The Presidential and Congressional campaigns are in full gear with Congress scheduled to return to Washington on September 6th with a target adjournment date of October 7th to prepare for the November 8th elections. In an election year that has been unconventional, there is considerable uncertainty about what the political landscape in Washington will be post-election, not only with respect to the Presidential election but also control of the Senate and the political makeup of the House.
When Congress returns in September, their highest priority will be to address the appropriations bills needed to fund FY 2017 starting on October 1st. Since the House has passed only five spending bills and the Senate only three spending bills, a Continuing Resolution (CR) will of necessity be considered – with an open question about whether the CR will extend into 2017 or terminate prior to the end of 2016 for consideration in a lame duck session.
Other issues that may be considered in the fall include Zika funding, gun control, criminal justice overhaul and a floor vote on impeachment of IRS Commissioner Koskinen. Progress on comprehensive tax reform is unlikely with most of the focus in Washington in the area of tax policy centered on guidance from the Treasury and IRS and the ongoing discussion in Congress of the potential impact of the proposed Code section 385 regulations. Other open issues include energy legislation, defense authorization, the Trans Pacific Partnership and the Water Resources Development Act.
Democratic Presidential nominee Hillary Clinton has targeted corporate outsourcing as a focus of her campaign with plans to use revenue raised from targeted tax increases to offset the cost of several other policy proposals including education and infrastructure programs. She also released a new platform for small business that includes a standard deduction for smaller companies, similar to that allowed to individuals.
Republican Presidential nominee Donald Trump issued a revised tax reform plan that included cutting the top income tax rate to 33 percent (rather than 25 percent). He and his advisors have continued to focus on his tax plan to benefit pass-through business with a top rate of 15 percent, stating that rules will be included to ensure that the wealthy do not benefit from the rules especially by circumventing them to characterize wage and salary income as business income.
The European Union (EU) issued a decision that Apple Inc. must pay 13 billion euros ($14.5 billion) plus interest as a result of a deal between the company and the Ireland’s government that allowed Apple to underpay its Irish taxes between 2003 and 2014 in return for 5500 company jobs. Apple’s effective tax rate ranged from 1 percent in 2003 to 0.005 percent in 2014. Both Apple and Ireland – to whom the taxes would be paid – have stated that they will fight the decision in EU courts. This decision is part of the ongoing EU probe in state-aid cases, which has drawn opposition from the US Treasury based on a belief that US companies have been targeted in the investigations.
The OECD released a Discussion Draft covering approaches to address base erosion and profit shifting (BEPS) involving interest in the banking and insurance sectors under Action 4 (Limiting Base Erosion Involving Interest Deductions and Other Financial Payments) of the BEPS Action Plan. The report on Action 4, which was released in October 2015, established a common approach to tackling interest deductions, but highlighted a number of factors which suggested that a different approach may be needed to address risks posed by entities in the banking and insurance sectors. The Discussion Draft focuses on (1) the risks posed by banking and insurance groups to be addressed under Action 4; (2) approaches to address risks posed by banks and insurance companies; and (3) approaches to address risks posed by entities in a group with a bank or insurance company. Comments must be submitted by September 8, 2016.
The Joint Committee on Taxation (JCT) issued its annual report describing the revenue proposals in the President’s FY 2017 Budget. Earlier this year, the JCT issued its summary of revenue estimates on these tax proposals. The report includes four sections covering: (1) new revenue proposals; (2) revenue proposals that have been substantially modified from prior budgets; (3) modified proposals resulting from legislation enacted in 2015; and (4) a summary of proposals that were included in prior year budgets.
The Financial Accounting Standards Board (FASB) issued a proposed Accounting Standards Update (ASU) to enhance disclosure requirements on income taxes. The proposed ASU would modify existing disclosure requirements and provide additional disclosure requirements for income taxes. The modifications and additions include describing an enacted change in tax law, disaggregating certain income tax information between foreign and domestic operations, and explaining the circumstances that caused a change in assertion about the indefinite reinvestment of undistributed foreign earnings. The proposed ASU would also require disclosing the aggregate cash, cash equivalents, and marketable securities held by foreign subsidiaries.
Section 385 Regulations
Senate Finance Committee Chair Hatch (R-UT) and several Republican members of the Ways & Means Committee including Chair Brady (R-TX) sent letters to Treasury Secretary Lew discussing the “grave concerns” they have with the proposed Code section 385 regulations. The Ways & Means letter “continues the discussion” which began with a June 28th letter, citing the broad scope of the rules, and a July 6th meeting with Treasury to “highlight the ways the regulations as proposed would prevent American businesses from conducting basic, day-to-day operations and transactions.” The letter states that during the July 6th meeting, the Treasury Tax Policy team acknowledged several unintended consequences of the proposed regulations that will be corrected before they are finalized including the areas of cash pooling arrangements and the impact on S corporations and REITs. The letter also notes that there are multiple areas of concern that Treasury did not adequately address in the meeting including covering foreign-to-foreign transactions and the effect on transactions involving partnerships and disregarded entities.
