An old friend who's a tax lawyer called to ask me if I am celebrating the Republican House bill. He had a particular (if partly tongue-in-cheek) reason why he thought I should be. A bit of background will supply the reason.
As I've noted, the special 25 percent percent rate for business owners in industries that the House Republicans like relies heavily on the passive loss rules in order to determine who gets the 25 percent rate as to all of their income from a given business, not just 30% of it.
I was in drafting sessions during my days as a legislative staffer, and I can totally understand why the drafters, if it was their call, decided to do this. It solves a drafting problem for them, related to higher vs. lower labor income component from a given business, without requiring them to draft anything new. The passive loss rules have been there for 30+ years, and apparently have worked okay for the most part. So why not borrow them for this purpose? Drafters do this sort of thing all the time, and indeed, given the constraints they face, they must.
But as I pointed out in an earlier post, the passive loss rules are highly unlikely to be able to function adequately in this new area. They most commonly induce taxpayers to try to claim they HAVE materially participated, not that they haven't. This question has strong factual inputs that the taxpayer can take care to document - e.g., hours spent on a given activity. And in any case the passive loss rules, by helping to shut down the late-1980s tax shelter industry, meant that a lot of the intended targets simply gave up, rather than trying to establish material participation.
Now, if the passthrough provision passes, we will have enormous tax stakes for people at extremely high income levels who have multiple "activities" for purposes of the passive loss rules, and who will want to DENY, not establish, that they have materially participated. This leaves the IRS in the uncomfortable position of having to prove that they have actually spent more time than they say on each item, or that others haven't spent more time, etc.
This strikes me as a huge problem. The passive loss rules were mainly able to handle the material participation issue that they created, but I don't think they can handle this problem adequately. It is going to be a mess.
But back to my friend's telling me I should celebrate. Here's the thing. I'm actually an expert on the passive loss rules. (A bit out of date at the moment as I haven't been involved with them for a while, but it would be easy to catch up.) I was present at the creation, as I was part of the team that designed and drafted them. Subsequently, I wrote a leading practitioner guide on the rules that I for a while was updating regularly. I've done consulting on the rules' proper application, and I've even been co-counsel, with a taxpayer's own representative, for purposes of discussing particular passive loss issues with IRS appellate conferees.
If this thing passes, I suppose I could hang out my shingle and do quite well, even keeping in mind that I'd want to keep the hours low due to (a) my greater enjoyment of doing academic work and (b) my internal normative compass.
So there's that, I guess.