimes for international taxation and businesses like partnerships and sole proprietorships, said Everson, who is the vice chairman of Alliantgroup, a provider of specialty tax services to small and midsized businesses.
Unlike other parts of the tax bill, which would merely alter or resize existing provisions of the tax code, those two parts of the overhaul would essentially create entirely new legal structures that the IRS would then have to enforce within a year.
“It’s fair to say on the partnership regime, we’re introducing an entirely new system,” said John Gimigliano, principal in charge of federal tax legislative services at KPMG LLP and a former senior tax counsel for the House Ways and Means Committee.
The regime would be a special tax break for “pass-through” businesses, or businesses that are not taxed at the corporate level but whose earnings instead pass through to owners’ individual returns.
Such partnerships, sole proprietorships, and S corporations make up the vast majority of businesses in the U.S. While most are very small, including many mom-and-pop businesses, like pizza joints and dry cleaners, some are large, like law firms and private equity firms.
Under the GOP bill, the owners of those companies would receive a 20 percent deduction on their businesses' earnings, subject to a complex set of rules. Combined with the new top individual rate of 37 percent, the deduction would mean that pass-through businesses effectively face a top tax rate of 29.6 percent.
The IRS doesn’t have experience administering such a provision and it’s impossible to predict what consequences might arise, said Everson.
But it’s sure people will make big changes to try to take advantage of the special new tax break. In fact, that is what happened after former President Ronald Reagan’s 1986 tax reform.
Before that law lowered the top individual relative to the corporate rate, corporations accounted for the vast majority of business income. Today, they earn half or less of all business income, with pass-throughs claiming the rest, having multiplied in the years since 1986 as corporations switched to pass-through forms to take advantage of lower rates.
Tax experts fear now individual salary earners will try to present themselves as pass-through entities like LLCs to take advantage of the special new tax break. The IRS would be charged with policing the boundary.
Similarly, the new regime for taxation of multinationals’ foreign profits will look like nothing the U.S. government has overseen before.
The biggest change is the Treasury will no longer tax all foreign earnings. Instead, profits earned overseas and taxed by foreign governments could be brought back without additional U.S. tax.
But that big policy shift comes with a raft of rules meant to prevent gaming of the system and to stop companies from placing operations in tax havens and selling products back into the U.S.
There’s a minimum tax on profits that look like they were routed through tax havens. There’s a special rate on intellectual property earnings to entice drugmakers and tech companies to do their research stateside. And the rules go on.
With tens of billions of dollars potentially to be gained by going around the rules, though, multinationals and their tax lawyers will immediately start trying to do so.
The Treasury and the IRS cannot predict what loopholes and workarounds they might find, said Everson. “As these rules change, behavior will change in unanticipated ways.”