IRS Process to Issue SALT Notice Was Reasonable, TIGTA Says

Review of the Issuance Process for Notice 2018-54

February 22, 2019

This report remains the property of the Treasury Inspector General for Tax Administration (TIGTA) and may not be disseminated beyond the Internal Revenue Service without the permission of TIGTA. This report may contain confidential return information protected from disclosure pursuant to I.R.C. § 6103(a). Such information may be disclosed only to Department of the Treasury employees who have a need to know this information in connection with their official tax administration duties.

Highlights

Final Report issued on February 22, 2019

Highlights of Reference Number: 2019-14-019 to the Commissioner of Internal Revenue.

IMPACT ON TAXPAYERS

On December 22, 2017, the President signed Public Law 115-97, commonly referred to as the Tax Cuts and Jobs Act (TCJA). The TCJA made significant changes to the tax code affecting individuals, businesses, and tax-exempt organizations. One such change limits individual taxpayer deductions for State and local taxes to $10,000 a year ($5,000 a year for married filing separate taxpayers). TIGTA estimates that this change could affect more than 10 million taxpayers in Tax Year 2018.

WHY TIGTA DID THE AUDIT

TIGTA initiated this audit based on a request from the Chairman of the U.S. House of Representatives Committee on Ways and Means concerning the prioritization and issuance of IRS Notice 2018-54, Guidance on Certain Payments Made in Exchange for State and Local Tax Credits. The overall objective of this audit was to evaluate the process used to prioritize and issue IRS Notice 2018-54.

WHAT TIGTA FOUND

TIGTA determined the IRS began working on guidance for the State and local tax deduction shortly after the TCJA was enacted. Guidance in this area was given priority due to taxpayer impact and emerging issues. In addition, TIGTA found that the process used for the issuance of Notice 2018-54 involved approvals from appropriate officials within and outside of the IRS.

The development of Notice 2018-54 began in January 2018 after the TCJA became law and imposed limitations on State and local tax deductibility. TIGTA found that the IRS Office of Chief Counsel prioritized the issuance of this guidance because of issues raised in the media and proposed State legislative actions. From January through March 2018, the IRS, in consultation with Department of the Treasury (Treasury) officials, worked to develop the draft guidance. On March 29, 2018, the IRS sent a draft press release announcing forthcoming guidance to Treasury for approval.

Subsequently, Treasury officials reviewed the press release and converted it into an IRS notice. The Notice 2018-54 was reviewed and approved by high-level Treasury officials, including the Secretary of the Treasury, and was sent to the Office of Management and Budget and the National Economic Council for review and approval. Finally, on May 22, 2018, the Acting IRS Commissioner approved the final Notice 2018-54, and the IRS issued it the next day to the public.

IRS and Treasury officials stated that sub-regulatory guidance might include higher-level reviews and approvals depending on the policy implications of the guidance. Because Notice 2018-54 addressed TCJA provisions, which could have a significant impact on taxpayers, Chief Counsel and Treasury officials indicated that expanded reviews were appropriate. Given the potential impact on millions of taxpayers, TIGTA found the review and approval process for Notice 2018-54 to be reasonable.

WHAT TIGTA RECOMMENDED

TIGTA made no recommendations as a result of the work performed during this review.

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February 22, 2019

MEMORANDUM FOR
COMMISSIONER OF INTERNAL REVENUE

FROM:
Michael E. McKenney
Deputy Inspector General for Audit

SUBJECT:
Final Audit Report — Review of the Issuance Process
for Notice 2018-54 (Audit # 201810024)

This report presents the results of our review to assess the process used to prioritize and issue Internal Revenue Service (IRS) Notice 2018-54, Guidance on Certain Payments Made in Exchange for State and Local Tax Credits. This audit was requested by the Chairman of the U.S. House of Representatives Committee on Ways and Means. This audit is included in our Fiscal Year 2019 Annual Audit Plan and addresses the major management challenge of Implementing the Tax Cuts and Jobs Act and Other Tax Law Changes.

