Democrats say Treasury's changes to reporting rules for tax-exempts allow 'dark money' to influence US elections; Hatch says Obama Administration sought similar changes

The Senate Finance Committee today (Thursday, July 26, 2018) held a hearing on the nominations of Justin Muzinich to be Deputy Secretary of the Treasury and Michael Desmond to be Chief Counsel for the IRS and an Assistant General Counsel in the Treasury Department. Materials from the hearing are posted here, and PDFs of member statements and witness testimony are also attached with this alert.

The hearing opened with Sen. Chuck Grassley (R-IA) temporarily presiding as chairman, but Chairman Orrin Hatch (R-UT) submitted a prepared statement that praised Muzinich's previous experience at the Treasury Department as a counselor to the Secretary on "several domestic and international policy initiatives, including tax reform." Hatch similarly noted Desmond's experience as Tax Legislative Counsel at Treasury from 2005 to 2008, and as a Justice Department trial attorney before that. The bulk of Hatch's statement addressed Democrats' "dramatic" complaints about a recent change made by Treasury to "streamline" information returns by certain tax-exempt organizations. (Hatch also gave remarks on the Senate floor on Wednesday, July 25, on the same issue.) Hatch said the policy, which dated back to the Nixon administration, required social welfare organizations, labor organizations and Chambers of Commerce to report their donors' names and addresses, but was problematic because the IRS didn't need the data for tax administration because the donations are not tax deductible: "If the IRS decides it does need the information, it is still available to them upon request." He said the rules consumed time and resources at both the IRS, which had to redact the information to protect it against improper disclosure, and at tax-exempt organizations. Hatch said the IRS knows of "at least 14 instances where this information was improperly released since 2010." Far from a conspiracy to "cloak the political world in so-called dark money, in reality this was a simple change to improve IRS efficiencies and protect taxpayer data," which was necessary after what Hatch called abuses of taxpayer information by the IRS during the Obama administration. Hatch said the Obama administration itself had sought to make "an even more extensive change" on Schedule B reporting.

In his statement, Ranking Member Ron Wyden (D-OR) criticized the Trump administration for "stonewalling" in its lack of responses to letters and policy issues, including no response from Treasury Secretary Steven Mnuchin on questions about abuse of shell companies. Wyden said that Muzinich would serve as Mnuchin's "right-hand man" and not as the "building manager," as he had described the job in a meeting with Wyden, so would be responsible for improving the agency's response. On the recent change to reporting rules for tax-exempts, Wyden said, "If your dark-money policy gives oligarchs in Moscow reason to throw back celebratory vodkas, and if their friends at the NRA have a green light to flood the airwaves with even more election secrecy, you made the wrong call." He said the administration's change was "hasty" with no public debate. Finally, Wyden said that after shunning bipartisan cooperation in the Tax Cuts and Jobs Act (TCJA), Republicans are mounting a new effort to "update the partisan tax playbook with another plan that will benefit the wealthy," though quarterly numbers from the Bureau of Labor Statistics "show real wages fell over the first half of this year" after passage of the tax reform law. He said the new proposal, being assembled in the House, would not resolve the problem that "there's one strict, punishing set of rules for factory workers and cops on the beat, and another loose set of rules that allow high-flyers to pay what they want, when they want."

Muzinich's prepared statement is posted here and Desmond's is here.

Questions

Chuck Grassley (R-IA) got Muzinich to agree that the changes to reporting rules for tax-exempts were appropriate because "this information is unnecessary for tax administration purpose and imposes unnecessary costs on both the IRS and taxpayers, while also putting private taxpayer information needlessly at risk." When Grassley asked which policy areas Muzinich believes deserve the most attention by Congress as it seeks to build on the tax reform law, Muzinich said: 1) implementation of the tax law, 2) housing reform and 3) regulatory reform.

Grassley said tax regulations for years have "skipped" the review process that other agencies had to follow in submitting significant regulations to the White House's Office of Information and Regulatory Affairs (OIRA) for cost-benefit analysis, but that changed in April with the release of a memorandum of understanding between Treasury and the Office of Management and Budget (OMB) putting in place such a review process. He asked if Muzinich saw that change as a positive or negative. Muzinich said it was a matter of balancing speed with oversight of the regulatory process, "and we think we've struck the right balance." Desmond told Grassley that as tax counsel, "I saw some problems with the regulatory review process. Having OMB involved now shouldn't be an impediment to getting timely guidance out; work can be done to expedite the guidance process."

Ranking Member Wyden asked if Treasury would support bipartisan legislation to end abuses of anonymous shell companies, revealing their beneficial owners. Muzinich said, "As the Secretary recently testified, it is an issue we're committed to. We do think there are significant law enforcement benefits to solving beneficial ownership. We haven't commented publicly on specific bills, but it is something we're committed to working with you very closely on." Wyden said that answer was "almost identical" to Mnuchin's a year and a half ago. Later in the hearing, Wyden also asked about the IRS's process for developing a new "postcard" form for tax returns, asking why so much effort was placed into the project when the postcard "actually adds six new schedules to taxes instead of simplifying," instead of finishing guidance to small businesses who complain that they cannot even do an estimate of their tax due. Muzinich said he believed the new postcard form "will simplify life for many Americans who take standard deduction … On time allocation, we think they're both important, but they're led by different groups in the IRS," so work on the postcard form was done by a different group from those working on the section 199A guidance, "and we hope to have that out soon."

