There are many quirks to the new tax legislation. Here are some that stand out. Along with the restructuring of the international tax landscape and the limitation of interest deductibility is the change in the treatment of alimony. Prior to tax reform, the payor was permitted to deduct alimony payments. Tax reform changed that: payments will neither be deductible by the payor nor included in the income of the recipient. The effective date, however, is January 1, 2019. Any amendments agreed by mutual consent after that date may be grandfathered. Any disputed changes will be subject to the new law.
This creates some strange incentives. 2018 could become the year to get divorced. If the courts are slow to adjust to calibrating alimony payments in after-tax terms, there is little incentive for recipients of alimony payments to agree to post 2018 amendments: argue and the judge will subject payments to the new regime and the alimony is received tax-free!
The Nick Saban Tax
Nick Saban, coach of the Alabama University Crimson Tide and one the most successful coaches in college football, received total pay in excess of $11m in 2017. He is the highest paid public servant. The Tax Cuts and Jobs Act imposes a 21% excise tax on tax-exempt institutions who pay compensation more than $1m to the five highest-paid employees. The way the law is drafted, the tax applies to institutions exempt under IRC Section 115(1) which, among other things, exempts certain government instrumentalities. The drafting problem highlighted originally in a blog post by Ellen April of Loyola Law School, is that the University of Alabama, a state university, has a good argument that its tax-exempt status is not by reason of IRC Section 115, but rather under the doctrine of implied statutory immunity, which exempts the income of states and political subdivisions absent a specific statutory authorisation.
It is not unconstitutional for the Federal government to tax states or their political subdivisions – it appears the University of Alabama would qualify as such – but there must be a specific act to do so. The reference to IRC Section 115(1) may not be enough.
Farmers and Co-Ops
IRC Section 199A creates a special pathway to savings for farmers who sell their grain to co-operatives. It permits a deduction of up to 20% of total sales to co-operatives. If they sold to private or investor-owned companies, they would be entitled only to deduct 20% of their net profit. The consequence is that companies such as Cargill, Archer Daniels Midland and Bunge are planning to set up co-ops in order not to be at a competitive disadvantage.
S-Corps and Capital Gains
The provisions requiring hedge funds to defer receipt of carried interest profits for three years in order to benefit from the long-term capital gains rate provide a structuring opportunity. The manner in which the legislation is drafted is to capture profits arising from holding an applicable partnership interest – the term used to describe the carried interests that are the source of much hedge fund manager compensation. The term applicable partnership interest is expressed not to be an interest held by a corporation.
The language gave rise to many S-Corporations being formed to hold carried interests, thus avoiding the three- year holding period requirement. There was not much substance to this: S-Corporations are clearly passthrough entities that are functionally very much the same thing as a partnership. The Treasury has already issued language indicating it will be issuing regulations to clarify this.
Fixing the Mess
The quirks mentioned above are only some of the technical issues that have arisen from a poorly drafted, ill-considered and hastily passed piece of legislation. Fixing the problems will not be straightforward because doing so will require sixty votes in the Senate. The Democrats, biding their time to see how they fare in the 2018 mid-term elections, are not feeling in a co-operative mood. There are, no doubt, things that both sides want. How they achieve their goals will be fascinating to watch.
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