Copies of this report are also being sent to the IRS managers affected by the report finding. If you have any questions, please contact me or Deann L. Baiza, Acting Assistant Inspector General for Audit (Management Services and Exempt Organizations).

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Table of Contents

Background

Results of Review

Appendices

Abbreviations

IRS	Internal Revenue Service
OIRA	Office of Information and Regulatory Affairs
SALT	State and Local Tax
TCJA	Tax Cuts and Jobs Act

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Background

On December 22, 2017, the President signed Public Law 115-97, commonly referred to as the Tax Cuts and Jobs Act (TCJA).¹ The TCJA made significant changes to the tax code affecting individuals, businesses, and tax-exempt organizations. Most changes in the new law take effect in Calendar Year² 2018 and will affect tax returns filed in Calendar Year 2019.

One of the TCJA provisions limits individual taxpayer deductions for State and local tax (SALT) payments to $10,000 a year ($5,000 for a married person filing a separate return), beginning in Tax Year³ 2018 and expiring at the end of Calendar Year 2025. SALT payments (including income and real property taxes) that exceed those amounts are no longer deductible by individual taxpayers unless the payments are made in pursuit of a trade or business.⁴ This also will affect taxpayers who must choose between taking the standard deduction⁵ or itemizing their deductions on Form 1040, U.S. Individual Income Tax Return, Schedule A, Itemized Deductions. When the TCJA became law, the standard deduction amounts increased as shown in Figure 1:

Figure 1: Standard Deduction Amounts and SALT Deduction Limitations Before and After the Passage of the TCJA

Filing Status	Tax Year 2017 Standard Deduction	Tax Year 2018 Standard Deduction	Tax Year 2018 SALT Limitation Amount
Single	$6,350	$12,000	$10,000
Married Filing Jointly	$12,700	$24,000	$10,000
Married Filing Separately	$6,350	$12,000	$5,000
Head of Household	$9,350	$18,000	$10,000
Source: IRS Publication 5307, Tax Reform Basics for Individuals and Families (October 2018) and Publication 17, Your Income Tax for Individuals (2017).

To determine the impact of the new cap on SALT deductions, we reviewed Federal tax returns filed in Tax Year 2017 and estimate that, if the SALT limitation had been in place in Tax Year 2017, it would have affected approximately 10.9 million taxpayers who would have been unable to deduct approximately $323 billion in SALT payments on Form 1040 Schedule A. See Figure 2 for more information.

Figure 2: Estimated Number of Taxpayers Subject to the SALT Limitations, and Amounts of State and Local Taxes Paid Over the SALT Limitations in Tax Year 2018⁶

Filing Status	Number of Taxpayers7	Total Amount Over SALT Limitation
Single	2,151,826	$116,744,057,916
Married Filing Jointly	7,763,869	$185,864,115,484
Married Filing Separately	391,820	$5,772,842,933
Head of Household	573,055	$14,746,499,306
TOTALS	10,880,5708	$323,127,515,6399
Source: Treasury Inspector General for Tax Administration calculations based on tax returns filed in Tax Year 2017.

Whenever Congress enacts new legislation affecting the tax code,¹⁰ the Internal Revenue Service (IRS) Office of Chief Counsel (hereafter referred to as Chief Counsel) is responsible for determining if guidance is necessary to address the new legislation. Chief Counsel also develops tax-related guidance for the public through its Priority Guidance Plan. While developing the annual Priority Guidance Plan, the IRS and the Department of the Treasury (hereafter referred to as Treasury) solicit recommendations from the public for items to include in the Plan. The type of guidance the IRS issues ranges from publishing informal news or press releases up to issuance of regulations, which are the most authoritative type of guidance.¹¹ Regulations provide Treasury's and IRS's official interpretation of tax laws and are binding on taxpayers because they have the force and effect of law.¹² Figure 3 illustrates the hierarchy of authority for IRS guidance.

[Editor's Note: The reference for footnote ¹³ appears in the image above.]

