With less than a month until Inauguration Day, tax advisors find themselves on the uncertain precipice of what might well be an historic overhaul of our federal tax system. President-elect Donald Trump’s tax plan and early indications from Treasury Secretary nominee Steven Mnuchin strongly suggest that the new administration will make tax reform a priority. The theme from the top is lower tax rates and simplification. But the tricky part for the President and Congress will be how to fit a multi-trillion dollar tax cut into revenue-neutral legislation. The solution will require some balancing and stepped-up enforcement.
What can CPAs expect? Where will IRS focus its resources? How might taxpayers get ready? The ultimate answers are uncertain at this time, but the following possible changes might contain clues about how to plan ahead.
Repeal of the Estate Tax
If the estate, gift, and generation-skipping taxes become a thing of the past, where do estate and gift tax advisors focus their efforts? That all depends upon what fills the void in the event of repeal. If Congress also eliminates the step-up in basis for inherited assets, then there may well be a new regime of carryover basis rules or year-of-death income tax assessment on unrealized gains. In any event, such a significant transition will require both the IRS and family wealth planning professionals to prepare for a serious shift in focus over the coming years.
It is unclear whether President-elect Trump’s proposed 15% business tax rate will apply to flow-through income, guaranteed payments, and compensation from businesses to their owners. If any distinction is drawn that might favor the retention of earnings within the business entity, tax advisors will have to focus more on reasonable compensation and debt/equity issues involving businesses and their owners. Greater IRS scrutiny should also be expected.
More Streamlined Audits
The authors expect that Congress will thin out the number of available business deductions and credits, such as those for historic preservation, research, energy, conservation easements, and local economic development. This trend will likely result in IRS audits that are narrower in scope but more focused and detailed on the issues targeted.
Increased IRS Scrutiny on Worker Classification
The employee-versus–independent contractor issue has traditionally been a hot item at the federal and state audit level. If the business income tax is lowered to 15%, workers who find themselves in the grey area on classification may consider whether they might be better off as self-employed. Expect the IRS to bolster the border between these classifications to prevent abuse and ensure the proper collection of tax revenues.
The new administration is expected to take a carrot-and-stick approach to its goal of repatriating revenue that U.S. businesses have earned and kept abroad. To offset the lower U.S. business tax rate, there may be a tax (rumored at 10%) on assets retained by U.S. businesses offshore. This combination would replace the current “tax holiday” approach, which has led businesses to accumulate earnings offshore, and could prove more effective than the occasional tax holidays offered in the past as incentives to repatriate funds. CPAs should be mindful of developments in this area, as any significant changes will likely redirect the focus of IRS audits and require multinational companies to revisit their financial and tax planning.
It is widely believed that a “law and order” platform can fund itself, the more it is applied to tax enforcement. As a result, tax preparers should anticipate a more aggressive approach to IRS tax enforcement. There has already been a strong trend toward parallel investigations (i.e., dual civil and criminal investigations on the same issues). In addition, with the ever-increasing use of civil and criminal forfeitures, tax restitution rules, and criminal fines, the IRS Criminal Investigation Division and the Department of Justice have gradually seen their roles broadened to include acting as profit centers for government resources. As a practical matter, increasing the agency’s use of these tools does not require legislation and thus represents a quicker, more efficient path toward generating government revenue.
The new administration is expected to take a carrot-and-stick approach to its goal of repatriating revenue that U.S. businesses have earned and kept abroad.
Corporate Tax Shelters
Given the anticipated lower corporate tax rate and the likelihood of increased tax enforcement, CPAs should expect a trend away from corporate tax shelters, as the rewards may no longer justify the risks. With that said, no federal tax overhaul comes without its share of counter-vailing interpretations and tax strategies—see, for example, the many tax shelter strategies whose foundations were laid in the 1986 Tax Reform Act. Therefore, tax advisors should certainly look to take full advantage of whatever opportunities might be provided in the new legislation, with the age-old qualification that if it looks too good to be true, it likely is.
Foreign Bank Account Reporting
The IRS has repeatedly warned owners of offshore bank accounts that its Offshore Voluntary Disclosure Program (OVDP) and streamlined options will not be around forever. With the Foreign Account Tax Compliance Act (FATCA) firmly in place and information coming in to the Financial Crimes Enforcement Network (FinCEN) and IRS from cooperating foreign banks, the Treasury Department and the Department of Justice could well decide to end the amnesty programs and enforce the civil penalties against OVDP holdouts under Titles 26 and 31.
Nothing Certain but the Taxes Themselves
There is, of course, no crystal ball that will reveal America’s tax future. The best CPAs can do in these uncertain times is to encourage their clients to stay educated and remain attuned to their businesses and finances. By being prepared and flexible, taxpayers can avoid pitfalls and seize the opportunities that will inevitably present themselves as the new tax landscape unfolds.