Washington Tax Insight October 2015

 
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Background

Congress faces significant and challenging fiscal issues that are likely to converge at the end of 2015 in one omnibus budget package rather than individual bills. As a result, hope of avoiding an end of the year fiscal cliff is fading quickly. Fiscal year 2016 began on October 1st and although a short term Continuing Resolution (CR) to fund the government was approved and a government shutdown was averted, the Congress will face the funding issue again when the CR expires on December 11th. The need to raise the federal government’s debt ceiling limit will likely hit in late November, while the short-term extension of the highway spending bill expires at the end of October. 

The tax extenders package of business tax incentives still needs to be approved retroactively in order to give taxpayers the tax benefits for 2015.  While the resignation of House Speaker John Boehner (R-OH) at the end of October facilitated approval of a short-term CR, it is unclear whether any of the other major issues can be dealt with until new House Republican leadership takes control after electing the new Speaker.

Congressional Activity

Government Spending Bill – Continuing Resolution

Both the House and Senate approved a “clean” short-term CR to fund the government until December 11th.  An attempt to pass a CR in the Senate that included a short term extension of current government spending levels with language defunding Planned Parenthood failed on the Senate Floor on September 24th.  Congressional leadership then developed a plan whereby a bipartisan, short-term CR without language to address the Planned Parenthood issue would be brought to the House and Senate Floors for a vote, and language defunding Planned Parenthood would be included in Budget Reconciliation legislation that has now been approved by the House Ways & Means Committee.  Reconciliation bills are considered under special rules that require only a simple majority to pass, and they cannot be filibustered in the Senate.  The budget reconciliation legislation, which also includes the repeal of several excise taxes and mandates in the Affordable Care Act, is expected to be approved by the House and the Senate, but will face a Presidential veto.

The Highway Bill and International Tax Reform

Although House Transportation Chair Shuster (R-PA) has stated that he is still focused on producing a multi-year bipartisan highway bill this year, he has said that another short-term extension into early 2016 may be more likely when the current extension expires on October 29th.  The Department of Transportation has indicated that the trust fund is not likely to exhaust its funds until the summer of 2016.  This DOT estimate will complicate efforts to move a multi-year bill offset by international tax reform proposals this fall, although lawmakers would still have to extend the authority for highway spending.  W&M Committee Chair Ryan (R-WI) plans to release a draft of international tax reform to his Committee members soon but it now appears that coupling that reform with a long-term highway bill is unlikely this year.

Tax Extenders

On September 17th, the W&M Committee approved a new series of unpaid-for tax bills that permanently extend certain expired business tax incentives including an expanded version of the 50% bonus depreciation deduction for qualified property, and provisions benefiting controlled foreign corporations (CFCs), the restaurant and retail industries, and secondary school teachers.  (Previously, the Committee and the full House approved several other permanent extensions including the R&E credit.)  The lack of revenue offsets for these bills continues the W&M approach of making some extenders permanent while allowing others to expire in advance of comprehensive tax reform.  W&M Democrats stated that although they generally support making tax extenders permanent on policy grounds, they do not agree with increasing the federal deficit by failing to include revenue offsets.  The White House has repeatedly stated that it will veto unpaid-for permanent extenders legislation.  The Senate Finance Committee took a different approach in early July by approving a package that would retroactively extend through 2016 most of the business tax incentives that expired at the end of 2014 despite general Committee support of permanent extensions, in order to provide certainty to taxpayers and avoid controversy this year.  The House is expected to approve the W&M Committee bills, although they are not yet scheduled for a vote, while Senate Majority Leader McConnell has not indicated when he will schedule the SFC legislation for a Senate Floor vote.  Chairs of both tax-writing committees have stated that they would like to avoid an end of the year vote on the extenders legislation, but the dueling approaches will make resolution challenging.

Senate Finance Committee Markup on tax fraud legislation and the Loving v. IRS case

The Senate Finance Committee postponed a markup on bipartisan legislation on tax fraud scheduled for September 16th after the AICPA objected to a provision that would expand the IRS authority to regulate tax preparers.  It is reported that the legislation would override a court decision in the Loving v. IRS case that rejected an IRS bid to regulate a broad group of preparers who are not required to pass any sort of competency test.  The DC District Court ruled that the IRS has jurisdiction to regulate some preparers including attorneys, accountants and enrolled agents, but not those preparers who aren’t in those categories.  In a letter to SFC Chair Hatch, the AICPA noted their general support of the legislation but not the grant of “unlimited authority” to the IRS to regulate tax return preparers.  SFC leadership believed the legislation was uncontroversial until receiving the letter and then announced that technical changes are being considered to the legislation which will be the subject of a markup at a later date.