Published guidance is important because it helps IRS personnel apply the tax laws correctly and uniformly and assists taxpayers with voluntarily complying with the tax laws. In addition, the IRS publishes guidance in the Internal Revenue Bulletin, which is the authoritative instrument for publishing revenue rulings, revenue procedures, notices, and announcements. Anything that is published in the Internal Revenue Bulletin requires three levels of clearance:

• Chief Counsel.

• The IRS Commissioner, to ensure that the proposed guidance is administrable.

• The Treasury, Office of Tax Policy, to ensure that the proposed guidance covers tax policy.

In addition, Chief Counsel, as the chief legal advisor to the IRS Commissioner on all matters pertaining to the interpretation, administration, and enforcement of the Internal Revenue Laws (as well as all other legal matters), provides legal guidance and interpretive advice to the IRS, Treasury, and to taxpayers.

This review was performed at the IRS National Headquarters in Washington, D.C., in the Office of Chief Counsel during the period June through November 2018. This review was requested by the Chairman of the U.S. House of Representatives Committee on Ways and Means. Based on the request, the scope of this audit was limited to the process followed by the IRS to prioritize and issue Notice 2018-54, and who was involved in the process. We conducted this performance audit in accordance with generally accepted government auditing standards. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objective. We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objective. Detailed information on our audit objective, scope, and methodology is presented in Appendix I. Major contributors to the report are listed in Appendix II.

Results of Review

The Internal Revenue Service Prioritized, Approved, and Issued Notice 2018-54

We determined that Chief Counsel, in collaboration with Treasury, began working on guidance for the SALT limitations shortly after the TCJA was enacted. Chief Counsel gave the SALT issue priority due to the impact on taxpayers, as well as to address proposed legislation by various States designed to circumvent the SALT limitations. This guidance was initially released in the form of Notice¹⁴ 2018-54, Guidance on Certain Payments Made in Exchange for State and Local Tax Credits, and later in the form of draft regulations. Notice 2018-54 was circulated for review within Treasury, including various Senior Treasury officials and the Secretary of the Treasury, because of the importance of administering the TCJA provisions and its impact on taxpayers. Additionally, Treasury stated that it forwarded the Notice 2018-54 to the Office of Management and Budget Office of Information and Regulatory Affairs (OIRA)¹⁵ and the National Economic Council¹⁶ for review. After all parties cleared the Notice 2018-54, the IRS issued it to the public on May 23, 2018, via an IRS News Release, IR-2018-122.

The prioritization of Notice 2018-54

The IRS stated that several factors led to Chief Counsel's decision to prioritize the issuance of guidance on the SALT limitations. Specifically, once the TCJA became law, several States began proposing or considering legislation that created workarounds designed to minimize the impact of the SALT limitations. Some State-run programs would allow taxpayers to contribute to various State and local governments in exchange for credits against State taxes.¹⁷ In addition, public concerns and questions about the new SALT limitations were being raised through the media.

According to Chief Counsel, although guidance on the SALT limitations was not in its Priority Guidance Plan until August 2018, Chief Counsel considered it a priority. Chief Counsel stated that development and issuance of guidance on the SALT limitation was a high priority, especially because the new limitations would affect the 2019 Tax Year filing season.¹⁸ As such, a collaborative effort began between Chief Counsel and Treasury to develop regulations concurrent with some type of announcement to the public. The guidance process officially began on January 11, 2018, when Chief Counsel assigned a lead attorney from the Income Tax and Accounting section to research SALT issues.

While Chief Counsel has developed detailed guidance for issuing regulations,¹⁹ the guidance for notices does not specify which offices they should be circulated²⁰ to for review and approval. In this instance, the Notice 2018-54 received expanded reviews by IRS and Treasury personnel, as well as reviews by executive branch agencies that are normally involved in issuing regulations, including the Office of Management and Budget and the National Economic Council.

From January through March of 2018, Chief Counsel in consultation with Treasury officials, worked to develop the draft guidance. After several meetings, Chief Counsel and Treasury decided to notify the public that the IRS was evaluating the SALT issue and formal guidance would be forthcoming.