Robert Casey (D-PA) also asked about the change to the IRS reporting rules for tax-exempts, asking if Treasury had consulted with Treasury's Financial Crimes Enforcement Network (FinCen) or the IRS's criminal investigation division before making the decision. Muzinich said he wasn't aware of that because he "was not a decision-maker" in the process. Casey said the change could make it easier for foreign agents to affect U.S. elections, and quoted former IRS tax-exempt official Marv Freelander as saying that the data had helped in investigations because "the ability to begin by looking at large donations, whether tax-deductible or not, was a useful tool in pursuing the possibility of corruption."

Pat Toomey (R-PA) said the Treasury's change to reporting rules was appropriate because the IRS's mission "is to determine what people owe in taxes. It's really not the business of the IRS to police who contributed what to these organizations in contributions that have no tax consequences … It might be appropriate for other agencies to look into this, but not the IRS. And if the IRS felt the need to audit them, that information needs to be retained." Toomey said Wyden had made a mistake in saying wages had not risen, because "people who have been continuously employed have experienced even higher wage gains." Wyden took exception, later using time to submit documents into the record backing up his statement.

Toomey said the tax reform law needs a technical correction for a drafting error related to qualified improvement property, which has the "unintended consequence of stretching out the cost recovery period for improvements in real estate" and is problematic for restaurants and retailers. Muzinich committed to work with the committee and Congress "to address these and other technical issues so congressional intent is achieved through guidance and rulemaking." On indexing capital gains, Toomey said, "We define gain on an asset as the difference between the sale and purchase price, and then you pay tax on that difference — when in fact in the majority of cases, the positive number results from inflation … So it routinely happens that people have a nominal gain that is less than inflation." He said his view is that Treasury has the authority to redefine cost to include real costs adjusted for inflation. Muzinich said he would work with Toomey on the issue.

John Thune (R-SD) said technical corrections to the tax law are also needed in intellectual property and a "net operating loss issue … a straightforward drafting issue on one word." Thune said the tax law requires guidance to implement reforms across individual and family situations, and that Congress had provided broad authority in section 7805; he asked if Desmond agreed that "specific authority provided to stress specific issues should be used broadly to address congressional intent?" Desmond said that in his Treasury position, they had relied on section 7805 authority for issuing regulations; there are some places where its scope is unclear, but "it certainly can be applied very broadly." Muzinich said Treasury "wants to interpret the law in a manner consistent with congressional intent." In a question about whether the relationship between the IRS chief counsel's office and the appeals process was working properly, Desmond told Thune that "the process can work more efficiently — there are issues with ex parte prohibitions and ensuring the chief counsel is not being used as a conduit between examinations and appeals … The system does work, with appeals in particular and the appearance of appropriateness in an exam," Desmond said.

Sheldon Whitehouse (D-RI) said the Justice Department has a policy of not prosecuting people who make a material false statement to the government unless there has been a referral from the IRS, which gives the Service a "chokehold" over such prosecutions. He asked Desmond to pledge to tell him the number of all such referrals and explain the policy behind them, adding, "I expect there's practically no referrals." Desmond said his only concern in such cases was protecting confidentiality. Whitehouse then asked about the proliferation of anonymous shell companies. Desmond said he had not seen any national security data about the issue so he could not speak to it. Whitehouse said the IRS publishes information about the top 0.001% of tax returns, in which the taxpayer has average earnings of $152 million a year but pays an average tax rate of only 24% — lower than people who earn 1/100th of that income. He asked Muzinich not to stop such reporting of such aggregate tax return income "if it shows this tax bill has been a huge windfall for those huge income earners." Muzinich said that "sounds reasonable to me."

Bill Cassidy (R-LA) focused on duty drawback rules, saying the Trade Facilitation and Enforcement Act of 2015 mandated that regulators promulgate by February 24, 2018, guidance on the drawback process that allows refunds for U.S. manufacturers to compete on a level playing field with foreign companies. But he said the regulations on duty drawbacks are still being processed. He asked if Muzinich would support U.S. manufacturers by fulfilling the intent of the 2015 act on duty drawback; Muzinich said he would.

Robert Menendez (D-NJ) focused on the New Jersey legislature's move to allow state tax credits for charitable contributions in response to the tax reform law's changes to the state and local tax deduction (SALT). He noted that in 2011, the IRS chief counsel released an advisory memo clarifying that state tax credits given in return for charitable contributions "don't mean that you earn more money, so you shouldn't be taxed more," and that the Supreme Court had ruled in 2011 that state tax credits given for charitable donations "did not reduce the value of charitable deductions and don't constitute a satisfaction of tax liability. You should not tax people on the value of a tax break they receive.'" But he said the IRS is nonetheless "threatening New Jersey taxpayers and others with potential consequences" for participating in the state's program. He asked if the witnesses would commit to "reversing course from having the IRS target these taxpayers and apply the law equally regardless of states." Desmond said IRS had issued "case-specific guidance" in the past, and that while he would commit to understanding the issues more carefully, "it involves donative intent." He said he could not point to any change in charitable donation laws in section 170. Menendez said the tax reform law had nothing in it that prevents this practice by states that are already doing it: "You either treat my state the same as the 32 other states, or you take it away from the 32 other red states. Until I have a sense of satisfaction that we're being treated fairly, and IRS is not being weaponized, I will have a problem with these nominations."

Rob Portman (R-OH) said he had some concern about implementation of regulation for the new tax reform law, particularly on the international side; the nominees committed to work with the committee on those issues, as well as on making the IRS's oversight board more effective, an issue Portman said is addressed in a bill reforming tax administration structures that he introduced today with Sen. Ben Cardin (D-MD).

At the conclusion of the hearing, there was no indication by Chairman Hatch as to when the nominations would be acted on by the Committee or on the Senate floor.

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ATTACHMENTS

Desmond Statement

Hatch Statement

Muzinich Statement

Wyden Statement