Treasury and the IRS

The IRS issued Revenue Procedure 2015-48, which provides guidance on the 2014 extension of the placed-in-service date for property qualifying for bonus depreciation, which is a 50% additional first year depreciation deduction.  This guidance also includes instructions on the extended application of Code section 179(f) dealing with qualified real estate property.

The IRS has issued several pieces of regulatory guidance related to regulated investment companies (RICs) under Code section 851.  The IRS issued final regulations that include revised examples that demonstrate how controlled group rules apply to the asset diversification tests for RICs (generally adopting the proposed regulations released in August 2013).  IRS Revenue Procedure 2015-45 describes conditions under which the IRS will treat a RIC that invests in one or more other RICs as satisfying the asset diversification requirements of Code section 851(b)(3)(B) (the 25% tests).

The IRS also issued guidance regarding spinoffs.  IRS Notice 2015-59 announces that the Treasury Department and the IRS are studying issues under Code sections 337(d) and 355 relating to certain distributions, described in Code section 355, in which the active business is small relative to other assets, or in which there is a substantial amount of investment assets.  The notice describes the transactions that concern the Treasury Department and the IRS and requests comments concerning those transactions.  IRS Revenue Procedure 2015-43 supplements Revenue Procedure 2015-3 by adding certain of these transactions to the list of no-rule areas.

The IRS issued proposed regulations making various changes to final and temporary regulations that would restrict favorable treatment under Code section 367 of the outbound transfer of active trade or business assets by subjecting any built-in gain attributable to foreign goodwill and going concern value to tax either through deemed royalty treatment under Code section 367(d) or current gain recognition under Code section 367(a).  If finalized, the proposed regulations would be effective as of September 14, 2015, when they were issued.  The IRS requests comments until December 15, 2015, on all issues related to the proposed regulations, including specifically on whether a “limited exception” to the proposed elimination of the goodwill exception should be provided in final regulations.

The IRS issued final regulations regarding the qualification of a transaction as an F reorganization under Code section 368(a)(1)(F) by virtue of being a mere change of identity, form or place of organization of one corporation.  The regulations also include rules for F reorganizations in which the transferor corporation is a domestic corporation and the acquiring corporation is a foreign corporation (an outbound F reorganization).  The final regulations generally adopt, with certain changes, the provisions of 2004 proposed regulations that were not previously adopted in final regulations in 2005.  The IRS explained that the regulations “are based on the premise that it is appropriate to treat the Resulting Corporation in an F reorganization as the functional equivalent of the Transferor Corporation and to give its corporate enterprise roughly the same freedom of action as would be accorded a corporation that remains within its original corporate shell.”  The regulations under Code section 368(a)(1)(F) apply to transactions occurring on or after September 21, 2015.  The IRS also issued final regulations under Code section 367(a) addressing outbound F reorganizations, adopting without substantive change provisions of 1990 proposed regulations regarding the close of the taxable year, deemed transactions, and characterization under foreign law.

The IRS issued temporary regulations on the arm’s length standard under Code section 482, which clarify the coordination of the application of the arm’s length standard and the “best method” rule under Code section 482 in conjunction with other parts of the tax code, applicable to taxable years ending on or after September 14, 2015.  The temporary regulations provide that arm’s length compensation must be consistent with, and must account for, all of the value provided between the parties in a controlled transaction without regard to the form or character of the transaction.  They also expand the circumstances in which two or more separate transactions must be aggregated under the transfer pricing rules and other provisions.

The IRS published two new International Practice Units (IPUs), which serves as both job aids and training materials on international issues for IRS employees.  They are titled “Inbound Liquidation of a Foreign Corporation into a US Corporate Shareholder”, which discusses certain transactions covered by Code sections 332, 367(b) and 368; and “Accounting for Intangibles and Services Associated with the Sale of Tangible Property – Outbound”, which includes discussions of “audit techniques for reviewing these types of tangible property transactions, as well as the valuation rules applicable to such transactions.”

IRS Revenue Procedure 2015-44 repeals a pilot IRS Appeals arbitration program established under Code section 7123(b)(2), under which a taxpayer and Appeals could jointly request binding arbitration on any issue unresolved at the conclusion of appeals procedures or unsuccessful attempts to enter into a closing agreement under Code section 7121 or a compromise under Code section 7122.  With only two cases settled during a 14-year period using arbitration, the IRS decided to eliminate the program noting the lack of demand for arbitration and its use as a tool to settle disputes without litigation as unsuccessful.