In March 2018, Chief Counsel at the direction of Treasury began to develop a press release concerning SALT guidance. According to the IRS, the press release was intended to communicate a word of caution because several States had proposed or passed legislation that was designed to circumvent the $10,000 cap on State and local tax deductions. It was also meant to inform the public that the IRS was working on guidance that would address these State-run programs.

After Chief Counsel and Treasury refined the Notice 2018-54, Treasury approved it for issuance. On May 23, 2018, the IRS released Notice 2018-54 to the public. As shown in Figure 4, it was the 24th guidance item issued concerning the TCJA since the law's enactment.

Figure 4: Number of TCJA Guidance Items Issued Before Notice 2018-54

Type of TCJA Guidance	Number of Guidance Items
Proposed or Final Regulations	None
Revenue Rulings	1
Revenue Procedures	7
Notices	14
Frequently Asked Questions	1
Total Guidance Issued by May 22, 2018	23
Source: Office of Chief Counsel, July 2018. Note: Notice 2018-54 was issued to the public on May 23, 2018, via an IRS News Release, IR-2018-122.

Notice 2018-54 stated that Treasury and the IRS intend to propose regulations addressing the Federal income tax treatment of certain payments for which taxpayers receive a credit against their State and local taxes. The Notice 2018-54 also informed the public “the proposed regulations [would] assist taxpayers in understanding the relationship between the Federal charitable contribution deduction and the new statutory limitation on the deduction for State and local tax payments.”

On August 23, 2018, Chief Counsel released proposed regulations addressing contributions in exchange for State and local tax credits associated with the SALT limitations. Chief Counsel advised us that the IRS would allow the public 45 days for submitting comments²¹ due to time constraints and the need to issue the rules in time for the 2019 Filing Season.

The proposed regulations generally provide that “if a taxpayer makes a payment or transfers property to or for the use of an entity listed in section 170(c), and the taxpayer receives or expects to receive a State or local tax credit in return for such payment, the tax credit constitutes a return benefit, or quid pro quo, to the taxpayer and reduces the charitable contribution deduction.”²² See Figure 5 for a timeline for the issuance of Notice 2018-54.

Figure 5: Chronology of Key Events for Notice 2018-54

1/11/18:	Chief Counsel assigns Income Tax and Accounting staff to begin work on the SALT deduction limitations and Internal Revenue Code §164 related provisions affected by the TCJA to determine if formal guidance is needed.
1/11/18 through 1/23/18:
	Chief Counsel gathers media reports, inquiries from the public, and proposed legislation designed to allow State residents to bypass the SALT limitations. Chief Counsel and Treasury meet to discuss a strategy for upcoming guidance.
1/24/18:	Chief Counsel officially establishes a proposed guidance project to determine what type of guidance should be issued.
2/15/18:	The Acting IRS Commissioner meets with several members of Congress to discuss the SALT limitation.23 Chief Counsel briefs Treasury officials.
3/08/18:	The Acting IRS Commissioner, Chief Counsel, and Treasury agree that the IRS should quickly issue a notice or announcement.
3/27/18 through 3/29/18
	Chief Counsel attorneys prepare a draft press release to address SALT issues and send it to Treasury for review.
5/07/18:	Treasury forwards a draft notice to the IRS (Treasury changed Chief Counsel's press release into a notice).
5/16/18:	The Treasury Secretary approves issuance of the draft Notice pending discussion with the Office of Management and Budget.24
5/22/18:	The Acting IRS Commissioner approves the Notice and forwards it to Treasury for review. The IRS initiates the process to publish the Notice in the Internal Revenue Bulletin.
5/23/18:	After receiving approval from the Treasury, the IRS issues Notice 2018-54 to the public.
Source: Interviews of Chief Counsel personnel and review of supporting documentation.

Reviews and approvals of Notice 2018-54

When Chief Counsel attorneys drafted the press release, and after the Acting Chief Counsel approved it, they sent it to Treasury for review on March 29, 2018. On May 7, 2018, Chief Counsel received a revised document, in the form of an IRS notice, from Treasury. IRS and Treasury officials determined that a notice was a better form of guidance because it is more authoritative than a press release. Chief Counsel advised us that when they received the draft Notice 2018-54 from Treasury, they circulated it within the IRS based on the IRS's standard process for review and approval of sub-regulatory guidance.

