The Second Report to the President on Identifying and Reducing Tax Regulatory Burdens (Second Report) was released to the public by Treasury Secretary Steven Mnuchin on October 4, 2017. This report is the U.S. Department of the Treasury’s (the Treasury) highly anticipated response to U.S. President Donald Trump’s Executive Order 13789. The order called on the secretary to identify regulations issued since January 1, 2016, that have added an undue burden on taxpayers or unnecessarily increased the complexity of federal tax law. Further, the order directed the secretary to provide specific recommendations to help remedy the identified issues. The Treasury’s report contains a summary of eight proposed, temporary and final regulations it believes should either be entirely withdrawn or otherwise revised.
Proposed Estate Tax Valuation Regulations to Be Withdrawn
One of the proposed regulations the Treasury identified to be entirely withdrawn relates to the use of discounts in the valuation of family-owned entities for estate, gift and generation-skipping transfer tax purposes. BKD’s articles from August 2016 and August 2015 provide an overview of the proposed regulations and the drastic implications they’d have on wealth transfer tax planning. In a Treasury press release issued subsequent to the report, the proposed regulations are called out for “hurt[ing] family-owned and operated business by limiting valuation discounts.”
According to the Treasury’s report, the proposed regulations, while meant to curtail the abuse of some of the provisions within Internal Revenue Code (IRC) Section 2704, would create an “unworkable” approach to valuing family-owned business and create an unwarranted burden of compliance for taxpayers. For all other regulations included in the report, the Treasury indicates the intention to follow up on and reassess the regulation, hoping to create a more palatable solution in the future. However, no plan to readdress regulations under §2704 was revealed. The report ends the §2704 discussion by stating the regulations should be withdrawn in their entirety and that a formal withdrawal of the proposed regulations would be published in the Federal Register “shortly.”
Partial Withdrawal & Modification of §385 Regulations
Another regulation identified in the Treasury report that received a great deal of attention relates to the recently finalized and temporary regulations under §385. These regulations addressed the classification of related-party debt as debt or equity for U.S. federal income tax purposes. See BKD’s prior alert for additional details on the content of the regulations.
The Second Report agreed with numerous commenters that several requirements under the documentation rules are a substantial deviation from current practice and would require corporations to build expensive new systems to meet the various tests required by the regulations. Accordingly, the Second Report recommends revoking the documentation rules and considers developing a new set of rules that would be substantially simplified. The Treasury and the IRS would develop and propose streamlined documentation rules with a prospective effective date to allow for comments and compliance.
The Second Report didn’t recommend revoking the distribution regulations portion of the §385 regulations. According to the report, the distribution regulations principally affect interests issued to related-party non-U.S. holders and are necessary to limit earnings stripping and diminish incentives for inversions and foreign takeovers. Instead, the Treasury intends to work with Congress to address these concerns through tax reform legislation. The Treasury will consider possible revocation of the distribution regulations to the extent tax reform eliminates the need for these rules.
Additional Regulations Addressed
The Second Report also recommends withdrawing proposed regulations affecting the definition of a “political subdivision” for purposes of determining taxability of the bonds issued by those entities. Although the report indicates additional guidance may be issued in the future, the current proposed regulations were considered to have an unjustifiable far-reaching effect on existing legal structures and were recommended for immediate withdrawal.
Regulations recommended for partial revocation include final regulations permitting the IRS to use private contractors to assist with tax audits and proposed and temporary regulations governing the allocation and classification of partnership liabilities.
The report also includes suggestions for substantial revision of regulations covering transfers to regulated investment companies and real estate investment trusts, foreign currency translations and the treatment of certain transfers of property to foreign corporations.
The Treasury intends to issue subsequent reports on the topic of reducing tax regulatory burdens, including an updated discussion on the status of the regulations the Second Report recommends for withdrawal or revision. Taxpayers should consider the practical effect of the recommendations included in the Treasury’s report and plan accordingly for when the regulations are formally withdrawn or otherwise revised.
Contact your trusted BKD advisor for help determining how these proposed changes affect your tax situation and to discuss potential planning opportunities.