International – OECD/G20 Base Erosion and Profit Shifting (BEPS) project

The OECD will release the final package of measures for a coordinated international approach to reform the tax system under the OECD/G20 Base Erosion and Profit Shifting (BEPS) project on Monday, October 5, 2015.  The final BEPS package will be presented at the G20 Finance Ministers meeting on October 8th in Lima, Peru.  A discussion of the final BEPS package will be included in the November Washington Tax Insight publication.

Feature: Senate Finance Committee Report of the Individual Income Tax Working Group

The report of the SFC Individual Income Tax Working Group was released in early July by co-chairs Senator Chuck Grassley (R-IA), Senator Mike Enzi (R-WY) and Senator Deborah Stabenow (D-MI).  The jurisdiction of this Working Group was potentially broad but initially, the Working Group identified areas with the potential for reform and bipartisan consensus which included home ownership, charitable giving, higher education and tax administration.  The report concluded that only 3 of these areas provided the opportunity for bipartisan agreement with the topic of home ownership deferred.  The report does not make specific recommendations in the other three areas but rather suggests that the SFC explore reform options noting that all members of the Working Group do not agree with “any or all” of the recommendations discussed.   The issue of the treatment of pass-through entities was considered as those entities pay taxes at individual rates, but jurisdiction over the treatment of pass-through entities was given to the Business Income Working Group, while this Working Group had jurisdiction only over individual tax rates.

Individual Tax Reform

The report states that the following principles should guide reform of the individual tax system:

  • Reform should seek to make the tax code fairer
  • Reform should seek to reduce complexity for individual taxpayers
  • Reform should help ensure that the tax code provides an adequate source of revenue to fund national priorities but not more revenue than is needed for federal responsibilities

The report also comments, however, there are differing views about the following:

  • What constitutes a “fair” tax system
  • What level of revenue the US tax system should raise
  • How tax rates affect growth
  • The degree of progressivity tax reform should aim for
  • What broad structural changes should be made to the tax code

Pass-Through Entities

The report notes that ensuring that pass-through entities are treated fairly is an essential part of the tax reform process since tax reform is intended to lower corporate tax rates and eliminate tax benefits for businesses.  The report describes different options that could be considered for achieving equitable treatment including:

  • Changes to the individual statutory rates
  • Options to provide enhanced tax expenditures to certain businesses
  • A special rate or deduction applied to business income

The report states that Working Group members acknowledge the importance of pass-through entities— which make up more than 90 percent of all businesses in the US—but there is disagreement as to whether that can be done as part of business tax reform or also requires tax reform of the individual provisions of the tax code.

Charitable Giving

Although the report does not make specific recommendations, it does recommend the examination of proposals that would provide more certainty to taxpayers and increased funds to charities.  Reform options discussed include:

  • Permanent extensions of the exclusions from gross income for qualified charitable distributions from an IRA and expansion of the types of charities to which qualifying distributions can be made and/or increasing the annual dollar limit for such distributions above the current $100,000 limit
  • Permanent extension of the increased charitable percentage limits and extension of the carryforward period for qualified conservation contributions, and rules to ensure that conservation easements are properly valued and serve a legitimate conservation purpose.

Higher Education

Existing education tax benefits include the Hope Credit, the American Opportunity Credit (AOTC), the Lifetime Learning Credit, the tax deduction for tuition and fees, and beneficial treatment for Pell grants, scholarships, and fellowships.  The working group reviewed proposals intended to consolidate and simplify these benefits but did not make specific recommendations.  Proposals considered include:

  • Repeal of the Lifetime Learning Credit in favor of a permanent and expanded AOTC, or alternatively, combining the AOTC, Hope Credit, Lifetime Learning Credit and tuition and fees deduction into a single credit for all post-secondary education
  • Exclusions of all Pell grant amounts from taxable income without regard to the use of the proceeds (e.g., tuition and fees or room and board).

Tax Administration

The report recommends consideration of the following proposals:

  • Prevention of tax-related identity theft through changes such as extending the IRS’s authority to use truncated Social Security numbers on Form W-2; adding civil and criminal penalties targeted at identity theft; notifying taxpayers of suspected identity theft; providing a single point of contact for identify theft victims; and studying an expansion of the Identity Protection Personal Identification Number (IP PIN) system
  • Simplification and rationalization of tax return due dates, e.g., requiring pass-through entities to file in advance of their individual and corporate investors
  • Alignment of the filing due date for FBAR reporting with income tax filing due dates
  • Acceleration of the filing deadline for information returns related to employee remuneration

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Robert M. Gordon
Managing Director & Assistant General Counsel
Robert.Gordon@tpctax.com
312-235-3321

 

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