There is a possibility that the Treasury Department's position on a tax break for hedge fund and private equity managers will be legally challenged after the government issues proposed rules.
The proposed rules would prevent S companies from taking advantage of a 2017 tax provision that would allow companies to get the favorable tax treatment of interest income faster – by holding assets for one year instead of three years. The rules raise a question of the Treasury's legal authority to exclude S-companies from the meaning of "company" in the provision. This question has already been raised in at least one court case and has been scrutinized by experts since the Treasury Department's first notice of plans in a 2018 notice.
With the Treasury Department pushing the final regulations forward and they get struck down by a court of law, private equity and hedge fund managers may seek to employ S companies to get better tax treatment after just a year, though some may also be specific Finding restrictions for S-companies is a nuisance.
If Congress extended the holding period on the tax overhaul, it may want to exempt only C companies from the tax because they pay taxes at both the corporate and shareholder levels, as opposed to S companies, which pass their income on to shareholders for tax purposes . However, several tax specialists told Bloomberg Tax that even if so, a court may conclude that the Treasury Department cannot rule out S-businesses given the broad language congress used in the statute.
Transferred interest is the portion of a mutual fund's return that is paid to managers. It is taxed at a preferential rate of 20%, which is usually accompanied by an additional net investment tax of 3.8% compared to the highest individual tax rate of 37%.
"The law on his face says corporations are corporations, and I believe that 'corporations' include suburban companies," said Steve Rosenthal, senior fellow at the Urban-Brookings Tax Policy Center at the Urban Institute. "Granted, that's a loophole, but I think Congress needs to fill the loophole, not the Treasury Department, not the IRS."
The Treasury Department has not returned a request for comment.
An appeals court has already suggested that the Treasury Department's planned move could cause legal problems.
In Charleston Area Medical Ctr. v. USA has joined the US Federal Circuit Court of Appeals in the Treasury Department's argument to interpret “corporation” in another part of the tax code in general. However, the court's decision of October 2019 also questioned whether the Treasury's proposed rules set out in the 2018 notice, given the Treasury's broad interpretation of "company" in this separate case, which deals with another section of the Code concerned, would be appropriate.
Whether or not the Treasury Department's final rules will be reviewed in court will likely depend on a taxpayer following S-Corporation's strategy and then questioning the rules. Some suggested that there will likely be a taxpayer willing to take the department to court.
"In my experience, anything that is clearly against the taxpayer is challenged because there is always someone with enough money at stake," said Howard Abrams, a visiting professor at Harvard Law School who specializes in partnership and corporate tax issues Has.
"Faithfulness to the law would mean the Treasury Department should lose," Abrams said in a legal challenge. He referred to the General Tax Code definition of “corporation” under Section 7701 (a) (3) and the Code's definition of “S corporation” under Section 1361 as an indication that an S corporation is a corporation.
Defense of the Treasury
However, the Treasury Department has arguments on its side. Long-standing case law supports the idea that the Treasury Department has a broad regulator to interpret the meaning of tax law, although more recently some judges have urged restricting those powers, said Alexander Anderson, a partner at O'Melveny & Myers LLP who focuses on tax issues.
Several tax experts suggested that some courts might be persuaded that the Treasury Department should be able to correct an obvious drafting error, or that the political arguments favor the Treasury Department.
In explaining its authority to issue the rules, the Treasury Department stated that it had been directed pursuant to Section 1061 (f) to issue rules or guidelines “necessary or appropriate for the purposes of the law”.
The department also noted that the definition of “corporation” in the Joint Tax Committee's Blue Book, which was created to explain the law after it came into force, “does not include an S corporation”.
However, some questioned the usefulness of the Blue Book for the Treasury Department in a future court case.
"Aside from the fact that courts do not usually believe the blue books because they are issued after they are issued, the blue book is just a concluding statement with no justification," said Monte Jackel, tax expert and former specialist advisor to the IRS chief counsel .
The Treasury Department's justifications come at a time when the department has expanded its explanations of key rules as it faces a growing risk of lawsuits challenging their validity.
Anderson said the Treasury Department's discussion of its regulator in the proposed rules was "a little exhaustive and not exactly a bulletproof defense," but cautioned not to read too much. "They may have a stronger case that they didn't set out in the proposed rules, and I also think that going too deep into the discussion would look overly defensive."
– With the support of Allyson Versprille.