A new report expects 2018 to be something of a “Wild West” for taxpayers and their advisors, who will rush to create “facts on the ground” that would hinder IRS efforts to reverse some of the gaming available in the Tax Cuts and Jobs Act.
An SSRN report written by a number of tax scholars, practitioners and analysts — The Games They Will Play: An Update on the Conference Committee Tax Bill — examines some of the major games, legal roadblocks and glitches in the conference bill.
“The legislation is still likely to cost more than the current estimates of over $1 trillion, to advantage the well-advised (and their advisors) playing tax games in ways that are both deliberate and inadvertent, and to face legal roadblocks like WTO noncompliance that could undermine key components of the legislation,” according to the report, which is the continued work of a group of legal experts from across the country.
According to the report, the bill still has glitches that could lead to “haphazard and unexpected results that could arbitrarily favor or penalize taxpayers.”
Specifically, the conference bill allows for the following four tax planning opportunities:
1. Using corporations as tax shelters.
The conference bill taxes C corporations at a 21% rate beginning in 2018. As a result, taxpayers would still be able to use corporations as tax-preferred savings vehicles.
With no further protections added to the bill to avoid this outcome, C-corps will be used to shelter income from the top ordinary income tax rate.
According to the report, “the use of corporations as tax shelters can result in labor income only being taxed at the preferential 21% rate, and entirely eliminate the ‘second layer’ of tax when an individual receives a dividend or sells the corporate stock.”
The incentive to use corporations as tax shelters is slightly reduced under the conference bill relative to the prior version as a result of the slightly higher corporate rate (from 20% to 21%) and lower top individual rate (from 39.6% to 37%). But, according to the report, the tax savings could still be considerable.
“Pre-existing safeguards to avoid these kinds of consequences are already inadequate and will be even more so in light of the planning incentives that this rate differential creates,” the report states.
2. Pass-through games.
The conference bill grants a 20% deduction for certain qualified business income, which in effect reduces the top tax rate from 37% to 29.6%. According to the report, this provides a “tremendous incentive” for taxpayers to shoehorn their income into the “qualified” category.
The report finds that the complex rules involved will invite plenty of gaming opportunities.
“There is no particular logic to who clearly fits into the preferred categories, and the game will be to get within the haphazard lines,” the report states.
In fact, the conference bill actually worsens matters along an important dimension, according to the report.
The conference bill allows owners of firms with no wages whatsoever, and just certain kinds of property, to take advantage of the lower rate.
“This change both expands the availability of the pass-through deduction and encourages firms to game the rule by increasing their ownership of qualifying property (for example, by owning instead of leasing) — and possibly even by replacing workers in the process,” the report states.