Chair Hatch’s letter states that he is “concerned that the Treasury Department is moving at an unprecedented pace,” and that he is concerned that Treasury is “acting contrary to statutory and Executive Order requirements” including the Congressional Review Act. He requests that Treasury re-propose the rules to ensure that should Treasury issue regulations under Code section 385, “the Department does so in a thoughtful, prudent, and legal manner.”
The US Chamber of Commerce and the Texas Association of Business filed suit against the IRS and Treasury in the US District Court for the Western District of Texas with respect to the regulations issued April 4th targeting inversions. The suit alleges that the “multiple domestic entity acquisition rule” included in the regulations harms members of the plaintiffs, citing the abandoned proposed merger between Pfizer Inc. and Allergan Plc. The suit argues that the regulations violate the Administrative Procedure Act and constitute “arbitrary and capricious rulemaking” and that Treasury did not provide sufficient notice and opportunity for comment with respect to the regulations.
The IRS has revised a chief counsel notice (CC-2016-009) from June 30, 2016, stating that any case in exam or litigation raising an issue under Code section 385 requires review by an Associate Office (and therefore National Office review) or the Special Counsel to the National Taxpayer Advocate. The updated requirements also expand the review requirement to issues involving Code section 385(a) and (b) in addition to 385(c) covered under prior requirements.
2016-2017 Priority Guidance Plan from the Treasury and IRS
Treasury and the IRS issued their 2016-2017 Priority Guidance Plan, which includes 281 projects that the IRS expects to work on for the next year.
The plan includes several continuing projects affecting corporations and shareholders, including the finalization of proposed regulations under Code section 385 on earnings stripping and related party debt. Other projects cover: (1) regulations under section 302 and related provisions regarding unrecovered basis in shares of stock that are actually or treated as redeemed; (2) final regulations under sections 305(c) and 1441 regarding the amount and timing of, and the withholding obligations on, deemed distributions from conversion ratio adjustments on convertible debt and stock; (3) regulations under section 336(e) to revise the treatment of certain stock dispositions as asset sales; (4) final regulations under section 337(d) regarding certain transfers of C corporation property to real estate investment trusts and regulated investment companies; and (5) several projects under section 355.
The plan includes a number of projects in the partnership tax area including: (1) final regulations under Code section 1.337(d)-3 relating to partnership transactions involving a corporate partner’s stock or other equity interests; (2) final regulations under section 469(h)(2) concerning limited partners and material participation; (3) final regulations under section 732(f) regarding aggregation of basis for partnership distributions involving equity interests of a partner; (4) final regulations under sections 704, 707 and 721 on management fee waivers; (5) final regulations under sections 704, 734, 743, and 755 relating to the disallowance of certain partnership loss transfers and no reduction of basis in stock held by a partnership in a corporate partner; (6) regulations under section 707 relating to disguised sales of property and regulations under section 752 regarding a partner’s share of liabilities; (7) final regulations under section 752 regarding related person rules; and (8) final regulations under section 7704(d)(1)(E) regarding qualifying income for publicly traded partnerships.
The plan includes nearly 40 projects in the area of international tax rules covering Subpart F, inbound and outbound transactions, foreign tax credits, transfer pricing, sourcing and expense allocation, and treaties. Two new international projects are included described as: (1) Regulations under Code section 1256(g)(2) regarding the definition of a foreign currency contract, in light of the decision in Wright v. Commissioner, 809 F.3d 877 (6th Cir. 2016); and (2) Guidance regarding the procedures for US persons that are ultimate parent entities of multinational enterprise groups to voluntarily report certain information on a tax-jurisdiction-by-tax-jurisdiction basis for reporting periods beginning on or after January 1, 2016, and before the applicability of section 1.6038-4 (related to country-by-country regulations issued earlier this year).
Audit Regime Election Rules for Partnerships
The IRS issued temporary and proposed regulations that instruct partnerships on the time, form and manner for electing to be subject to the new audit regime enacted in the 2015 Bipartisan Budget Act (BBA). The new regime is applicable to partnerships with returns filed for tax years beginning after November 2, 2015 and before January 1, 2018. In Notice 2016-23, the IRS outlined additional partnership audit guidance that it expects to issue in the near future.
