Pass-Through Tax Rules May Add $1.3B in Compliance Costs: IRS

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By Robert Lee

Taxpayers could end up paying $1.3 billion to comply with proposed regulations implementing the tax law’s 20 percent deduction for pass-through entities, according to estimates from the Internal Revenue Service.

The regulations could add 25 million hours in new annual reporting requirements for 10 million corporations and partnerships, the IRS said in proposed rules (REG-107892-18; RIN:1545-BO71) released Aug. 8. An annualized cost valuation of those hours reaches a price tag of $1.317 billion over 10 years, the agency estimates.

The IRS is right in expecting to impact a “huge reach” of taxpayers, Steve Rosenthal, a senior fellow at the Urban-Brookings Tax Policy Center, told Bloomberg Tax Aug. 8. The new deduction has piqued the interest of many clients who are interested in taking advantage of the new tax perk, Rosenthal said, so the IRS’s expectation of 10 million potential respondents to its regulations “seems right in terms of magnitude.”

The IRS calculated its estimate using the following assumptions:

  • Certain pass-throughs—businesses for which income flows directly to the owners, who are taxed as individuals—will spend 2.75 hours annually to report Section 199A information to approximately 8.8 million owners.
  • About 1.2 million pass-through owners will spend an additional two-thirds of an hour annually to voluntarily aggregate trade or business reporting.

Valuing the burden hours of aggregation decisions at $39 per hour and the burden hours of pass-through reporting 199A information at $53 per hour, the IRS totals the estimated gross costs of the proposed regulations at $1.317 billion over the next decade.

The agency didn’t provide a dollar estimate of the compliance savings of the new regulations or a net estimate of the compliance costs, but said the regulations will “substantially” reduce costs in several areas. For example, the proposed regulations would exempt a trade or business from being considered a specified service trade or business if it only provides a small amount of services in a specified service activity, which will reduce compliance costs for millions of businesses, the IRS said.

Moreover, “because of the scope of the section 199A deduction,” the IRS said most affected entities that see new costs will be “small, and medium in size.”

IRS Underestimates Burden

The projected reporting burden of 25 million hours, at an estimated average of 2.5 hours per respondent, “underestimates the amount of intrusiveness and time these regulations will occupy,” Rosenthal said.

“It certainly feels like a low estimate,” he continued. “A lot of people are going to devote significant time to working through these and being as aggressive as they can to take advantage of this deduction.”

There is no doubt the new rules add administrative work for partnerships and S corporations who will now have to disclose new information, Troy Lewis, a managing member at Lewis & Associates CPAs LLC in Draper, Utah, and an associate professor of tax and accounting at Brigham Young University, told Bloomberg Tax.

“The rules clarify a lot of anxiety-laden questions that were out there and helping to make sure you don’t take any actions that could be irreversible,” Lewis said.

The IRS is soliciting comments on the assumptions and the methodology used to calculate the compliance costs imposed by the proposed regulations. The agency also said it will hold an Oct. 16 public hearing on proposed rules.

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