Implementing tax reform won’t be easy for an agency whose budget has been cut steadily.
Understaffed and under-budget, the IRS will face a tough challenge rolling out any tax overhaul Congress may pass.
Throughout August, lawmakers and the White House have worked out details on a unified tax-reform outline they hope to unveil in September, with an eye toward committee work on a bill in the fall. But they haven’t agreed on key provisions, including the scope of an overhaul bill.
Broad reform legislation that is revenue-neutral, eliminates deductions, broadens the tax base, and lowers rates may ultimately be too heavy a lift for a highly partisan Congress and a White House distracted by outside controversies. Instead, some in the Washington tax world are eyeing smaller changes to the code paired with tax cuts that could expire at the end of the budget window, currently set at 10 years.
But whatever Congress passes, the IRS will likely face a costly administrative task in implementing the legislation, and it may not get help from a Congress that has made its mark criticizing the agency.
“There will be significant rule changes and there will be significant transitions, and there will be significant requirements for guidance from the agency,” said Ed Karl, vice president for taxation at the American Institute of CPAs.
Tax bills carry a mandate for new rules, and it’s the IRS that interprets and implements them. That often comes in the form of guidance published by the agency to give stakeholders directions on how to comply with the law. Guidance can range from broad regulations to private letter rulings that offer compliance directions for a taxpayer’s specific case.
New provisions could also provide an enforcement challenge. For example, a House proposal would lower the tax rate for pass-through businesses, entities in which income is passed to the owners to be taxed at individual rates. The House proposal would lower the rates for pass-through income to 25 percent. By comparison, the current top individual rate is about 39 percent. That could entice some individuals to recast their personal salaries as income from a pass-through entity in order to evade the higher rate.
As happened after the landmark 1986 tax-reform legislation, there will likely be a flood of questions from stakeholders if Congress passes a new bill.
“Any time you start changing the provisions of the tax law, what are its rates, or any other provision, you are going to find that the change affects taxpayers that no one anticipated,” said Larry Gibbs, who served as IRS commissioner when the agency implemented the 1986 bill and is now senior counsel at Miller & Chevalier.
But today the agency is beset with budget and staffing issues and stretched thin with new responsibilities.
“It’s different now; the resources are very different,” Gibbs said. “It will be a total challenge.”
Lawmakers have cut the IRS budget by about $1 billion since 2010. President Trump’s proposed 2018 budget would further reduce funding by $239 million, about 2 percent less than last year’s appropriation of $11.2 billion. The agency has about 80,000 employees, a drop from about 94,000 in 2010.
The funding and staff declines have come as the IRS workload grows, with the number of returns increasing and globalization making corporate tax filings ever more complex. The Affordable Care Act created new, unfunded challenges when it tasked the IRS with administering premium subsidies and penalties for the uninsured. That’s led the agency to shift resources to administering the new programs, according to a January post by the Tax Policy Center.
“The levels of service at the agency have diminished to the point where it’s challenging not only for taxpayers but for tax professionals to deal with the agency,” Karl said.
IRS Commissioner John Koskinen and National Taxpayer Advocate Nina Olson have told Congress the cuts affect taxpayer services and collections.
And some in the Trump administration have echoed that argument. During his Senate confirmation hearing in January, Treasury Secretary Steven Mnuchin said the IRS was under-resourced to perform its duties and further cuts would hamper its ability to collect revenue. Staffing up the IRS would help close the federal government’s $450 billion tax gap, or the amount of taxes owed versus the amount it actually collects, he said.
But the Republican-led Congress has been reluctant to offer up more funding. The cuts started in 2010, and lawmakers soured on the IRS even more after the 2013 tax-exempt controversy, when critics accused the Obama-era IRS of targeting conservative groups applying for nonprofit status. House Ways and Means Chairman Kevin Brady has promised to restructure the IRS in legislation that would follow tax reform.
“We are proposing a dramatically simpler tax code,” Brady told reporters following a tax-reform speech in California last week. “It demands a dramatically simpler tax collector. So we do propose to bust up the IRS as it is today and redesign it into a 21st-century agency with one singular mission: customer service.”
The IRS has been here before, staring down a tax-code overhaul while working through major administrative difficulties. During the 1985 filing season, glitches in a new computer system led to major delays in refunds for millions of taxpayers. It was a scandal, and a daunting challenge for Gibbs, who took office in late 1986.
“As I came aboard, the 1986 act was not the focal point,” he said. “The focal point was doing whatever needed to be done so that the 1985 filing season didn’t ever happen again.”
But Gibbs said he used the computer crash as a way to rally IRS employees—from the chief counsel’s office to rank-and-file workers—to tackle tax reform, particularly since lawmakers didn’t provide any additional money to the agency that year.
“We had to use the resources that we had, to use the fact that the IRS embarrassed itself in 1985, to encourage the IRS folks that we’re going to be involved in carrying out the act,” he said.
He added that the agency today is up to the challenge.
Congress eventually boosted IRS resources in 1987 and 1988, Gibbs said, but he added that the 1986 reform bill passed through a Democratic House and a Republican Senate, and the agency shouldn’t expect that level of cooperation in the current political reality.
“Things are very, very different today,” he said. “We face a partisan, not a bipartisan, Congress. I don’t know if Congress will appropriate resources to the IRS to implement a tax-reform act. I’m not sure that can be counted on.”