Under the rules, a partnership that elects to apply the new partnership audit regime to a partnership return filed for an eligible taxable year may not elect out of the new rules under the small partnership exception under Code section 6221(b) as added by the BBA with respect to that return. Once made, the election can only be revoked with the consent of the IRS. The rules do not permit early opt-in elections unless and until either an actual examination of a relevant partnership tax year (e.g. 2016 or 2017) starts or a refund request is filed for such a year in 2018 or thereafter.
Foreign Currency and QBUs
The IRS issued three new International Practice Units (IPUs) on issues covering foreign currency transactions under Code section 988 and Qualified Business Units (QBUs) under Code section 989. IPUs are written by the IRS’s Large Business and International (LB&I) Division and are intended to “serve as both job aids and training materials on international tax issues.”
The first IPU, “Overview of Qualified Business Units (QBUs),” describes QBUs as “subdivisions of taxpayers which separately compute their own income/loss, often in a currency that is different than that of its owner.” It includes instructions to auditors on requesting certain structural documents from taxpayers, giving extra scrutiny to “Other Comprehensive Income,” and separating foreign currency gains and losses to apply the correct tax treatment for each. The second IPU, “Character of Exchange Gain or Loss on Currency Transactions,” includes definitions of terms and issues in this area, including debt instruments, payables and receivables, financial instruments, and the disposition of nonfunctional currency. The third IPU, “Overview of IRC Section 988 Nonfunctional Currency Transactions,” covers these topics: (1) “Functional currency” (FC) and its application; (2) Definition of section 988 transactions; (3) Computation of foreign currency gain/loss under section 988 on receivables/payables denominated in a nonfunctional currency; and (4) Computation of foreign exchange gain/loss under section 988 on debt instruments denominated in a nonfunctional currency.
The IRS issued temporary and proposed regulations on the income inclusion rules under Code section 50(d)(5) that are “applicable to a lessee of investment credit property when a lessor of such property elects to treat the lessee as having acquired the property.” The IRS states that “In addition, these temporary regulations provide rules regarding income inclusion upon a lease termination, lease disposition by a lessee, or disposition of a partner’s or S corporation shareholder’s entire interest in a lessee partnership of S corporation outside of the recapture period. ” The rules coordinate with the basis adjustment rules under Code section 50(c) and require, in lieu of a basis adjustment, that a lessee must include the credit amount in gross income.
The IRS released final regulations relating to property transferred in connection with the performance of services with no changes to the proposed regulations issued in July of 2015. The final regulations affect certain taxpayers who receive property transferred in connection with the performance of services and make an election to include the value of substantially non-vested property in income in the year of transfer. They also remove the requirement in the existing regulations that a taxpayer submit a copy of a section 83(b) election with the taxpayer’s tax return for the year in which the property subject to the election was transferred.
The IRS issued proposed regulations under Code section 2704 to prevent the undervaluation of interests in corporations and partnerships when calculating estate, gift, and generation-skipping transfer taxes. The proposed regulations focus on certain lapsing rights and restrictions on liquidation in the valuation of transferred interests including: (1) what constitutes control of an LLC or other entity or arrangement that is not a corporation, partnership, or limited partnership; (2) deathbed transfers that result in the lapse of a liquidation right and clarification of the treatment of a transfer that results in the creation of an assignee interest; (3) changes to the definition of “applicable restriction” with respect to a comparison to the liquidation limitations of state law; and (4) new rules to address restrictions on the liquidation of an individual interest in an entity and the effect of insubstantial interests held by persons who are not members of the family.
The IRS has issued proposed regulations affecting insurer and employer information reporting of minimum essential coverage under the Affordable Care Act (ACA). Under Code section 6055, health insurers, certain employers and others that provide minimum essential coverage to individuals must report to the IRS the type and period of coverage. Similar statements are required to be furnished to covered individuals. The proposed regulations make a number of adjustments to these reporting rules, including changes affecting the reporting of catastrophic coverage, the reporting of basic health plan coverage, the use of truncated taxpayer information numbers (TINs), reporting for overlapping health plan coverage, and the rules for soliciting TIMs required to be reported for covered individuals on Forms 1095-B and 1095-C.
The IRS issued final regulations regarding the imposition of a user fee to apply for or renew a preparer tax identification number (PTIN). These regulations supersede and adopt the text of temporary regulations that reduced the user fee to apply for or renew a PTIN from $50 to $33.
The Security Summit, which is a partnership between the IRS, state tax agencies, and the tax community formed to combat identify theft, released Fact Sheet 2016-23 to expand its public awareness campaign on data security to include tax professionals. The fact sheet outlines critical steps necessary to protect taxpayer information and urges preparers to follow the security recommendations found in Publication 4557.
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Robert M. Gordon