Treasury officials indicated that the reviews they performed were extensive because Notice 2018-54 addresses the SALT limitations, which will potentially affect millions of taxpayers and billions of dollars in tax revenue.²⁵ Treasury also stated that sub-regulatory guidance (e.g., notices, announcements) could require a wider range of reviews by higher-level officials depending on the policy implications of the guidance. Treasury also advised us that it does not have written procedures outlining who should review various guidance; however, Treasury is required to send proposed regulations to the OIRA if the anticipated impact is $100 million or more.²⁶

Treasury's expanded review included various Senior Treasury officials and the Secretary of the Treasury. A Senior Treasury Official, who was involved with issuing Notice 2018-54, explained that Treasury performs a wider review on most TCJA-related guidance.²⁷ Treasury personnel also advised us that they brief the Treasury Office of General Counsel²⁸ and the Secretary of the Treasury if the guidance relates to a significant policy or if the guidance is part of TCJA implementation.

Treasury also sent the Notice 2018-54 to the OIRA for review, although the Memorandum of Agreement between Treasury and OIRA addresses only proposed regulations, not sub-regulatory guidance such as notices. A Treasury official involved in the review advised that they shared the Notice 2018-54 with the OIRA to ensure compliance with the Memorandum of Agreement. The official explained that they routinely share TCJA-related guidance with the OIRA. Our review confirmed that the Treasury has forwarded other TCJA-related notices to the OIRA for review.

After OIRA reviewed the Notice 2018-54, they forwarded it to the National Economic Council for review. The OIRA and the National Economic Council cleared Notice 2018-54 for issuance and did not have any comments. It appears that the reviews and approvals performed by Chief Counsel and the Treasury were appropriate given the need to notify the public about the potential impact of the SALT limitations.

See Figure 6 for more information about Treasury's review process.

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Appendix I

Detailed Objective, Scope, and Methodology

The overall objective was to evaluate the process used to prioritize and issue IRS Notice 2018-54, Guidance on Certain Payments Made in Exchange for State and Local Tax Credits. To accomplish our objective, we:

Internal controls methodology

Internal controls relate to management's plans, methods, and procedures used to meet their mission, goals, and objectives. Internal controls include the processes and procedures for planning, organizing, directing, and controlling program operations. They include the systems for measuring, reporting, and monitoring program performance. We determined that the following internal controls were relevant to our audit objective: Chief Counsel's policies and prioritization for issuing notices. We evaluated these controls by reviewing Chief Counsel's guidance, interviewing Chief Counsel and Department of the Treasury personnel, evaluating the documentation related to Notice 2018-54, and analyzing the review process for Notice 2018-54.

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Appendix II

Major Contributors to This Report

Deann L. Baiza, Acting Assistant Inspector General for Audit (Management Services and Exempt Organizations)

Troy D. Paterson, Director

Jonathan T. Meyer, Director

Janice M. Pryor, Audit Manager

Yasmin B. Ryan, Lead Auditor

Mary F. Herberger, Senior Auditor

Thomas F. Polsfoot, Senior Auditor

Joseph P. Smith, Senior Auditor

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Appendix III

Report Distribution List

Deputy Commissioner — Attn: Chief of Staff

Chief Counsel

Director, Office of Audit Coordination

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Appendix IV

Notice 2018-54

Guidance on Certain Payments Made in Exchange for State and Local Tax Credits

NOTICE 2018-54

SECTION 1. PURPOSE

This notice informs taxpayers that the Department of the Treasury (Treasury Department) and the Internal Revenue Service (IRS) intend to propose regulations addressing the federal income tax treatment of certain payments made by taxpayers for which taxpayers receive a credit against their state and local taxes.

SECTION 2. BACKGROUND

Section 11042 of “The Tax Cuts and Jobs Act,” Pub. L. No. 115-97, limits an individual's deduction under § 164 for the aggregate amount of state and local taxes paid during the calendar year to $10,000 ($5,000 in the case of a married individual filing a separate return). State and local tax payments in excess of those amounts are not deductible. This new limitation applies to taxable years beginning after December 31, 2017, and before January 1, 2026.

In response to this new limitation, some state legislatures are considering or have adopted legislative proposals that would allow taxpayers to make transfers to funds controlled by state or local governments, or other transferees specified by the state, in exchange for credits against the state or local taxes that the taxpayer is required to pay. The aim of these proposals is to allow taxpayers to characterize such transfers as fully deductible charitable contributions for federal income tax purposes, while using the same transfers to satisfy state or local tax liabilities.

Despite these state efforts to circumvent the new statutory limitation on state and local tax deductions, taxpayers should be mindful that federal law controls the proper characterization of payments for federal income tax purposes.

SECTION 3. GUIDANCE TO BE ISSUED

The Treasury Department and the IRS intend to propose regulations addressing the federal income tax treatment of transfers to funds controlled by state and local governments (or other state-specified transferees) that the transferor can treat in whole or in part as satisfying state and local tax obligations. The proposed regulations will make clear that the requirements of the Internal Revenue Code, informed by substance-over-form principles, govern the federal income tax treatment of such transfers. The proposed regulations will assist taxpayers in understanding the relationship between the federal charitable contribution deduction and the new statutory limitation on the deduction for state and local tax payments.

SECTION 4. DRAFTING INFORMATION

The principal authors of this notice are Mon Lam and Merrill Feldstein of the Office of Associate Chief Counsel (Income Tax & Accounting). Other personnel from the Treasury Department and the IRS participated in its development. For further information regarding this notice, contact Ms. Lam or Ms. Feldstein at (202) 317-5100 (not a toll-free call).

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Appendix V

Offices Involved in the Issuance of Notice 2018-54

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Appendix VI

Key Internal Revenue Service and Treasury Personnel Involved in Drafting, Reviewing, and Approving Notice 2018-54

Organizations Involved	Offices Involved	Positions Involved
IRS	Office of the Commissioner	Acting Commissioner
		Deputy Commissioner, Services and Enforcement
		Special Assistant to the Commissioner (Reporting to the Deputy Commissioner)
		Acting Attorney-Advisor to the Deputy Commissioner, Services and Enforcement
	Office of Chief Counsel	Acting Chief Counsel
		Special Assistant to the Chief Counsel
		Associate Chief Counsel, Income Tax and Accounting
		Deputy Associate Chief Counsel, Income Tax and Accounting
		Special Counsel, Income Tax and Accounting (2 Employees)
		Senior Counsel, Income Tax and Accounting (3 Employees)
		General Attorney, Income Tax and Accounting
Treasury	Office of the Secretary	Secretary of the Treasury
	Office of Tax Policy	Assistant Secretary for Tax Policy
		Tax Legislative Counsel
		Deputy Tax Legislative Counsel
		Attorney Advisor
	General Counsel	General Counsel
		Deputy General Counsel
		Attorney, General Counsel
Source: Interviews with Chief Counsel and Department of the Treasury officials, as well as reviews of supporting documentation.

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Appendix VII

The Department of the Treasury's Review Process for Notices Not Related to the Tax Cuts and Jobs Act

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Appendix VIII

Memorandum of Agreement Between the Department of the Treasury and the Office of Management and Budget

Review of Tax Regulations under Executive Order 12866

Executive Order 13789 directed the Department of the Treasury and the Office of Management and Budget (OMB) to “review and, if appropriate, reconsider the scope and implementation of the existing exemption for certain tax regulations from the review process set forth in Executive Order 12866 and any successor order.” Treasury and OMB share a commitment to reducing regulatory burdens and providing timely guidance to taxpayers. Accordingly, this Memorandum of Agreement (MOA) provides the general terms under which the Office of Information and Regulatory Affairs (OIRA) within OMB will review tax regulatory actions.¹

Brent J. McIntosh
General Counsel
Department of the Treasury

Neomi Rao
Administrator
Office of Information and Regulatory Affairs

Date: April 11, 2018